National Australia Bank, the country's top lender, finally moved to review its underperforming UK operations and said conditions were challenging as it reported a 7.7 percent rise in first-quarter cash profit, just shy of market forecasts. That news sent its shares down over 3 percent.
NAB, which has held onto its UK operations that span over 300 branches through its Yorkshire and Clydesdale brands in hope of an economic turnaround, was forced into a review since it now said it expected a longer period of subdued growth.
The UK operations were a key reason for the rise in NAB's bad debts charge after several quarters of falls.
NAB reported a first-quarter cash profit of A$1.4 billion ($1.50 billion), up from A$1.3 billion a year ago but below a A$1.45 billion average forecast of five analysts polled by Reuters.
Chief Executive Cameron Clyne said the review of UK operation, due to be completed in May, would lead to changes.
"The review will assess many options and it's still too early to determine the recommendation. We can say that retaining the existing business mix and structure will not be an outcome," Clyne told analysts in a conference call on Tuesday.
Previously, NAB has said it was comfortable with its UK operations and did not want to either sell out or bulk up.
"I'm not sure whether that means they are going to be more likely to sell it, compared to before, but obviously we'll know more during the first half results," said John Buonaccorsi, analyst at Royal Bank of Scotland.
NAB, which has grown mortgages at nearly twice the industry rate, said higher deposit and funding costs were impacting its core Australian operations.
"Increased wholesale and deposit funding costs had a material effect on our financial performance this quarter, reducing our revenue by approximately $80 million," said Clyne.
Weak Loan Growth
In December, NAB had forecast a challenging 2012 with business and consumer sentiment subdued, and it reiterated that in Tuesday's update.
Last year, NAB and its three main rivals together made a record $25 billion in profits as a booming resources sector helped the Australian economy sail through the global economic downturn with little of the turmoil experienced by peers in Europe and the United States.
But credit growth has fallen to the lowest level since the 1970s as households increase savings and corporates pay down debt, forcing banks to focus on cost controls.
Investor focus is on funding costs, with Australian banks relying on offshore markets for the bulk of their $100 billion annual funding needs.
As funding costs soar, investors fear margins will erode and banks will look to pass on the higher costs to customers, NAB's first quarter net interest margin fell to 2.19% from 2.28% in the half year to 30 September 2011.
NAB fully passed on a 25 basis point cut in the central bank's cash rate in December to mortgage rates, even as higher funding costs raised concerns some banks would hold back part of the official rate cut.
The Reserve Bank of Australia is due to meet later on Tuesday and is expected to cut the cash rate by a further 25 basis points to 4.0 percent.
NAB, which is expected to raise between $20 billion to $25 billion of wholesale funds in 2012, said it has raised A$7 billion so far this financial year. Fund raising by banks so far this year have come at twice the average margin a year ago as the European crisis roils credit markets.
Provision for doubtful debts increased to $545 million, from $493 million in the first quarter last year, as UK banking conditions grew increasingly difficult.
NAB said the higher charge for bad and doubtful debts in wholesale banking was mainly due to provisions raised against two customers.
NAB reported its capital position remains strong with a Tier 1 ratio, a measure of a banks ability to absorb losses, was 10.02 percent compared with 9.7 in September.