Investment Matters

Commonwealth Bank Issues

The CBA put out its first-half results (for the six months ending 31-Dec-17) this week.  In summary, they disappointed the market (CBA share price was -0.8% on the day of the announcement, vs the market (XAO) +0.9%).

Cash profit fell 1.9%, which on a per share basis (which is what matters to shareholders), was a fall of 3.2%.

Just below the surface, there were a number of interesting issues.  Firstly, provisioning.  The CBA put aside $375m for future fines and costs associated with the AUSTRAC breaches.  

ARE THEY DREAMING??????

Given the extent and apparently egregious nature of the AUSTRAC breaches, we should not be surprised to see $1billion+ of penalties in Australia – given the CBA’s size (market cap) and profit level (H1FY-18 cash profit = $4.735 billion).  A lesser amount (of say $375m) would barely be a slap on the wrist.  And then there are the US regulators which we believe do have standing to take action over the CBA’s breaches, as Wry & Dry has repeatedly noted.  And they really do have some very large and very sharp teeth – as Wells Fargo has recently experienced.

CBA also set aside $200m for ‘regulatory, compliance and remediation’ costs – read costs associated with things like the royal commission, and potentially the BBSW court case.

If we exclude the provisions, cash profit per share would have increased 8.6%.  In other words, this result marks the first time that past CBA’s actions have weighed on the company’s financial performance.  The share price had already started to react:

 

Source: IRESS, First Samuel

Also of note regarding the provisioning – it also flowed through to things like Return on Equity, and capital /balance sheet strength.  So the ramifications are serious for shareholders.

Other issues:

Net interest margin increased from 2.10% (Dec-16) to 2.16% (Dec-17).  Seems like a small % increase, but it equates to a lot $ wise.  The big driver of this was, quite perversely (as the government's/ APRA’s goal was to reduce risk in the residential property market, not increase banks’ profits), the switching of loans from interest only to P&I – done by putting big interest rate increases through on interest only investor loans.    

[Net interest margin is in effect the margin the banks makes between its funding cost and the interest cost it charges mortgagees.]

Longer term, we would not expect the NIM to increase further from here.  In fact, it may settle a little and then come under pressure - depending on wholesale funding pressures originating from overseas (reference current issue of US interest rate tightening).

Impairments and arrears remain benign.  Although it was noted that a new accounting standard (effective 1-Jul-18) which takes a more forward-looking approach would mean an extra ~$850m of impairment provisions would have been required.  A $595m loan impairment expense was taken in the Dec-17 half.  We view increasing impairment charges as a future risk to the CBA (and the other banks).

Also interesting was the CBA’s focus on lending – noting that it had reduced exposure to property development (apartments), and to investor loans (owner-occupier residential mortgage growth of +7.5% vs investors home loan growth of +0.5% which are typically more orientated to apartments).   If such borrowers can’t get funding from alternative sources such as shadow banking this may create further downward pressure on prices.