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Nicholas Grove is a Morningstar journalist.

National Australia Bank (NAB) on Tuesday said cash earnings, a preferred measure of underlying performance among the big banks, stood at $1.4 billion for the first quarter to the end of December, up 7.6 per cent on the $1.3 billion recorded in the same quarter in the prior year.

Morningstar head of Australian banking research David Ellis described the quarterly result as "disappointing".

"We expected cash earnings of $1.5 billion, but lower net interest margins and higher bad debts in UK banking slowed earnings growth," Ellis said.

In a quarterly update, the bank descibed the result as "solid," reflecting increased revenue, and said it was achieved despite challenging operating conditions including higher deposit and wholesale funding costs, subdued credit demand and an increased charge for bad and doubtful debts.

In a statement, NAB said growth in revenue was driven by its Wholesale Banking, and to a lesser extent, its MLC & NAB Wealth divisions.

Revenue in Business and Personal Banking was relatively flat, with higher funding costs largely offset by volume growth, the bank said. Higher funding and deposit costs also contributed to a decline in revenue in UK Banking.

As a result, the bank said its first-quarter net interest margin fell to 2.19 per cent from a quarterly average of 2.28 per cent in the half year to 30 September 2011.

The charge for bad and doubtful debts for the quarter increased to $545 million or 0.45 per cent of gross loans and acceptances (GLA), NAB said, compared to 0.35 per cent of GLA for the quarterly average of the second half of the 2011 financial year.

The main driver of the higher charge for bad and doubtful debts was in UK Banking, where operating conditions became increasingly difficult, NAB said.

The charge for bad and doubtful debts also increased in the Wholesale Banking and Specialised Group Assets (SGA) units, due to provisions on predominantly UK-based exposures, it said.

Given the bank's outlook for a longer-term recovery in the UK economy, NAB CEO Cameron Clyne also announced on Tuesday that the bank has started a strategic review of the UK Banking division.

"We will inform the market of the outcomes of the review, which we expect to occur by the time of our interim result in May 2012," he said.

City Index chief market analyst Peter Esho said the situation in NAB's UK business is "far from perfect," but when stripping out the UK problems, his initial impression of the half-year result implies things in Australia are actually going well, and perhaps even slightly ahead of expectations.

Morningstar's Ellis said the overall group performance provides enough positives to support his upbeat view of the bank.

"Selling the two UK banks at book value would be a significant share price catalyst and we look forward to a resolution of the UK 'problem' when the strategic review concludes in May," he said.

The bank said its capital position improved in the quarter, with the Tier 1 ratio at 10.02 per cent compared to 9.70 per cent as at 30 September 2011. The Core Tier 1 ratio was 7.89 per cent.

To view a related video on NAB's earnings, please click here.