Australia | Nov 08 2018
Commonwealth Bank is moving back to being a retail and business bank and brokers welcome the potential for capital management down the track.
-Regulatory and compliance headwinds being dealt with
-Outlook still challenging as housing market weakens
-Scope for capital management by 2020
By Eva Brocklehurst
Brokers concur that Commonwealth Bank ((CBA)) has made good progress on addressing the concerns raised during the Hayne Royal Commission, simplifying its business and improving credit quality.
Cash net profit in the first quarter was $2.57bn, benefiting from lower impairment expenses. Revenue momentum appeared weak, with little or no growth in the quarter and, while costs were well managed, Ord Minnett notes there is a timing element because of lower investment spending. The broker was not surprised that net interest income was flat, given the revenue pressures flagged by other banks during reporting season.
Bell Potter observes the transition in the bank's business raises the issue of whether it has retained much of its original identity. Still the broker becomes positive in view of CBA mastering the myriad of changes that have been imposed in the last 12 months. Following the sale of CFS Global Asset Management, Commonwealth Bank should move back to being predominantly a retail and business bank.
The broker downgrades earnings estimates by around -4% from 2020, to exclude the CFSGAM earnings and maintains a $73 target, with the value offset arising from an expected post-tax gain on sale of around $1.5bn and the release of around $2.9bn in CET1 capital. The broker, not one of the eight monitored daily on the FNArena database, maintains a Buy rating as the bank continues its transformation.
Operating income, excluding one-off items, was 1% higher as higher other banking income more than offset flat net interest income. Overall, troublesome exposures remained stable in the quarter, although impaired assets were up, which Bell Potter attributes to "usual mortgage stresses – presumably in WA and Queensland".
Credit Suisse likes the falling operating expenses and considers CBA to be the emerging story of the sector, as many of the regulatory and compliance headwinds have been or are being dealt with. The focus now is on cost reductions and capital. A CET1 ratio of around 11.2% in a dividend-paying quarter indicates capital management could be on the cards and Credit Suisse upgrades to Outperform from Neutral.
Morgans agrees credit quality remains sound and forecasts a CET1 ratio of 11.3% by the end of FY20, agreeing there is scope for capital management, given APRA's unquestionably strong benchmark is 10.5%.
UBS is more cautious about extrapolating quarterly trends but accepts business momentum is continuing. Expenses, while well managed, were aided by the timing of investment expenditure and software impairments in the prior half-year, and the broker expects higher costs will continue in FY19.
Assuming the completion of divestments, the pro forma CET1 ratio will rise by 120 basis points, which the broker suggests will push the ratio towards 11.8% by the first half of 2020, allowing for a $5bn on-market buyback in its forecasts from late 2019. The outlook is still likely to be challenging, and potentially deteriorate as the housing market weakens.
Still, the core retail franchise is intact, although UBS retains a Neutral rating in the context of an overall cautious view on Australian banks.
The aspect of the quarterly update that most displeased Credit Suisse was the lower net interest margin, although re-pricing benefits are expected to take effect from the second quarter.
Morgans believes the bank is offering good value at the current share price and points to the net interest margin boost from the recent increase to all Australian variable home loan rates of 15 basis points. Household deposit growth was also strong in the quarter, at 8.9% annualised and the main driver was transaction deposits.
The broker also believes there are signs that front book home loan discounting in Australia has peaked and this is positive for the margin outlook. Deutsche Bank assesses the 3% growth required in the second quarter to meet its first half cash net profit forecasts is achievable, giving the upcoming benefit from mortgage re-pricing.
FNArena's database shows two Buy ratings, five Hold and one Sell (Morgan Stanley). The consensus target is $73.95, suggesting 5.9% upside to the last share price. The dividend yield on FY19 and FY20 forecasts is 6.2% and 6.3% respectively.
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