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CommBank gets reporting season off to a solid start

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In all the commotion about Wall Street, reporting season for Australia’s listed companies got underway in earnest yesterday. Commonwealth Bank, CIMIC Group (formerly Leighton Holdings), furniture retailer Nick Scali and Carsales each reported soundly.

CommBank’s result highlighted two important trends. First, the on-going pricing power that the major banks have, with CBA able to increase its overall net interest margin by 6bp to 216bp thanks largely to re-pricing its home loan book.

Secondly, the cost of compliance and regulation. While a provision of $375m for the AUSTRAC money-laundering fine will get most of the headlines (this is CBA’s best guess - it could potentially be as low as $50m and as high as $1,000m), CBA also disclosed that it booked an additional provision of $200m for an expected compliance program spend. Further, the cumulative spend on compliance programs across the Group  over the last 5.5yrs was just under $4.0bn and had grown at a staggering compound annual growth rate of 33%.

THE RESULT

Adjusting for the AUSTRAC fine and discontinued business lines, CBA’s underlying cash profit for the first half was $5.11bn, up 5.8% on the $4.83bn for the corresponding half in FY17. Underlying operating income grew by 4.9% mainly due to higher net interest income, while operating expenses grew by 4.7%. This led to “positive jaws”, with operating performance up by 5.1%. Eliminating the $200m provision for compliance program costs, “business as usual” expenses grew by 2.0%.

Loan impairment expenses were flat at $596m or just 16 basis point (0.16%) of gross loans and advances.

On the capital front, CBA’s CET1 (Common Equity Tier 1) ratio rose to 10.4%. On a pro-forma basis, this will reduce to around 10.15% on 1 July 18 when CBA adopts a new “forward looking” provisioning standard. The leverage ratio increased to 5.4%.

For shareholders, CBA increased the interim dividend by 1c to $2.00 per share.

POSITIVES

The main positive was the increase in interest income from the home loan book. Together with a moderate increase in volumes and tight cost control, this helped the all-powerful Retail Bank grow NPAT by 7.7% to $2.65bn. Its cost to income ratio fell to a remarkable 30.1%.

In fact, most divisions recorded healthy profit rises. Business & Private Bank grew cash NPAT by 9.3%, BankWest by 16.9%, New Zealand by 14.1% and Wealth Management by 33%. The exception was Institutional Banking & Markets, where NPAT decreased by 13.2% due to lower income in financial markets, subdued lending volumes and higher provisions.

NEGATIVES

Underlying volume growth was disappointing and remains a key challenge for the Bank. Average interest earnings assets grew by 3.4% over the 12 months to $851bn, and by a dismal 0.6% over the last six months.

On a product basis, this translated to growth in home loans of 2.9% in the six months ending 31 December compared to system growth of 4.2%. With business loans, CBA grew balances by 0.1% compared to system growth of 1.9%.  Accordingly, CBA went backwards in market share in home loans and business lending - down to a share of 24.6% with the former compared to 25.0% 12 months earlier.

Another negative was the dividend of $2.00, slightly less than the $2.06 forecast by some analysts.

THE BROKERS

The brokers were marginally negative on Commonwealth Bank going into the result, with 1 buy, 5 neutral and 2 sell recommendations. According to FN Arena, the consensus target price was $78.13, compared to last night’s closing price of $76.79.

Their main concerns were those echoed in CBA’s results - lack of momentum in balance sheet growth, and the ongoing cost of the compliance and regulatory obligations, including the “Royal Commission” risk.

Following the result, UBS and Citi confirmed their respective targets and recommendations. In the next couple of days, the other major brokers will update their forecasts, and while it was a result that met expectations, there was little “new news” and changes should be limited.

MY VIEW

CBA’s result was sound without being spectacular. It supports why I remain bullish (and overweight) the major banks. Interest margins are holding up, there is no uptick in bad debts, the pressures on capital have subsided and cost pressures are modest.

Downside risks include the compliance and regulatory burden, and the biggest challenge of all - volume growth.

However, price/earnings multiples are reasonable by historical standards, dividend payouts are high, and there is still an enormous opportunity to go really hard on the costs.

My view is somewhat at odds with many in the market, who are down on the major banks because of the lack of revenue growth and potential “Royal Commission” risk. I have argued that the market will get bored with this in due course and come to recognize the major banks as low risk, annuity style investments paying high fully franked dividends. Stay long the banks. 

 

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Published: Wednesday, February 07, 2018


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