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Reprieve For CommBank Likely Shortlived

Australia | Nov 13 2019

This story features COMMONWEALTH BANK OF AUSTRALIA. For more info SHARE ANALYSIS: CBA

Despite a reprieve in the first quarter, margin pressures are expected to continue for Commonwealth Bank. Will the bank sustain its dividend?

-First quarter margins underpinned by delay in passing on rate cuts
-Macquarie suspects dividend may be hard to maintain
-Stock considered expensive/fully valued

 

By Eva Brocklehurst

While Commonwealth Bank ((CBA)) performed strongly, and better than most expected in the first quarter, brokers suspect the issues surrounding ultra-low interest rates will continue to have an impact.

Moreover, given margin pressures from lower interest rates and the narrowing of the front-to-back book spread, Macquarie believes the dividend will be increasingly difficult to sustain, unless the bank can offset revenue pressures through further mortgage re-pricing.

Morgans was generally pleased with the quarterly outcome, given an increase in net interest income and growth in home and business loans. Asset quality appears sound and there were no new customer remediation provisions.

Cash net profit in the first quarter was $2.3bn. UBS notes this is around $150m ahead of the "run rate" embedded in first half estimates but remains cautious about extrapolating the update because quarterlies are inherently volatile.

UBS increases first half forecasts, largely offset by reductions later in the year and notes margins were underpinned by a sharp fall in bank bill swap rates (BBSW) and the delay of around three weeks in passing on variable mortgage rate reductions to customers.

Consumer arrears improved over the quarter because of seasonality and the benefit of higher tax refunds. The bank has indicated troublesome assets in the corporate sector continue to reflect weakness in discretionary retail, construction and agriculture, as well as some single name exposures.

Margins And Costs

Commonwealth Bank grew deposits of 10.4% annualised in the quarter vs major bank peers at around 7-9%, yet Ord Minnett cuts forecasts by -4% in FY20 and -5% in FY21, mostly because higher costs are anticipated.

It would appear from the results that the loan-to-deposit spread is stable, yet Shaw and Partners asserts this is contrary to popular wisdom, where falling interest rates reduce the benefits of low-cost retail deposits that cannot be offset elsewhere and exacerbate the decline in net interest margins.

Costs still increased despite management's objective of reducing the overall expense base, Macquarie notes. While earnings downgrades are likely to be smaller than peers, and a superior capital position should provide near-term support, the broker expects low interest rates will affect the future performance of the bank and elicit cost pressures.

Net interest margins for Commonwealth Bank are likely to start falling in the second quarter as official rate cuts impact on spreads, brokers suspect. Morgan Stanley forecasts a -4 basis points year-on-year decline in net interest margin in FY20.

However, this indicates Commonwealth Bank could achieve better margin and volume outcomes vs peers, making it the only major bank able to grow revenue in FY20. The bank continues to win market share, particularly in mortgages, the broker notes, although greater productivity gains need to be delivered for Commonwealth Bank to reach its full-year targets.

Capital Returns

The bank continues to outperform peers and has a strong capital position. UBS assumes $3bn in capital returns in the second half following the completion of life insurance sales. The market may be relieved by the update, but Citi suspects the implications for the buyback will put pressure on the valuation premium relative to peers, and the buyback is likely to be delayed 18 months.

Credit Suisse considers "11% is the new 10.5%" in terms of CET1 ratios and lowers buyback expectations to $2.5bn, to be executed in FY21. As is the case with other banks, the broker factors in a further $300m in FY20 pre-tax as a top up of aligned dealer group remediation.

Morgan Stanley expects the CET1 ratio to approach 11% in the first half once all asset sales are completed. While Macquarie assesses the bank's capital position is leading the sector it will need to target a level II CET1 ratio of over 11%. On this basis, the broker estimates a capital surplus of $2.6bn amid scope for capital management in FY20.

The stock is now trading on 17x FY20 estimates, which makes it one of the most expensive developed-market bank stocks in global history, UBS asserts. Other brokers agree the share price is expensive, with Ord Minnett calculating an adjusted price-to-earnings ratio of around 16.5x FY21 earnings. Still, the broker points out that the total estimated 12-month return is a barely in negative.

Shaw and Partners, not one of the seven monitored daily on the FNArena database, has a Hold rating and $80 target. The database has three Hold and four Sell ratings. The consensus target is $73.30, signalling -8.5% downside to the last share price. The dividend yield on FY20 and FY21 forecasts is 5.4% and 5.2% respectively.

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