NAB: Q1 2016 trading update

On the face of it, a 3% increase in cash earnings from continuing operations (that is, excluding CYBG, which NAB no longer owns) in the first quarter of 2016 is nothing to complain about. But, as they say, the devil is in the detail.

Revenue rose by 4% due to increased lending volumes, a good Wealth division result and the increase in home loan rates that NAB and the other majors pushed through in October 2015. These positives more than offset rising funding costs and continued strong competition in business banking, meaning NAB's net interest margin also improved. 

Expenses, however, rose by 5%, although management expects the full-year increase to be 'less than FY15 expense growth of 4.1%'. 'Higher personnel costs' were the main culprit.

So, in other words, pre-provision cash-earnings actually fell. Saving the day was the dramatic reduction in bad and doubtful debts expense of 52% or $91m, which accounted for most of the rise in cash earnings.  

This reduction is understandable given very low interest rates are minimising the number of borrowers in distress. Australia and New Zealand's (slowly) growing economies are also helping in this regard.  

Over the medium to long term, however, we doubt such improvements in bad debt provisions – collective provisions are now around 1% of total credit risk weighted assets – can continue and so they appear close to cyclical lows.

Despite APRA requiring them to hold more capital against mortgages to help reduce their competitive advantages over the regional banks, the big banks remain oligopolies, as those with home loans from them can readily attest.

Nevertheless, very low provisions, increased capital requirements, rising funding costs and moderate credit growth are all likely to result in the big banks' earnings and dividends growing at slower rates than they have in the past.

NAB's disappointing earnings growth and higher than target payout ratio of 76% (see NAB: Result 2015) means its dividend is more at risk of being cut than, say, CBA's or Westpac's. The extremely low bad debt expense in this result is merely confirmation of this. HOLD.