National Bank of Australia's UK business poses a big threat to profits

Despite accounting for only a small GLA.

While National Australia Bank’s (NAB) UK business only accounts for ~10% of its GLA, it continues to be a dominant force on the issues front.

According to a research note from Nomura, in its 3Q14 trading update NAB has flagged a number of risks surrounding its UK business, guiding for further substantial conduct-related provisions.

While in a group context Nomura estimates additional provisions deduct only ~30cps from NAB's valuation, rationalisation of underperforming businesses had been an integral part of the investment case for NAB, and today’s announcement is a reminder of the challenges associated with an eventual sale.

Although Nomura continues to expect NAB to ultimately dispose its UK business, given the risks and uncertainties associated with that franchise, the likelihood of imminent disposal is limited.

Here’s more from Nomura:

Excluding the noise around conduct-related charges, NAB's 3Q14 performance appears to broadly resemble trends seen across peers.

Given its overweight position in business banking and the challenging markets environment it wasn’t surprising that revenue trends were weak (declined by 1%).

Also similar to peers, the BDD expense remained low. On a pre-provision profit basis (ex conduct-related charges) we estimate earnings declined by ~2% in 3Q14.

We have downgraded our earnings forecast by ~1% reflecting higher conduct-related charges and ~1% due to softer revenue performance.

While estimating conduct-related charges is difficult we expect new management to err on the side of conservatism when setting new provisions.

In that regard we have doubled our estimates for the shortfall in PPI provisions (relative to peers) and now assume total conduct-related provision charges of ~A$900mn in 2H14 (A$300mn above the line and A$600mn below the line consistent with previous treatment).