Australia | May 14 2019
The third quarter was always going to be the weakest for Commonwealth Bank, and a range of new customer initiatives signals the re-basing of its business is significant.
-Remediation expenses in the near term, revenue challenges in the medium term
-Divestments to provide an uplift to capital surplus
-Further cost savings likely over the medium term
By Eva Brocklehurst
Third quarter trends were weak for Commonwealth Bank ((CBA)), brokers agree, but the extent to which these trends are deteriorating remains the key question. Citi suspects the majority of the weakness can be considered temporary, while Morgans opts to downgrade to Hold from Add, given the extent of re-basing announced by the bank.
Commonwealth Bank has, since FY18, introduced a range of new customer initiatives, including fee removal, fee reductions and pre-emptive fee alerts for the benefit of customers. This is expected to result in foregone annual income across continuing operations of $415m, of which $275m will be recognised in FY19. This re-basing predominantly affects non-interest income but also reduces net interest income because of a change in the calculation of interest on credit cards.
The March quarter provided evidence that Commonwealth Bank, while in an enviable position in the Australian banking landscape, is not immune to the challenges, Ord Minnett observes. This was particularly evident in the $714m of additional remediation, regulatory and compliance provisions that were taken in the quarter, as well as the ongoing pressure on non-interest income.
Valuation is fair to full, the broker assesses. Macquarie concurs Commonwealth Bank is ahead of its peers with respect to re-setting the business to the current environment, but challenges in retail banking remain and it is difficult to justify the stock's current premium valuation.
Macquarie downgrades estimates by -5%, largely as a result of higher remediation expenses in the near term and the revenue challenges in the medium term and, while it is hard to ascertain whether the bank is being more assertive versus its peers, the results confirm the sector's revenue challenges.
Credit Suisse, albeit disappointed with the March quarter outcomes, assesses the structural re-basing of the business has been completed, downgrading FY19 estimates for earnings by -7% to incorporate the $500m post-tax remediation charge. Outer year estimates are down -4% because of lower revenue.
While maintaining an Outperform rating, Credit Suisse agrees there are immediate challenges for the sector, amid some cautious commentary regarding asset quality. Against the backdrop of further regulatory uncertainty the banking sector is considered unlikely to outperform the market.
Third quarter revenue fell -4% on the quarterly average of the first half. Morgan Stanley believes the update highlights the growing pressure on retail bank profitability from slower loan growth, margin pressure and new customer initiatives. The broker argues that a reduction in profitability may be required over the next few years to win back the support of key stakeholders and enhance long-term sustainability.
While the bank is taking steps to restructure and simplify, UBS considers the significant headwinds in the sector make it hard to envisage much upside.
CBA topped up its provisions for remediation, and believes there is little more to be done in this regard. Morgan Stanley disagrees and forecasts a further $200m of charges, which would bring the bank's total, ex AUSTRAC, to the lower end of the peer group. The broker calculates CBA booked around $1.7bn in fines and remediation over the past two years, including the AUSTRAC settlement.
Citi is more positive, suspecting the bank has ruled a line through customer remediation, choosing to accelerate this across a number of business products and services. After this announcement, CBA's advice remediation is on par with Westpac's ((WBC)) and expected to be sufficient. Morgans acknowledges the bank's comment but remains mindful of further costs in the future.
Asset quality metrics deteriorated, as bad and doubtful debts increased and consumer arrears were higher. Total accounts in negative equity came in at 3%, and approximately three quarters of this was in Western Australia and Queensland. The bank has stated that emerging signs of weakness in the discretionary retail, drought-affected communities and single name exposures drove the increase in troublesome assets.
Morgan Stanley forecasts around $3.5bn of buybacks over the next two years, noting that capital management cannot commence until asset sales are completed and it will not be sufficient to offset the dilution from the divestments program.
However, Ord Minnett expects a strong capital position should emerge over the next 12 months, while there are cost savings to be had over the medium term. The CEO has stated that, contrary to recent media reports, the bank is not contemplating large-scale branch reductions in the near term.
Morgans expects Commonwealth Bank to achieve APRA's unquestionably strong CET1 benchmark of 10.5% by January 1 2020, calculating divestments will provide an uplift of around 120 basis points, subject to regulatory approvals. The divestment of Comminsure Life is expected to be completed in the first half of FY20. While this is likely to underpin surplus capital of around $5.5bn, the broker is mindful that some of this will be pulled into matters classed as contingent liabilities.
FNArena's database shows three Sell ratings, four Hold and one Buy (Credit Suisse). The consensus target is $69.58, signalling -3.5% downside to the last share price. Targets range from $60 (Deutsche Bank) to $78 (Credit Suisse). The dividend yield on FY19 and FY20 forecasts is 6.0% and 6.1% respectively.
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