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Why the share price of National Australia Bank Ltd. is surging higher this morning

Credit: NAB

Shares in National Australia Bank Ltd. (ASX: NAB) are leading the banking sector higher following the release of its quarterly update.

The stock jumped 2.7% to $29 in lunch time trade, while the other Big Banks like Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC) and Australia and New Zealand Banking Group (ASX: ANZ) are up by around 0.5%.

NAB’s December quarter cash earnings improved 3% over the same time last year to $1.65 billion as revenue increased by 1%.

Thank goodness expectations are fairly low as the banking sector is facing a number of headwinds, which include stagnant wage growth, record high household debt, rising costs and a softening lending market.

It also helps that Citigroup has upgraded NAB to a “buy” on the back of this update, as reported in the Australian Financial Review. The broker cited the stock’s cheap valuation of 12 times price-earnings (P/E) and its 7% yield as the reasons for the upgrade.

There is also a sense of relief that NAB’s reputation is not as tarnished as Commonwealth Bank’s with ongoing fines and investigations for bad behaviour.

The upcoming Royal Commission could put more heat on the sector but I don’t think NAB will be singled out in particular. Commonwealth Bank will have to contend with being the whipping boy for the sector for a while yet.

However, there are a few negatives in NAB’s latest update that I am not so thrilled about (and I am a shareholder).

The first is the all-important net interest margin (NIM), which fell in the quarter. Management said if the Markets and Treasury operations were excluded, NIM would be flat. This compares to Commonwealth Bank’s results yesterday where it reported a 6-basis point increase to NIM.

It’s a pity NAB couldn’t pull off the same feat as costs are starting to bite. The bank said expenses rose 4% due to higher investment spend and personnel cost.

Is this an early sign that the wage growth recession in our country is coming to an end? That’s perhaps for another article.

The issue is that the rise in expenses is outpacing earnings growth, and that is not what I like to hear even though management is committing to cutting more than $1 billion in costs by the end of FY20.

Another thing I am not happy to see is the 23% drop in Bad and Doubtful Debt (B&DD) charges to $160 million.

Don’t get me wrong, this in itself is good but it obviously helped drive the bank’s profit growth. I’d much rather see earnings grow because the bank is attracting more business as opposed to the lowering of provisioning to bolster its bottom line – particularly in this part of the economic cycle.

NAB produced a decent update but it won’t convince me to increase my weighting on the banking sector – an area of the market where I am relatively underweight on.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, National Australia Bank Limited, and Westpac Banking. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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