National Australia Bank

Transcription

1 AUSTRALIA NAB AU Price (at 04:00, 17 Jun 2015 GMT) Outperform A$33.37 Valuation A$ - DCF (WACC 9.6%, beta 1.0, ERP 5.0%, RFR 5.8%) month target A$ month TSR % Volatility Index Low GICS sector Banks Market cap A$m 87, day avg turnover A$m Number shares on issue m 2,615 Investment fundamentals Year end 30 Sep 2014A 2015E 2016E 2017E Net interest Inc m 13,775 14,410 15,413 16,272 Non interest Inc m 5,138 5,309 5,480 5,660 Underlying profit m 8,733 10,792 11,538 12,436 Reported profit m 5,295 6,977 7,465 8,070 Adjusted profit m 5,184 6,748 7,247 7,852 EPS adj EPS adj growth % PER adj x PER rel x Total DPS Total div yield % Franking % ROA % ROE % Equity to assets % P/BV x NAB AU vs ASX 100, & rec history Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, June 2015 (all figures in AUD unless noted) 18 June 2015 Macquarie Securities (Australia) Limited Inflection Point Event The NAB thesis centres on 3 areas. Recent changes provide further upside if things turn out better than expected (conduct charges, life/mlc). Secondly, there is upside from the business banking turnaround, which will take time. Finally, we note the renewed shareholder value focus which is set to improve returns in other areas of the bank (e.g. retail, IT). As a result, we resume coverage with an Outperform and $38.02 price target. With a sector leading yield, capital ratio and FY16 earnings inflection point, NAB becomes our top pick. Impact Further upside from UK conduct and MLC - The recently announced changes at NAB (capital raising, demerger of the UK, reinsurance at MLC) are now well and truly reflected in the NAB share price. However, looking forward there are potential sources of upside. Whilst there is no guarantee, there is a chance NAB won't need to use all the reserving set aside for conduct (84bp capital). Likewise, the reinsurance of MLC may well be the start of a longer term solution around the life book of NAB which could release ~72bp of capital. Both of these provide room for further growth. Business bank turnaround in train but will take time - As highlighted in our note " - Back in Business", 14/01/15 we believed that NAB needed to hire more frontline bankers. The bank continues this process at pace. However, as highlighted in our note, the turnaround will take time with the upside of c$300m most likely a 2016/17 prize. Shareholder focus restored at NAB, which will be good for shareholders (and the sector) - The final part of the thesis is the evidence pointing towards a greater level of pragmatic and rational behaviour at the bank. As we had pointed out in our note " - Back in Business", 14/01/15, we believe that NAB's discount pricing strategy in mortgages hadn't added to shareholder value with market share gains largely offset by cuts in fees and margin erosion. The reversal of this strategy with the most recent mortgage repricing (+1.3% cash earnings upside) is an indication of something broader emerging at the bank. Clearly the new management team is giving greater consideration to the creation of longer term shareholder value which is positive for NAB and the sector in general. Earnings and target price revision Following the 1H15 result as well as announced changes, we upgrade our FY15 cash earnings by 4%, FY16 cash earnings by 1% and our target price moves to $ Price catalyst 12-month price target: A$38.02 based on a DDM/PE methodology. Catalyst: 3Q15 Trading update August. Action and recommendation We resume coverage with an Outperform recommendation. With a sector leading yield, capital ratio and FY16 earnings inflection point, NAB becomes our top pick. Please refer to page 17 for important disclosures and analyst certification, or on our website

2 Analysis The NAB thesis centres on 3 areas. Recent changes announced (conduct charges/ MLC) provide further upside if plans made turn out better than expected. The second leg of the thesis depends on the business banking turnaround, which will still take time. The final leg to the thesis centres on a newfound shareholder value focus which is set to improve returns in other areas of the bank (e.g. retail, IT). We discuss each of these in further detail below. Further upside from UK conduct and MLC The recently announced changes at NAB (capital raising, demerger of the UK, reinsurance at MLC) are now well and truly reflected in the NAB share price. Looking forward there are potential sources of upside. Release of UK conduct reserve - Whilst there is no guarantee, there is a chance the bank won't need to use all the reserving set aside for conduct (84bp capital). Sale of MLC Life Likewise, the reinsurance of MLC may well be the start of a longer term solution around the life book of NAB which could release 72bp of capital. Both of these provide room for further growth. We discuss these sources of upside in further detail below. Potential capital release if reserving set aside for conduct is not needed As part of the proposed Clydesdale de-merger, NAB has set aside 1.7bn (~AU$3.3bn) to provide capital support for any further conduct provisions. This figure is capped and was reached in agreement with the UK Prudential Regulation Authority (PRA). The capital support of 1.7bn is to be deducted from NAB CET1 at separation and equates to c84bps of CET1. In addition to the 1.7bn severe stress test cap, NAB currently has a 726m provision remaining related to UK conduct charges. It is worth noting that the 1.7bn will only be utilized once the 726m provision has been fully utilized. The chart below details the utilized vs. remaining provision currently. Fig 1 In addition to the 1.7bn capital support, NAB has 726m in un-utilized UK conduct provisions at 1H15 Source: NAB, June 2015 Per NAB as at 2H14, Clydesdale had a PPI utilization rate of 36% and a 39% utilization rate for interest rate hedging products. The tables below compares Clydesdale s utilization rates to peers. 18 June

