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.  


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.