Investment Matters

Insights from CBA's result

Other stocks reporting

Other stocks to report this included the electricity provider AGL (-7.7% for the week) and Telstra (-8.6% for the week). We do not own either company for fundamental reasons. Over the last couple of years, both companies have been considered as attractive options for “yield or income” investors, with both companies “offering” high levels of franked dividends.

The problem with any strategy that just relies on the dividend alone is that income is worthless if it is accompanied by larger losses of the value of the stock. Both Telstra and AGL have significantly underperformed the market (including dividends and franking credits) over the past year.

Commonwealth Bank reports

As investors would be aware our portfolio has a small position in both National Australia Bank and ANZ Bank. Despite a small amount of buying this week, we hold far less banks that the broader share market. As a result, if banks shares underperform the market your portfolio will tend to outperform the market.  In absolute terms, however, it is important that our holdings in these banks make you money, regardless of how the market performs. 

The results of Commonwealth Bank (CBA) this week, provide some insights into the performance of the broader banking industry, as COVID changes the way our economy is operating.

Four points to note;

•The Australian banking system has strong levels of capital (relative to past cycles) to buttress against the risks that clearly face the economy.  

•The huge increases in government support for the economy is leading to significant increases in deposits in the banking system. As we all know deposits pay almost nothing in interest and therefore increases in deposits help the profitability of banks. Instead of relying on more expensive sources of funds. The chart below shows how much of CBA’s funding comes from deposits and the change since last year.

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•The large number of mortgage clients that took advantage of the option to defer payments presents the bank sector with higher risks of defaults in the coming years. It was crucial in the CBA result to see many those who chose to defer already back paying. Similar outcomes hold for CBA’s personal loans and business loans. 

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•Watching how the CBA chose to interpret the current conditions was critical. Since assuming a higher level of losses due to COVID in the previous quarters results, CBA has assumed that since the “non-deferred loans” are performing better, and the deferred loans are relatively well behaved the outlook has not deteriorated. Time will tell, we remain cautious, and have chosen to avoid the banks with the highest exposure to the consumer and home loan market (CBA and Westpac).

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Some charts of note ….

The critical importance of the government interventions in the economy since the COVID-19 shutdowns began is illustrated in recent data from Illion. For the economy to survive a dramatic reduction in activity, spending by households needed to be supported.

Higher income households have the capacity the save in good times and bad, and the chart below (red line) shows that when faced with uncertainty, spending amongst this cohort was cut further, with savings rates rising higher still.

Less spending by high-income earners has a huge impact on lower income household's employment outlook. The best remedy is to increase the purchasing power of lower income households, and that is exactly what the government did, supported by the RBA with lower interest rates. The purple line shows the relative rise in spending by the lower income cohort, both overall and on discretionary items.

The data also indicates the critical importance in maintaining support for low-income earners in the post-COVID period as the economy restructures. Many will recall the simple story of Henry Ford and his insights into the connections between wages on the assembly line and demand for his Model T …

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