3 Fig 2 PPI provision utilization rate % (as at 2H14) Fig 3 Interest Rate Hedging products provision utilization % (as at 2H14) Source: NAB, June 2015 Source: NAB, June 2015 Another measure which could indicate a potential utilization rate is data from the UK Financial Ombudsman (available for PPI claims only) comparing the % of cases resolved in favour of the consumer vs. peers. The UK Ombudsman also discloses the number of new cases for the previous 6 months. Clydesdale has an average resolution rate of 58% vs. peers at 57%. Fig 4 Clydesdale PPI resolution vs. peers Business Name PPI - % of cases resolved in PPI - Number of new cases favour of the consumer (6 months to Dec ) Lloyds Bank PLC 82% 20,145 Aviva Insurance Limited 77% 770 Barclays Bank Plc 68% 15,768 MBNA Limited 68% 3,982 HSBC Bank plc 61% 8,648 Capital One (Europe) plc 60% 6,289 Financial Insurance Company Limited 60% 3,176 Clydesdale Bank Plc 58% 2,131 Bank of Scotland Plc 54% 15,732 National Westminster Bank Plc 50% 3,216 The Co-operative Bank Plc 48% 792 The Royal Bank of Scotland Plc 46% 3,642 Santander UK Plc 44% 3,575 Tesco Personal Finance PLC 43% 893 Allianz Insurance Plc 39% 736 Marks & Spencer Financial Services plc 34% 625 Canada Square Operations Limited 25% 1,669 Yorkshire Building Society 7% 652 Nationwide Building Society 5% 3,025 Average across all institutions 57% Source: UK Ombudsman, June 2015 It is worth noting that the 1.7bn represents a severe stress scenario, which NAB has stated is far higher than NAB and Listco s conduct stress scenarios, specifically on: PPI severe stress scenario includes the potential for higher levels of walk-in complaints and potential outcome of the past business review which considered all sales since IRHP/FRTBL severe stress scenario includes potential for additional claims for redress sales of out-of-scope products At their 1H15 result, NAB noted that actual losses lower than 1.7bn should result in a capital release to the group over time. Every 200m of capital not utilized represents c10bps of CET1. Another potential source of upside is also the sale of the MLC Life. We discuss the upside in further detail below. 18 June

4 Upside from sale of MLC Life At the 1H15 result, NAB announced a reinsurance transaction with a major reinsurer that released ~$500m (13bps) of CET1 capital to the Group, resulting in a reduction in cash earnings of approximately $25m pa, implying a P/E of ~20x. Additionally, NAB estimates the capital released represents approximately 15% of NAB Wealth s life insurance embedded value, implying an EV for the entire life business of ~$3.3bn. The pricing of the deal implies that going forward NAB s experience losses will normalise to near zero from ~$33m in the last three periods, which suggests this was a good deal for NAB. Fig 5 Upside remains should NAB complete additional reinsurance transactions CET1 (bps) CET1 ($m) Earnings ($m) Implied P/E (x) Announced Reinsurance transaction Gross up (@15%) 85 3, Remaining 72 2, Source: Company data, Macquarie Research, June 2015 Whilst entering into additional reinsurance arrangements would benefit the Group, it would appear the preferred option is to dispose of the Life business altogether. A recent AFR report suggested that NAB had received an offer north of $2.5bn from Nippon Life, although there does appear to still be a shortfall from NAB s internal embedded value calculation. Should NAB receive their internal valuation for the Life Company they would see their capital increase by 85bps; however, given the recent reinsurance deal reached, it would seem likely any transaction would be completed at a discount to EV of ~20%. Fig 6 NAB s group CET1 ratio could be boosted by bps depending on the price received for the Life Company P/EV 0.6x 0.7x 0.8x 0.9x 1.0x EV Gain/loss on sale CET1 benefit Source: Company data, Macquarie Research, June 2015 Business bank turnaround to take time though As highlighted in our note " - Back in Business", 14/01/15 we believe NAB needs to hire more frontline bankers. The bank continues this process at pace with 150 new hires announced in 1H15. However, as highlighted in our note and by management, the turnaround will take time with the upside of c$300m most likely a 2016/17 prize. In order to restore the business franchises status as the undisputed market leader, we believe management will have to implement the following: Hiring additional frontline business bankers (150 hired so far with more expected in 2H15); Increasing capex/reinvestment in the business bank; Working out ways of normalising retail fees perhaps by offering customers additional value added products and services; and A normalisation of the business banking margin (in train and in our numbers). We now assess the likely financial impact and timing of the proposed solutions. Hiring additional frontline business bankers and look to retain existing bankers At their 1H15 result, NAB announced they had hired 150 new additional frontline bankers with plans to hire a further 70 bankers in 2H15. Given the amount of business bankers that have left the franchise in recent years, in our view NAB would have to hire closer to 400 business bankers (250 more post 1H15). In the scenario below, we assume that NAB is able to hire the required bankers by the end of This in turn would generate $709m of additional revenue as at 2H17. This assumes annual revenue of $1.1m per business banker with half of this delivered in the period after hiring and the balance being obtained one year after being hired. 18 June

5 The additional staff would bring about just above $190m of increased salary expenses over the same period (using NAB s historical business bank disclosures, we have estimated a $220k annual salary per business banker). Of course the cost would be incurred before the revenue uptick which could be hard for the market to swallow. The other option for NAB is to try and utilize the broker market more which could variabilize the cost base although this obviously comes with a lower quality (and disintermediated) cost base. Fig 7 Estimated impact from the addition of 250 new bankers up to 2H17 2H15 1H16 2H16 1H17 2H17 Total Bankers hired Revenue Generated ($m) Salary expense increase Source: Macquarie Research, June 2015 Increasing capex/reinvestment in the business bank An additional ca$150m required We think that NAB needs to direct any additional investment spend towards the NextGen business banking platform and other customer centric tools, which would likely drive future growth in the business bank. Fig 8 Investment initiatives announced by NAB at the FY14 result Fig 9 making progress on those initiatives in 1H15 Source: Company Data, Macquarie Research, June 2015 Source: Company Data, Macquarie Research, June 2015 We factored in ~$129m of additional costs from 2H15 to 2H17 assuming $25m of additional costs in 2H15, then 2% annualised cost growth in FY16 and FY17. We note that much of this increased investment spending is likely to be from the utilization of productivity benefits NAB is likely to receive, however, given this would have been a cost saving if not reinvested and should result in future benefits for NAB, we are of the view that it is prudent to classify these as additional costs. Fig 10 Additional costs arising from reinvestment in the business bank 2H15 1H16 2H16 1H17 2H17 Total Additional Costs ($m) Source: Macquarie Research, June June

