Credibility Now The Issue For NAB

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This story features NATIONAL AUSTRALIA BANK LIMITED, and other companies.
For more info SHARE ANALYSIS: NAB
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

On Friday the National Australia Bank ((NAB)) took another $830m of provisions against US collateralised debt obligations held by its conduits. The move follows a further weakening of the US mortgage market, and raises important questions not only about NAB, but about every global bank. NAB has taken its provisions from about 10% of total CDO exposure in April to about 90% now. At the time of taking 10% into provision, management implied it was a conservative move. It doesn’t look very conservative now.

Bank analysts are not happy at all. This has come as a bolt from the blue, and the frustration for analysts is that given a lack of disclosure as to the specifics of the bank’s exposures the analysts can’t really make any judgment for themselves. They can but only rely on guidance, and given the extraordinary leap from 10% to 90% provision in one go on Friday, any guidance has now lost all credibility. It is this credibility that has served to divide fresh analyst ratings.

The problem is that NAB also has a portfolio of other US “collateralised obligations” worth another $4.5bn. Once again, analysts have not been made privy to the nature of these exposures, and on Friday NAB provided no update on their value. Will there be more write-downs to come? Analysts can only expect such as a safety measure and value accordingly.

FNArena has long warned that a bank’s “cheap” PE is dependent upon that E – which is an analyst estimation for the period ahead – not falling. Today all analysts reduced their FY08 forecast earnings (year-end September) by in excess of 10%. Reductions in FY09 earnings ranged from zero – in the expectation that FY08 will see the end of such write-downs – to in excess of 10% once more, in the expectation more is to come.

NAB otherwise announced that its dividend payout will not be affected, and that no capital raising will be required. This is a furphy, because in order to maintain its dividend NAB will have to enact an underwritten dividend reinvestment plan, and that’s just another form of capital raising. Following dilution to the capital base, the resulting dividend per share payout will be some 2% lower.

The Macquarie analysts are now kicking themselves as they had only just raised their rating on NAB to a sector Outperform based on what they thought was an oversold situation. They apologise, but given they can’t trust what NAB is telling them they have now moved straight to Underperform. There is no reason to own NAB right now, they suggest.

Merrill Lynch has focused on the risk of further write-downs to that other $4.5bn in deciding to take NAB from Neutral to Underweight. Citi, which already had a Sell, does not believe we’ve heard the end of it either. This was not a “scorched earth” write-down, the analysts suggest, and with more to likely follow the dividend remains at risk. JP Morgan’s Sell has been rusted on since the credit crisis began.

Among the three brokers retaining a Buy rating, both Deutsche Bank and GSJB Were have done so given the market’s share price reaction on Friday, although Weres can’t see any reason why the share price would rally as yet. ABN Amro has focused on NAB’s underlying business (outside of subprime hell) and decided it looks quite strong.

The average target price in the FNArena database has fallen from $31.63 to $29.65, on a range from $23.30 (JP Morgan) to $33.33 (Were).

The ramifications for the global banking sector cannot go unmentioned either. While NAB’s subprime exposure is unique among its local peers, the bank’s 90% write-down and its reason for doing so throw up the question of why other banks – US in particular – have not yet taken their write-downs to such extremes. There is a danger they soon will.

And just when you thought things couldn’t get any worse, ANZ Bank ((ANZ)) has joined the fun.

The biggest risk for Australian bank earnings in the current climate, apart from increased funding costs, is increased local loan losses stemming from higher interest rates and higher costs of everything else. JP Morgan had for so long been a lone voice in the wilderness in warning that analysts were underestimating the potential for a loan loss blow-out, but slowly others are beginning to see the light.

ANZ today has increased its provisions by $1.2bn – not for any subprime exposures, this is nothing to do with subprime or the US – but for possible loan losses locally.

After these latest developments, FNArena can only reiterate its longstanding warning about investing in Australian banks at present, but for a long term value view. If dividends can be held steady then yields provide for great value, but there is a still a risk that dividends may be cut, or capital raised, or both, and there is always a risk that another explosion in the US will send us down again. However, Australian banks have now shown they can do this all by themselves.

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