- Commonwealth Bank's (CBA) 1H18 cash NPAT, excluding the civil penalty provision, was $5.246bn, 2.4% better than our forecast. An interim dividend of $2.00 per share has been declared, a little less than we expected which we believe is due to the impact of the civil penalty provision.
- A strong net interest margin (NIM) outcome was a real positive and bodes well for the sector NIM outlook. The result also shows that asset quality conditions remain benign, again a positive for the sector.
Provisions weigh on result
CBA has taken a civil penalty provision of $375m (not deductible for tax) in relation to the AUSTRAC case. Additionally, a $200m expense provision has been taken for expected costs relating to currently known regulatory, compliance and remediation programs, including the Financial Services Royal Commission.
Risks remain despite provisions
CBA believes the civil penalty provision to be a reliable estimate of the level of penalty that a Court may impose based on currently available information. While this provision reflects CBA's current view, it is likely that AUSTRAC may have a different view, which leads to the risk that the penalty may end up being greater than $375m. We also remain cognisant of the risk that APRA's prudential inquiry into CBA results in adverse findings in relation to CBA's governance, culture and accountability frameworks which lead to credit rating downgrades for CBA as well as an increase in CBA's operational risk regulatory capital requirement.
We believe a one-notch downgrade in CBA's long-term credit rating and a 20% increase in the regulatory capital requirement for operation risk may result in an approx. 50bps reduction in CBA's return on tangible equity (RoTE).
Positives for the sector
CBA's NIM expanded 6bps from 2H17 to 1H18 despite 1H18 including the full period impact of the major bank levy. The NIM outcome was assisted by the building up of funding tailwinds and narrower basis risk, both of which bode well for the NIM outlook for the sector, in terms of asset quality. CBA's result was marred by the impairment of a large single name corporate exposure which we believe to be the UK's Carillion. We believe no other Australian major bank has material credit exposire to Carillion. The underlying asset quality trends in CBA's result point to continuation of benign asset quality conditions, which also bodes well for the sector outlook.
Investment view and changes to forecasts
We have reduced our cash earnings per share (EPS) for FY18F by 1.2%, largely due to the impact of the civil penalty provision. We have increased our cash EPS forecast by 2.1% in FY19F and 1.5% in FY20F, largely due to higher NIM forecasts.
Our share price target remains unchanged, and we retain our Add recommendation.
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