6 This additional investment would likely lead to future revenue benefits and based on the same assumptions highlighted above (50c of revenue in perpetuity for each $1 of growth capex), NAB could see ~$270m of revenue generated between now and 2H17 if reinvested productively. Fig 11 Potential future revenue generated from reinvesting in the business bank 2H15 1H16 2H16 1H17 2H17 Total Revenue Benefit ($m) Source: Macquarie Research, June 2015 Fully normalise the business banking margin to claw back market share losses Recently, NAB has sought to arrest the slide in their market share of business loans, with their share remaining at ~23% since March Not surprisingly, this has led to some margin contraction in the business bank. Whilst this confirms that normalisation of the business banking margin has commenced, we still think there are some segments where NAB is out of the market, suggesting that there may be additional margin contraction to come. Our current estimates for NAB s Group NIM is for 2bps of margin contraction in FY15 and a benefit to NIM in FY16 from the increase in free funds post capital raise. These are broadly in line with consensus estimates. As highlighted in - Once and Done, we expect margin contraction in the business bank (24bps through to the end of FY16). Fig 12 The expectation is for NAB to experience margin compression in FY15 but expansion in FY16 FY14A FY15E FY16E Consensus Net Interest Income 13,775 14,438 14,607 Total Assets 883, , ,910 Implied Interest Earning Assets 711, , ,768 Consensus NAB Group NIM 1.94% 1.92% 1.90% Macquarie NAB Group NIM 1.92% 1.94% Macquarie NAB Aus. Bank Business NIM 2.21% 2.04% 1.97% Source: FactSet, Macquarie Research, June 2015 We believe NAB can close much of the A$ b revenue gap although it will cost money upfront and has some execution risk In return for the investment outlined above, we believe NAB can close a vast majority of the earnings gap. The only issue remains that investors will need to wear the initial investment (A$350m cumulative to 2H17) before the revenue upside comes through over the course of the next 1-2 years. All of this might be made a little easier if NAB was able to find a way of restoring lost retail banking fees, which would provide some investment breathing space for the business bank. Fig 13 NAB could reinstate over $400m pa of revenue from FY17 $m 2H15 1H16 2H16 1H17 2H17 Total Costs Salary expense from hiring new staff Investment spend from reinvestment Foregone revenue from lost mkt share Benefits Revenue generated from new staff Benefit from growth capex Retail fee income recovered Net PPOP generated from initiatives Net Cash profit Cumulative Cash Profit % of forecast earnings -0.4% 1.9% 2.8% 3.9% 4.4% Source: Macquarie Research, June June

7 As demonstrated in the table above, NAB could close the majority of the revenue gap by the end of FY17, with ~$420m of annual revenue being generated from these new initiatives. This would add ~$300m annually to cash earnings or ~4% from FY17. Fig 14 Revenue and earnings trajectory should NAB effectively execute on the various business bank initiatives $m H15 1H16 2H16 1H17 2H17 Revenue Cash Profit Source: Macquarie Research, June 2015 The above initiatives do of course come with an associated level of execution risk (inability to hire staff, the economic cycle turns or investment is not productively utilized); however, given NAB s decisive streak since their new CEO has taken over and their clear intentions to refocus their energy back on their domestic franchise, we are optimistic the new management team can restore the strength the business bank once possessed. Shareholder focus restored at NAB which will be good for shareholders (and the sector) The final element of the thesis is the evidence pointing towards a greater level of pragmatic and rational behaviour at the bank with the most recent mortgage repricing as an indication of something broader emerging at the bank. Other examples of the renewed focus on longer term shareholder value includes repricing of high rate UBank deposits, the restructuring of the NextGen rollout as well as NAB s change in strategy in New Zealand. Clearly the new management team is giving greater consideration to creation of longer term shareholder value which is a pleasant occurrence for NAB and the sector in general. We discuss below. Discount pricing strategy on the break-up campaign did not add customer value Due to the impact the break-up campaign had on the retail divisions, NAB s other businesses were expected to fill the revenue gap or at least not worsen the problem, which was done through managing the margin. This however resulted in below system growth that is still being seen today. 18 June

