A solid increase in quarterly profit wasn't enough to lift National Australia Bank Ltd.'s (ASX: NAB) share price into the black this morning as the bank warned it could take a more than £500 million ($1.05 billion) hit from its UK operations.
Management said it will have to make an increased provision relating to misbehaviour at its Clydesdale Bank and the provision, which is used for potential compensation claims, will range between £290 million and £420 million.
A further £60 million to £80 million in provisions may also be needed for redressing customers who were sold inappropriate interest rate hedging products, although the final bill could be much higher given that it's too early to work out the total costs for its misconduct.
The good news is that NAB has already set aside a £1.7 billion "conduct mitigation package" to support its divestment of Clydesdale and the final provisions will be deducted from this package. It looks unlikely that the final cost will exceed the money that has been set aside.
The other piece of good news is that NAB's cash earnings for the June quarter increased around 9% from the same time last year to $1.75 billion and that's about 6% above the average of the last two quarters.
The bottom line growth was bolstered by a 15% decline in bad and doubtful debts in its Australian banking operations to $193 million. NAB had made provisions for agriculture and resources loan defaults in the March half year, which were not repeated.
NAB shares were trading 0.2% in the red at $32.77 in morning trade but that's a little better than its peers.
I think NAB's quarterly update is pleasing, particularly its 107 basis point (1.07 of a percentage point) increase in its common equity tier 1 (CET1) ratio to 9.94%. NAB is well positioned to meet the new higher requirement capital ratio that's being imposed by Australian banking regulators.
However, I would have preferred to see earnings growth better supported by rising revenue as top-line growth of 4% in the quarter was offset by a similar increase in expenses, which was driven by the exchange rate, investments in the bank's priority customer segments and an impairment of a small legacy equity investment.
Management also said that group net interest margin (NIM) declined due to competition for business lending and weaker Markets and Treasury income, although it didn't elaborate.
I believe the margin squeeze is fairly mild and that's important because analysts are expecting NIM to stay relatively stable. I think this is a reasonable expectation and there could even be room for NIM to expand given that the sector is either lifting interest charges on certain types of loans or curtailing lending.
Investors will now be looking eagerly to NAB's full year result in November as the bank is expected to provide lot more detail about its proposed divestment and initial public offer of Clydesdale.
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