Markets: NAB's UK problems fester

National Australia Bank’s sore that is its UK bank Clydesdale has not turned gangrenous but it is festering and giving off a decided whiff.

Moody’s Investors Service says it has downgraded Clydesdale, probably named after the plodding horse, to Baa2 from A2. The credit rating agency says NAB’s Clydesdale is a weakened franchise. NAB’s efforts to turn around Clydesdale by strengthening risk management and cost controls “will take some time to be effective”.

NAB itself is also subject to short-term business pressures, says Moody’s. The asset quality of its business loan book is under pressure, it says. NAB suffers from low profitability that “reduces the bank’s financial flexibility,” the agency says.

That’s not pleasant reading for NAB chief executive Cameron Clyne. Worse is to follow. “Moody’s believes the bank’s (NAB) franchise as a retail and selective business lender has been materially weakened following a strategic pull back from commercial real estate and other areas of business lending,” says the rating agency.

Meanwhile, Clydesdale is putting further pressure on its parent. The UK bank’s low profitability and poor efficiency – it has a cost to income ratio of 70 per cent – reduces NAB’s ability to absorb provisions and write offs, says Moody’s. Cost cutting through firings may help Clydesdale’s efficiency but Moody’s notes efforts to reduce the bank’s business is not without execution risks.

Clyne’s response to Moody’s is that its credit rating is disappointing and “the restructure of the UK operations is driving significant improvements in the business”.

That may be not enough to reassure NAB investors. NAB shares are up 30 per cent this year and 16 per cent since June 12. Given Moody’s analysis they may have already reached their 2013 peak.