8 Fig 15 Between 1H11 and 2H13 NAB s Business Banking margin was the most resilient vs peers... Fig 16...however, this translated to below system growth, with the flow on effects still being seen today 0.00% -0.05% -0.10% 30% 25% 20% -0.15% 15% -0.20% 10% -0.25% -0.30% -0.35% Business Division NIM delta (1H11-2H13) ANZ CBA NAB 5% 0% 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 NAB Cumulative Business Credit Growth System Cumulative Business Credit Growth Source: Company Data, Macquarie Research, June 2015 Note: System data includes institutional banking divisions Source: APRA, Macquarie Research, June 2015 As a result, we estimate the total foregone revenue from NAB s business bank since 1H12 to be ~$1.3bn (or $440m p.a.). To arrive at this figure we have assumed NAB s business credit growth was in-line with that of system growth and when NAB s margin was holding up we have applied the average margin contraction of peers to NAB. Fig 17 Assuming system growth and margin compression in line with peers NAB s business bank has foregone ~$1.3bn of revenue since 1H12 $m 3,400 3,300 3,200 3,100 3,000 2,900 2,800 2,700 2,600 2,500 Cumulative foregone revenue ~$1.3bn since 1H12; $440 p.a. 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 NIM 2.70% 2.60% 2.50% 2.40% 2.30% 2.20% 2.10% 2.00% Operating Income Foregone Revenue Actual NIM Revised NIM Source: Company Data, Macquarie Research, June 2015 Upside from retail fee adjustments around A$24m cumulative As we discussed in our note " - Back in Business", 14/01/15, we believe that NAB's discount pricing strategy in mortgages hadn't added to shareholder value with market share gains largely offset by cuts in fees and margin erosion. NAB has foregone ~$180bn annually in retail fee revenue since the launch of the break-up campaign in To date, this has translated to a ~70bps increase in their share of the mortgage market. Assuming NAB would sacrifice ~25% of their market share gains, but recover the same proportion of their lost retail fees, we estimate NAB would see revenue in the retail bank increase by ~$9m p.a. 18 June

9 Fig 18 We estimate NAB would receive an additional $24m of revenue through to 2H17 by normalising retail fees, which equates to ~$9m p.a. 2H15 1H16 2H16 1H17 2H17 Total Market share losses (bps) Reduction in Mortgages ($b) Lost NII ($m) Recovered Non-NII ($m) Net revenue benefit ($m) Source: Macquarie Research, June 2015 Doing this would provide NAB with some breathing space to compete in business banking. The bank might look to negotiate this sort of strategy not as a clawback of the break-up campaign but rather as an extension of the value for money strategy, perhaps via: A clear expression to customers of the value that they have received from NAB over comparable products at other major banks, thanking them for their support and asking if there are other needs that NAB retail could help with; Considering other value adding products could be launched to leverage the newly acquired customer base as well as the existing business banking driven customer base; and Considering charging for behaviours which reduce value (such as low level depositors which still get access to bonus rates, high offset customers who get competitive mortgage rates). Recent mortgage repricing seen as a reversal of this strategy and a more rational focus on creating longer term shareholder value The first example of the shift in strategy at NAB is the recent mortgage repricing undertaken. In line with the May rate cut (-25bp to 2.00% cash rate) NAB took the opportunity to reprice mortgages, only cutting their SVR by 20bps. We estimate that by holding back 5bps on the SVR, NAB will be able to uplift earnings by 1.3%.This will provide NAB with an earnings advantage over ANZ and WBC who did not take the opportunity to reprice as much. Fig 19 Potential earnings uplift of 1.3% from mortgage repricing Australian mortgages ($m) Repricing (bps) Additional Earnings FY15 cash earnings Earnings uplift ANZ 217, , % CBA 370, , % NAB 258, , % WBC 362, , % Source: Company data, Macquarie Research, June 2015 Further rate cuts could provide NAB with an opportunity to further reprice. Our economics team currently forecasts an additional 25bps cash rate cut in 4Q15. Deposit metrics are also indicating a more rational approach towards retail banking Since 2H13, NAB s deposit growth has been driven by transaction accounts, partially offset by modest declines in term deposits. As a result, NAB s deposit NII has benefitted from this approach. Given deposit OOI has declined, NAB s low fee strategy is apparent; however, with annualised deposit income growth from 2H13 of ~9% this has been the correct approach. 18 June

10 Fig 20 NAB have been increasing deposits through transaction accounts... Fig 21...which has given deposit income a boost $b % annualised deposit income growth rate since 2H H13 1H14 2H14 1H15 Source: NAB, Macquarie Research, June 2015 Source: Company data, Macquarie Research, June 2015 NII OOI During the same period, NAB has been repricing their higher rate UBank deposits. At the beginning of 2012, the average UBank term deposit rate was ~100bps above the peer average. That spread is currently 33bps, suggesting there could still be some additional upside from repricing. Fig 22 UBank deposits have been repriced by ~70bps since Jan Fig 23...which has led to a slowdown in deposit growth % Jan-12 3-Jan-13 3-Jan-14 3-Jan-15 Ubank TD rate vs peer average NAB TD rate vs peer average UBank TD's are still ~33bps above the peer average Source: Canstar, Macquarie Research, June 2015 Source: NAB, Macquarie Research, June 2015 A further 33bps of repricing, could boost earnings by ~$40m pa, or 0.6%. Whilst this could result in continued pressure on UBank deposit balances, the recent growth in transaction account balances has not yet started to normalise and would likely offset any lost deposit balances in the near term. Fig 24 Repricing UBank deposits to peer average could boost Group earnings by 0.6% UBank deposits ($bn) 16.8 Earnings from repricing ($m) 38.8 Earnings upside 0.6% Source: Company data, Macquarie Research, June June

11 Tech roll-out More rational approach to roll-out likely to benefit retail While NAB s former management had an ambitious NextGen rollout program, current management realised they needed to prioritise and focus on certain delivery streams. We think this is the correct strategy and will allow NAB to deliver shareholder value. Fig 25 Management highlighted a shift in strategy on NextGen at 2H14 Source: NAB, Macquarie Research, June 2015 One of the NextGen streams that management has prioritised is the Personal Banking Origination Platform. This is expected to be rolled out in 2H15 and will allow NAB to process personal banking applications faster as well as reduce the need for physical documentation. Fig 26 Personal banking origination platform implementation should assist with refocus on retail Source: NAB, Macquarie Research, June June

