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By Paul Rickard

After three underwhelming profit reports from the ANZ, NAB and Westpac, bank “earnings season” finished yesterday with CBA delivering a solid first quarter update. The market gave it the tick, with the share price rallying 2.7% to close at $80.27.

On a headline basis, CBA’s cash profit looked pretty good. At $2.65 billion, this was up around 10% on the corresponding quarter in 2016, and up 6% on the average of the last two quarters.

A big fall in loan impairment expenses, down 20% on the last two quarters, and an improvement in net interest margin (NIM) were the drivers. At a record low of just 11 basis points (0.11% of gross loans), the impairment charge was just $198 million compared with $322b million for the same quarter in 2016.

The net interest margin also improved, as CBA was able to reprice home loans and other assets, and reduce liquid asset balances. Volumes also ticked up, although the overall growth in the home loan book at an annualized rate of 2.7% was below system growth and well down on the rate of 6.9% achieved in FY 16/17. Overall, operating income grew by 4%.

Operating expenses also grew by 4% (no positive jaws), but CBA said part of this increase was due to provisions for project work relating to regulatory actions and compliance programs. This covers work to remediate shortcomings in its anti-money laundering controls, but not the cost of any fine imposed should AUSTRAC’s civil penalty proceedings be successful.

A highlight of the result was the generation of capital from earnings and through the de-risking of the asset book.  This saw the CET 1 (Common Equity Tier 1) ratio remain at 10.1%, notwithstanding the payment of the September dividend that knocked 55 basis points (0.55%) off the base. 

When the sale of its Australian and New Zealand life insurance operations to AIA completes in 2018, it will increase the capital ratio by 0.7%. CBA’s pro-forma CET1 ratio on 30 September is now 10.8%, above APRA’s 2020 “unquestionably strong ” benchmark of 10.5%.

While APRA might yet make some further modifications in relation to the risk weights used for assigning capital for higher risk mortgages, the bottom line for CBA is that it has met its capital targets and dilutive capital raisings are now wholly off the agenda. Like Westpac and ANZ, it won’t be too far down the track before it can start to think about returning capital, and if earnings increase, dividends can also increase.

Challenges remain

Challenges remain, however. Firstly, CBA (like its peers) is virtually growthless. Low single digit volume increases is barely growth, and while NIM has improved, there is a limit on just how often the asset book is repriced. Then there’s the impact of initiatives such as killing foreign ATM fees and reducing fees on old style transaction accounts, as well as the loss of earnings from divested assets to factor in. Revenue growth is going to be a struggle.

On the cost side, the Bank will feel a little constrained on addressing costs too aggressively until such time as the AUSTRAC proceedings, APRA’s independent prudential inquiry into governance, culture and accountability at the CBA, and shareholder class actions are out of the way. No headlines like NAB’s “6,000 jobs to go”.

But it does need to address its cost base, and quickly. And while the cost of these inquiries, court proceedings and potential fines is manageable, they will act as a huge distraction for management and continue to sully CBA’s reputation, making it harder to increase share in the key consumer markets.

The appointment of a new CEO to replace Ian Narev could be the trigger that gives CBA some clear air.

What do the brokers say

Citi was one broker to upgrade its recommendation following the result, from sell to neutral. This sums up the analysts, who are in aggregate neutral on the stock and see it as pretty fully priced. While there may be some minor revisions to target prices and earnings estimates in the coming days, the consensus target price is $77.63, about 3.3% below yesterday’s closing price. CBA is trading on a multiple of 13.9 times FY18 and FY19 forecast earnings.

Individual broker recommendations (source FN Arena) are as follows:

Bottom Line 

It wouldn’t surprise me if yesterday’s market action goes down as a bit of a “relief rally”. The worst is probably behind CBA (and hence its bounce from a low of $73.20 on 8 September), but yesterday’s update was no stunner. Better than the others, but not brilliant.

I am no seller of CBA, but in the absence of the new CEO and clear air, I prefer others who can get a little more serious about cutting costs. ANZ by a nose.

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Published: Thursday, November 09, 2017

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