National Australia Bank’s sale of UK real estate loans is a good move: Moody's

Because it will improve NAB's asset quality.

National Australia Bank Limited has recently announced that it had agreed to sell £625 million of UK commercial real estate loans to an affiliate of Cerberus Global Investors, and in line with this, Moody’s believes the sale of these loans is credit positive for NAB because it will improve NAB’s asset quality and release capital.

According to a research report from Moody's Investors Service, in addition, although the loans accounted for just a small portion of NAB’s overall balance sheet, the sale signals that NAB’s troubled UK operations are finally improving.

NAB’s portfolio of UK commercial real estate loans has performed poorly since 2008, causing a material drag on the bank’s profitability and asset quality and becoming a significant area of focus for investors.

Here's more from Moody's:

The sale of these loans will reduce NAB’s exposure to UK commercial real estate loans by 20% to £2.38 billion and will reduce the potential for further losses or deterioration from this portfolio.

Following the sale, we estimate that UK commercial real estate loans will equal only 0.8% of NAB’s global loan book.

The loans that NAB is selling to Cerberus are either in default, past maturity or near maturity and are largely nonperforming, and thus their sale will improve NAB’s asset quality.

On a pro forma basis as of 30 June 2014, the sale will reduce NAB’s gross impaired UK commercial real estate loans by 48% to £501 million from £964 million, while loan-loss reserve coverage on the remaining impaired assets will improve to 60% from 51%.

The sale will release approximately £127 million of capital for NAB, which we estimate would improve NAB’s common equity Tier 1 ratio to 8.70% on a pro forma basis as of 31 March 2014 from 8.64%.

We also expect NAB’s profitability to improve because NAB since 2012 has cumulatively recorded £755 million in loan-loss provisions for its UK commercial real estate portfolio.

NAB has also recorded cumulative net losses, on a cash basis, of £246 million from the portfolio in the 12 months to March 2014.

The Cerberus transaction will result in a small gain above net book value, indicative of the improving economic conditions in the UK and boosting prospects for further resolution of legacy impaired assets.

At the same time, improving conditions should support the eventual sale of NAB’s UK banking subsidiary, Clydesdale Bank plc (Baa2 stable, D+/ba1 stable), which NAB has indicated that it wants to sell, subject to a favourable transaction.

NAB has the capital strength to wait for market conditions to improve before making a sale.

On balance, we would view the sale of Clydesdale as credit positive, in light of the structurally higher profitability of the Australian banking market compared with that in the UK.