12 NAB trying to take a more long term approach to NZ NAB recently held an investor day in NZ and highlighted the change in strategy at their New Zealand business, BNZ particularly on the retail side of the business. New Zealand currently represents 11% of group NPAT and BNZ thinks their current retail market share (16% market share in housing lending) is below what it naturally should be. To try and address their underpenetration in retail, BNZ is focused on addressing three areas; Auckland, Broker and Digital. We discuss this strategy in further detail below BNZ is under-penetrated in Auckland BNZ s retail main bank share is 9% in Auckland (compared to 12% nationally) driven by an underweight position in Auckland housing. Auckland currently accounts for 35% of NZ GDP and is forecast to grow at 5% p.a over the next 3 years. To grow their market share in Auckland, BNZ is investing in mobile bankers and has hired 50 new frontline bankers with 50 more to hire. Re-entering Broker channel BNZ re-entered the broker channel on May 18 after a 12-yr absence. They have partnered with NZ Financial Services Group (largest broker in NZ with c50% of broker flow in Auckland). They will launch with 100 brokers initially with the aim to lift to 450 in first 12mths. BNZ noted that the broker channel reduces the lending margin by 30bps but that they still see a strong housing RoE. Fig 27 NAB is under-represented in the Auckland market vs. peers Fig 28 BNZ has just re-entered the NZ broker market % Auckland Housing 44% 43% 42% 41% 40% 39% $bn % 35% 30% 25% 20% 15% 38% 26% 22% 38% 5 10% 37% ANZ NAB WBC Auckland housing lending ($bn) (RHS) Auckland % of total housing - 5% 0% 1% ANZ BNZ WBC System Note: CBA do not disclose % of lending that is attributable to Auckland Source: Company Data, Macquarie Research, June 2015 Source: Company Data, Macquarie Research, June 2015 Digital Investing in their digital capabilities and have 132 digital focused FTEs. BNZ were the first to launch a digital wallet in NZ (launched in March 2015). They are currently migrating all customers to YouMoney to grow retail presence. BNZ highlighted that they are the only bank that has bio-metrics recognition (have 200k customers registered). NAB is also well placed to benefit from any RBNZ regulatory change vs. peers with RBNZ investor mortgage risk weight changes likely to have a minimal impact to Group CET1. BNZ has an average mortgage risk weight of 32% vs. ANZ at 24% and ASB at 28%. BNZ also noted that 10.5% of their portfolio is above 80% LVR (vs. peers at 14-18%). BNZ also noted they use a serviceability buffer of 7.6%. 18 June

13 Fig 29 NAB has the highest mortgage risk weight vs. peers Fig 30 NAB has the lowest proportion of >80% LVR mortgages vs. peers Mortgage Risk weight % 33% 31% 29% 27% 25% 23% 21% 19% 17% 15% ANZ CBA NAB Note: WBC mortgage risk weight not disclosed Source: Company Data, Macquarie Research, June 2015 Source: Company Data, Macquarie Research, June 2015 Overall, we think there are several opportunities for NAB to focus on returning shareholder value, most notably around mortgage and deposit repricing as well as prioritising their IT rollout and changing their NZ strategy. Investment View The recently announced changes at NAB (capital raising, demerger of the UK, reinsurance at MLC) are now well and truly reflected in the NAB share price. Similar to the other majors, we believe that the market overcorrected for NAB post the Wayne Byres speech on 29 April (see our notes Australian Banks - Byres Beats Basel on Capital Blow and Australian Banks - May Madness). In our view, the sector would require $ b of additional capital to offset an increase to average mortgage risk weights of 25-30%, with $ b of market overreaction in the month following Byres speech. Fig 31 The market priced in a more than worst case capital scenario for the majors 0.0% -1.0% -2.0% -3.0% -4.0% -5.0% -6.0% -7.0% -8.0% -9.0% $ b market overreaction on $ b market overreaction on risk weights ANZ CBA NAB WBC Relative performance Impact from Byres' Speech Additional capital (30%) / Mkt cap $ b market overreaction on risk weights Additional capital (25%) / Mkt cap $ b market overreaction on risk weights Source: Company data, FactSet, Macquarie Research, June 2015 The NAB thesis centres on 3 pillars. Recent changes announced provide further upside if plans made turn out better than expected (conduct charges, life/mlc). The second thesis leg depends on the business banking turnaround which will still take time. The final leg to the thesis centres on a newfound shareholder value focus which is set to improve returns in other areas of the bank (e.g. retail, IT). As a result, we resume coverage with an Outperform and $38.02 price target. With a sector leading yield, capital ratio and FY16 earnings inflection point, NAB becomes our top pick. 18 June

