NAB's UK blight overshadows its improving performance

If it weren’t for National Australia Bank’s UK banking business, Andrew Thorburn would be reasonably satisfied with the foundations of the group that Cameron Clyne handed over to him at the start of this month.

The UK bank, however, can’t be quarantined from the group’s results and has been a consistent source of costly issues for the group. The latest likelihood is that NAB will be forced to increase its provisions for miss-selling payment protection insurance and interest rate hedging products by almost $450 million when it finalises its full-year results.

Thorburn has made no secret of his ambition of exiting the UK as soon as it is practicable. But with the group saying there remain a "wide" range of uncertain factors in determining the total costs associated with conduct-related matters, that may be easier thought than executed.

With NAB having a significant exposure to Scotland through its Clydesdale Bank, next month’s vote on Scotland’s independence is another uncertain factor. While releasing NAB’s third-quarter update today, Thorburn said a vote in favour of independence could result in significant extra costs and risks for Clydesdale.

The new provisions mar what would otherwise be an improving position for NAB in the UK. Its portfolio of troubled commercial property exposures are running down -- it’s now about $5.4 billion, before the recently-announced $1.1bn sale of part of the portfolio -- and investor appetite for UK banking assets is improving.

They also overshadow the performance of the rest of NAB’s operations, as they have done now for the best part of a decade.

Third-quarter cash earnings for NAB as a whole, at about $1.6bn, were 7 per cent higher than for the same quarter a year ago and about 2 per cent above the run-rate for the first six months.

That’s despite a 1 per cent decline in revenue, mainly attributable to lower markets income. With low levels of volatility in the markets, all the majors have experienced softer trading income.

Excluding the impact of the UK conduct issues, costs were actually down a very creditable 6 per cent. The charge for bad and doubtful debts was 9 per cent lower, with reduced charges in both the Australian and UK banking businesses. Lower costs and improved asset quality are indicative of solid management of the things NAB can control.

NAB has been growing its Australian residential mortgage portfolio strongly. It grew at an annualised rate of 8.5 per cent in the quarter, slightly above the system’s growth rate. It has been cautious in its core business banking franchise, which grew at less (0.8 per cent) of the system’s growth rate.

NAB said its wealth management business, which has been a source of under-performance, had increased cash earnings, as had its New Zealand business.

Thorburn has made it apparent that retaining and building on NAB’s sector-leading position in commercial lending is one of his key ambitions, so it will be interesting to see whether he is prepared to continue growing that portfolio at less than the system’s rate.

With a strong background in retail banking it could be expected that he will also want to see the resurgence of NAB’s retail bank continue.

The big decisions, however, will be how and when he decides to exit the UK and, perhaps, what he does with the group’s small beachhead in the US, its Great Western Bank.

NAB said today that Great Western’s earnings were lower over the quarter due to the revaluation of foreclosed properties and lower releases of bad and doubtful debt provisions.

NAB acquired Great Western in 2007 as a test-bed for the exporting of its skills in agribusiness lending. While the US bank has been profitable and is fully deposit-funded, the market believes it is too small and non-strategic within the context of NAB to be anything but a distraction for management.

If Thorburn is able to orchestrate an exit from the UK and US, it would mark an end to the group’s long-held ambition to build an international presence in retail and commercial banking.

It would, however, expose what has been masked by the weight of the UK bank’s problems -- that NAB’s Australian franchise is actually a high-performing business.