The current recovery in Australian business as the country emerges from lockdowns augurs well for National Australia Bank although interest margins could tighten further

-Further compression in net interest margins still likely in FY22
-NAB re-commits to a CET1 target range of 10.75-11.25%
-AUSTRAC investigation ongoing, contributing to uncertainty
 

An improved operating performance and balance sheet momentum has set National Australia Bank ((NAB)) apart during the recent bank reporting season. The main weakness was markets income, although peers were similarly affected.

Credit Suisse considers the bank's "simple" strategy is working well making it well-positioned for a rebound in the economy, while Jarden believes the current environment is the most favourable for business credit - the bank's strength - since the GFC.

Jarden is positive about the upside potential in business credit growth given business investment intentions are the highest in more than ten years. The broker is also encouraged about the skew in investment expenditure towards growth.

Business confidence has rebounded to pre-pandemic levels, boosted by low rates, readily available credit and government incentives.

FY21 cash earnings of $6.56bn were underpinned by a write-back of bad debts. The final $0.67 dividend reflected a pay-out ratio of 68% while the CET1 capital ratio was a healthy 13% in the second half.

Citi believes the bank has established the best core earnings outlook across the sector. Interest margins appear more resilient compared with peers while there is momentum in the mortgage and business lending books.

Furthermore, costs continue to be well-managed. The broker compares this with peers which have been unable to achieve success across revenue and cost lines simultaneously.

As NAB is the largest in terms of business banking, Goldman Sachs suggests it will benefit more from the continued economic recovery. The weakest point was markets and treasury income which the broker notes was well below the typical run-rates in the second half.

The bank has signalled that volatility has increased recently so opportunities should emerge in that segment. Markets income was soft but no worse than peers, Ord Minnett asserts, and anticipates increased volatility should mean improvement is forthcoming.

Margins

The main issue, Jarden suggests, is how much further net interest margins can fall. The drag from lower lending margins has been offset by lower funding costs and deposit rates, yet further compression is expected amid competition and low interest rates.

Net interest margins were flat to end FY21, ex the impact of markets and treasury, and are likely to remain so, the bank points out, in the low interest rate environment in prospect for FY22. Competitive pressures are expected to continue affecting house lending margins.

Still, Morgan Stanley is now more confident loans can expand at an improving rate to reflect the better environment and assumes Australian housing and non-housing loan growth of 5.5% and 6%, respectively.

The broker calculates a margin decline in the fourth quarter of FY21 of up to -10 basis points, largely stemming from higher liquid assets and lower treasury income. The margin is expected to decline to1.64% in FY22 while net interest income increases by 3.5%.

Valuation

Going forward, demonstrable returns on equity are critical to drive the share price, Citi asserts, anticipating earnings growth of 8% in FY22. Nevertheless, the broker believes the stock is fully priced and already allows for stronger future growth.

Credit Suisse agrees the valuation appropriately captures the bank's relative positioning, noting the mortgage market is holding up well while the business bank remains the highlight. Non-housing lending annualised 12% in the second half.

Macquarie considers the stock no longer relatively cheap compared with peers, although the improved franchise performance deserves a premium. Revenue growth is expected to be underpinned by better markets income and an improving outlook for rates.

Management remains committed to expense targets, yet the broker does highlight the risk that some catching up may be required in terms of disclosure compared with its peers, or the latter will appear to have more scope in reducing expenses.

Ord Minnett notes NAB also has the strongest capital position, with a return on equity profile that is second only to Commonwealth Bank ((CBA)), and yet trails by -6 PE (price/earnings ratio) points.

Management has recommitted to a CET1 target range of 10.75-11.25% despite impending capital changes. Macquarie considers excess capital provides scope for a return to shareholders while Morgan Stanley assumes buybacks totalling $7bn occur out to FY24, although this will still mean the share count is around 7.5% above FY19 levels.

AUSTRAC

The AUSTRAC investigation is ongoing and Jarden notes this contributes some uncertainty to the outlook, particularly in the form of any fines and/or higher compliance-related costs going forward.

Morgans agrees the investigation is an overhang although, because of the highly contingent nature of the issues, does not include a penalty in any forecasts. Macquarie notes there is still a provision of $1.19bn for remediation in the bank's accounts, with 82% relating to customer payments. Major remediation is expected to be completed in 2022.

Among the stockbrokers that are not monitored daily on the FNArena database, Jarden reiterates an Overweight rating with a $31.00 target while Goldman Sachs has a Buy rating and $31.15 target.

The database has two Buy ratings and four Hold. The consensus target is $29.47, signalling -2.1% downside to the last share price. The dividend yield on FY22 and FY23 forecasts is 4.6% and 5.0%, respectively.

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