14 Fig 32 FY16 metrics show NAB moving ahead of peers... Fig 33...with EPS growth hitting a point of inflection in 2H16 post capital raise and GWB removal ANZ CBA NAB WBC Cash NPAT growth 3.0% 4.2% 7.4% 4.4% Dividend Yield 5.6% 5.4% 6.0% 5.9% CET1 ratio (2H15) 8.6% 9.3% 10.1% 9.3% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% -4.0% EPS Inflection Point for NAB in 2H16 ANZ CBA NAB WBC 2H15 1H16 2H16 1H17 2H17 Source: Company data, Macquarie Research, June 2015 Source: Company data, Macquarie Research, June 2015 We have made the following changes to our earnings: Capital raising On a 1H15 pro-forma basis, the capital raise results in cash EPS dilution of 4.5%. The dilution is spread over FY15 and FY16 given the timing of the raise and the use of average shares to determine diluted EPS. 1H15 result NAB s 1H15 result was a 3.3% beat vs. our estimates due to better than expected operating income while expenses were in line with expectations. Sell-down of GWB The exclusion of GWB post 2H15 reduces assets by c$9bn and results in a reduction of cash earnings by cus$108m (1H15 cash earnings of US$54m). Life reinsurance transaction reduces NAB Wealth earnings by c$25m p.a. NIM We estimate the 2H15 margin is positively impacted (+1bps HoH) by the additional earnings on free funds. CET1 Positive impact from rights issue (c140bps), GWB sale (30bps), Life reinsurance (13bps) as well as cash earnings generation partially offset by UK conduct provision (c84bps), conglomerates ruling (FY15 impact of 19bps) as well as RWA growth. Fig 34 Earnings changes FY15 FY16 FY17 Cash NPAT Old 6,485 7,162 7,778 New 6,748 7,247 7,852 % Change 4.1% 1.2% 1.0% Cash EPS Old New % Change 2.4% -5.2% -4.6% Dividend Old New % Change -0.5% -0.5% -2.4% Source: Macquarie Research, June 2015 While the above Cash EPS growth in FY16 may not seem like much at 0.4% YoY it is skewed by the impact of the capital raise as well as the sale of GWB. Below we show a pro-forma cash EPS figure adjusting for the impact of the capital raise as well as for the remainder of the sale of GWB. Cash EPS adjusting for these items is much stronger at 6.2% in FY16 and 7.4% in FY17. Fig 35 Pro-forma Cash EPS (adj for capital raise & GWB) shows solid FY16 & FY17 growth FY15 FY16 FY17 Pro-forma Cash EPS EPS Growth % 6.2% 7.4% Source: Macquarie Research, June June

15 Fig 36 NAB Financial Summary Year Ending 30 September H14 2H H15 2H Outperform PER SHARE DATA Cash EPS (AUD) - Macquarie Basis Current Price Target Price Cash EPS Growth (%) 5% 3% -35% -14% 60% -2% 25% 0% 7% A$33.35 $38.02 DPS (AUD) Total Shareholder Return 19.9% BVPS (AUD) NTA PS (AUD) Bloomberg: NAB AU Shares on issue (m) 2,349 2,354 2,366 2,366 2,421 2,625 2,625 2,647 2,668 Reuters: NAB.AX VALUATION METRICS Macquarie Equities Australian Banks P/E (Cash) Analyst(s) Contact(s) P/B (Stated) Michael Wiblin P/NTA Anita Stanley RoE (%) 12.2% 13.6% 8.6% 11.1% 13.7% 12.9% 13.3% 12.5% 12.8% Brendan Carrig RoA (%) 0.7% 0.7% 0.5% 0.6% 0.7% 0.7% 0.7% 0.7% 0.8% Dividend Yield (%) 5.7% 3.0% 3.0% 5.9% 3.0% 3.0% 5.9% 5.9% 6.0% Margins & Volumes Dividend Payout (%) 75.8% 75.4% 116.3% 91.5% 72.7% 74.0% 73.4% 73.2% 69.2% Net Interest Margin (%) GLAA growth (%) Sustainable RoE used in Valuation (%) 12.7% 12.7% 12.7% 12.7% 12.7% 12.7% 12.7% 12.7% 12.7% 8.0% Cost of Equity (%) 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 2.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 40.0% 30.0% 20.0% 10.0% 0.0% -10.0% -20.0% -30.0% 160% 150% 140% 130% 120% 110% 100% 90% 80% 70% 60% H14 2H H15 2H Efficiency Cost / Income Ratio (%) Cost growth (%) H14 2H H15 2H Asset Quality Impairment Charge / GLAA (bp) Coverage (%) H14 2H H15 2H % 1.0% 0.5% 0.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% -10.0% PROFIT & LOSS (AUDm) Net Interest Income 13,407 6,843 6,932 13,775 7,121 7,289 14,410 15,413 16,272 Non-Interest Income 5,173 2,644 2,494 5,138 2,663 2,646 5,309 5,480 5,660 Fees & Commissions 3,561 1,804 1,848 3,652 1,221 1,261 2,482 2,616 2,673 Financial Markets ,007 Life and Funds 1, , ,582 1,651 1,717 Other Revenue Total Operating Income 18,580 9,487 9,426 18,913 9,784 9,935 19,719 20,893 21,931 Total Operating Costs 8,174 4,456 5,724 10,180 4,460 4,467 8,927 9,355 9,495 Employee Costs 4,362 2,292 2,240 4,532 2,329 2,376 4,705 4,319 4,493 Other Costs 3,812 2,164 3,484 5,648 2,131 2,091 4,222 5,036 5,002 Pre-Provision Operating Profit 10,406 5,031 3,702 8,733 5,324 5,468 10,792 11,538 12,436 Impairment Charge 1, ,055 1,101 Pre-Tax Profit 8,472 4,503 3,353 7,856 4,869 4,970 9,839 10,483 11,335 Tax Expense 2,337 1,263 1,229 2,492 1,424 1,433 2,857 3,018 3,265 Minority Shareholders Other Post Tax Items Stated Net Profit 5,452 2,856 2,439 5,295 3,440 3,537 6,977 7,465 8,070 Extraordinary & Other Items Hybrid Distributions IoRE/Non Controlling Interest Derivatives & Hedging Revaluation Macquarie Cash Profit 5,936 3,150 2,034 5,184 3,320 3,428 6,748 7,247 7, % BALANCE SHEET & CAP AD (AUDm) Risk Weighted Assets * 362, , , , , , , , ,582 Interest Earning Assets 662, , , , , , , , ,042 Gross Loans, Advances & Acceptances 521, , , , , , , , ,876 Total Deposits 559, , , , , , , , ,016 Total Assets 808, , , , , , ,272 1,019,073 1,067,562 Shareholders Equity 46,620 47,478 47,908 47,908 49,868 56,415 56,415 59,453 63,037 Tier 1 Capital 37,480 39,774 39,758 39,758 43,752 48,185 48,185 50,310 53,021 Tier 1 Ratio (%) * 10.4% 10.8% 10.8% 10.8% 11.1% 12.4% 12.4% 12.1% 10.9% Core Tier 1 Ratio (%) - Basel III 8.4% 8.6% 8.63% 8.6% 8.9% 10.1% 10.1% 10.0% 9.0% ASSET QUALITY Impairment Charge / GLAA (bp) Coverage (%) 63% 68% 76% 76% 146% 144% 144% 140% 134% Total Stage 1 Dividends DDM Valuation 7.19 Total Fade Period Dividends Total Perpetuity Dividends 0.78 Total Surplus Capital Per Share KEY RATIOS & GROWTH Net Interest Income growth (%) 0.8% 0.6% 1.3% 2.7% 2.7% 2.4% 4.6% 7.0% 5.6% Non-Interest Income growth (%) 5.0% 4.5% -5.7% -0.7% 6.8% -0.6% 3.3% 3.2% 3.3% Total Revenue growth (%) 2.0% 1.7% -0.6% 1.8% 3.8% 1.5% 4.3% 6.0% 5.0% Cost growth (%) 4.4% 6.1% 28.5% 24.5% -22.1% 0.2% -12.3% 4.8% 1.5% Pre-Provision Profit growth (%) 0.1% -2.0% -26.4% -16.1% 43.8% 2.7% 23.6% 6.9% 7.8% RWA growth (%) 9.3% 1.4% 0.1% 1.5% 7.0% -1.1% 5.8% 6.7% 17.6% GLAA growth (%) 4.2% 2.4% 2.1% 4.5% 5.2% 1.6% 6.9% 6.3% 5.7% Deposit growth (%) 4.9% 2.8% 4.1% 7.1% 3.8% 1.6% 5.4% 6.3% 5.7% Net Interest Margin (%) 2.03% 1.94% 1.94% 1.94% 1.91% 1.92% 1.92% 1.94% 1.94% Cost / Income Ratio (%) 44.0% 47.0% 60.7% 53.8% 45.6% 45.0% 45.3% 44.8% 43.3% Source: Company data, Macquarie Research, June 2015 *B , B onward 18 June

16 Macquarie Quant View The quant model currently holds a marginally positive view on National Australia Bank. The strongest style exposure is Growth, indicating this stock has good historic and/or forecast growth. Growth metrics focus on both top and bottom line items. The weakest style exposure is Profitability, indicating this stock is not efficiently converting its investments to earnings as proxied by ratios such as 336/666 Global rank in Banks % of BUY recommendations 47% (7/15) Number of Price Target downgrades 3 Number of Price Target upgrades 1 Fundamentals Attractive Quant Local market rank Global sector rank Displays where the company s ranked based on the fundamental consensus Price Target and Macquarie s Quantitative Alpha model. Two rankings: Local market (Australia & NZ) and Global sector (Banks) Macquarie Alpha Model ranking A list of comparable companies and their Macquarie Alpha model score (higher is better). Factors driving the Alpha Model For the comparable firms this chart shows the key underlying styles and their contribution to the current overall Alpha score. ANZ Bank Westpac Banking Corporati Commonwealth Bank Suncorp Scentre Group Westfield Corporation ANZ Bank Westpac Banking Corporati Commonwealth Bank Suncorp Scentre Group Westfield Corporation % -80% -60% -40% -20% 0% 20% 40% 60% 80% 100% Valuations Growth Profitability Earnings Momentum Price Momentum Quality Macquarie Earnings Sentiment Indicator The Macquarie Sentiment Indicator is an enhanced earnings revisions signal that favours analysts who have more timely and higher conviction revisions. Current score shown below. Drivers of Stock Return Breakdown of 1 year total return (local currency) into returns from dividends, changes in forward earnings estimates and the resulting change in earnings multiple. ANZ Bank Westpac Banking Corporati Commonwealth Bank Suncorp Scentre Group Westfield Corporation ANZ Bank Westpac Banking Corporati Commonwealth Bank Suncorp Scentre Group Westfield Corporation % -50% -30% -10% 10% 30% 50% 70% Dividend Return Multiple Return Earnings Outlook 1Yr Total Return What drove this Company in the last 5 years Which factor score has had the greatest correlation with the company s returns over the last 5 years. Dividend Yield FY0 Dividend Yield LTM Price to Sales FY0 Dividend Yield FY1 Return on Equity FY1 EBITDA Revisions 3 Month Return on Equity NTM Profit Margin FY1 Negatives Positives -25% -27% -28% -28% 28% 27% 27% 35% -40% -20% 0% 20% 40% How it looks on the Alpha model A more granular view of the underlying style scores that drive the alpha (higher is better) and the percentile rank relative to the sector and market. Alpha Model Score Valuation Growth Profitability Earnings Momentum Price Momentum Quality Capital & Funding Liquidity Risk Technicals & Trading Normalized Score Percentile relative to sector(/666) Percentile relative to market(/415) Source (all charts): FactSet, Thomson Reuters, and Macquarie Research. For more details on the Macquarie Alpha model or for more customised analysis and screens, please contact the Macquarie Global Quantitative/Custom Products Group (cpg@macquarie.com) 18 June

17 Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie First South - South Africa Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie - Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie - USA Outperform (Buy) return >5% in excess of Russell 3000 index return Neutral (Hold) return within 5% of Russell 3000 index return Underperform (Sell) return >5% below Russell 3000 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down % in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 40 60% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 30 40% in a year. Low medium stock should be expected to move up or down at least 25 30% in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Asia/Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 31 March 2015 AU/NZ Asia RSA USA CA EUR Outperform 48.99% 59.51% 49.30% 43.79% 59.59% 52.20% (for US coverage by MCUSA, 7.42% of stocks followed are investment banking clients) Neutral 34.12% 26.62% 35.21% 50.29% 34.93% 31.32% (for US coverage by MCUSA, 5.68% of stocks followed are investment banking clients) Underperform 16.89% 13.87% 15.49% 5.93% 5.48% 16.48% (for US coverage by MCUSA, 0.87% of stocks followed are investment banking clients) NAB AU vs ASX 100, & rec history (all figures in AUD currency unless noted) Note: Recommendation timeline if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, June month target price methodology NAB AU: A$38.02 based on a DCF methodology Company-specific disclosures: NAB AU: Macquarie and its affiliates collectively and beneficially own or control 1% or more of any class of 's equity securities. MACQUARIE EQUITIES LIMITED or one of its affiliates managed or co-managed a public offering of securities of Ltd in the past 12 months, for which it received compensation. MACQUARIE CAPITAL (AUSTRALIA) LIMITED or one of its affiliates managed or co-managed a public offering of securities of Ltd in the past 12 months, for which it received compensation. Macquarie Capital (Australia) Limited or one of its affiliates may provide Limited investment advisory services for which it may or may not receive compensation. Macquarie Capital (Australia) Limited or one of its affiliates may provide Limited investment advisory services for which it may or may not receive compensation. Important disclosure information regarding the subject companies covered in this report is available at Date Stock Code (BBG code) Recommendation Target Price 10-Mar-2015 NAB AU Outperform A$ Feb-2015 NAB AU Outperform A$ Jan-2015 NAB AU Outperform A$ Oct-2014 NAB AU Neutral A$ Oct-2014 NAB AU Neutral A$ Oct-2014 NAB AU Neutral A$ Sep-2014 NAB AU Neutral A$ Sep-2014 NAB AU Neutral A$ Jul-2014 NAB AU Neutral A$ May-2014 NAB AU Outperform A$ May-2014 NAB AU Outperform A$ Mar-2014 NAB AU Outperform A$ Feb-2014 NAB AU Outperform A$ Jan-2014 NAB AU Outperform A$ Dec-2013 NAB AU Outperform A$ Oct-2013 NAB AU Outperform A$ Sep-2013 NAB AU Outperform A$ June

18 16-Sep-2013 NAB AU Outperform A$ Sep-2013 NAB AU Outperform A$ Aug-2013 NAB AU Outperform A$ Jul-2013 NAB AU Outperform A$ Jun-2013 NAB AU Outperform A$ May-2013 NAB AU Outperform A$ May-2013 NAB AU Outperform A$ Mar-2013 NAB AU Outperform A$ Mar-2013 NAB AU Neutral A$ Feb-2013 NAB AU Neutral A$ Feb-2013 NAB AU Neutral A$ Jan-2013 NAB AU Neutral A$ Jan-2013 NAB AU Neutral A$ Oct-2012 NAB AU Neutral A$ Oct-2012 NAB AU Neutral A$ Oct-2012 NAB AU Outperform A$ Jul-2012 NAB AU Outperform A$ Jul-2012 NAB AU Outperform A$27.27 Analyst certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd (ABN , AFSL No ) ( MGL ) and its related entities (the Macquarie Group ) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. General disclosure: This research has been issued by Macquarie Securities (Australia) Limited (ABN , AFSL No ) a Participant of the Australian Securities Exchange (ASX) and Chi-X Australia Pty Limited. This research is distributed in Australia by Macquarie Equities Limited (ABN , AFSL No ) ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited ( MENZ ) an NZX Firm. Macquarie Private Wealth s services in New Zealand are provided by MENZ. Macquarie Bank Limited (ABN , AFSL No ) ( MBL ) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. None of MBL, MGL or MENZ is registered as a bank in New Zealand by the Reserve Bank of New Zealand under the Reserve Bank of New Zealand Act Any MGL subsidiary noted in this research, apart from MBL, is not an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Australia) and that subsidiary s obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that subsidiary, unless noted otherwise. This research is general advice and does not take account of your objectives, financial situation or needs. Before acting on this general advice, you should consider the appropriateness of the advice having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision. This research has been prepared for the use of the clients of the Macquarie Group and must not be copied, either in whole or in part, or distributed to any other person. If you are not the intended recipient, you must not use or disclose this research in any way. If you received it in error, please tell us immediately by return and delete the document. We do not guarantee the integrity of any s or attached files and are not responsible for any changes made to them by any other person. Nothing in this research shall be construed as a solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any transaction. This research is based on information obtained from sources believed to be reliable, but the Macquarie Group does not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. The Macquarie Group accepts no liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this research and/or further communication in relation to this research. The Macquarie Group produces a variety of research products, recommendations contained in one type of research product may differ from recommendations contained in other types of research. The Macquarie Group has established and implemented a conflicts policy at group level, which may be revised and updated from time to time, pursuant to regulatory requirements; which sets out how we must seek to identify and manage all material conflicts of interest. The Macquarie Group, its officers and employees may have conflicting roles in the financial products referred to in this research and, as such, may effect transactions which are not consistent with the recommendations (if any) in this research. The Macquarie Group may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case. The Macquarie Group s employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research. Important disclosure information regarding the subject companies covered in this report is available at 18 June