Soft banking non-interest income
Commonwealth Bank (CBA) has announced unaudited cash earnings of approximately $2.35bn for 3Q18 on a continuing operations basis. Underlying operating income reduced by 4% on a run-rate basis from 1H18 to 3Q18. The softness was driven by weaker treasury and trading income.
We understand that the weaker treasury outcome was the result of a one-off hedging loss stemming from restructure of economic hedges relating to offshore term wholesale funding. We also understand the weaker trading income performance was largely the result of lower customer sales income. However, with the BBSW-OIS spread elevation since early-March, we expect to see increased customer demand for interest rate hedging in 4Q18.
Regulatory/compliance spend risk for CBA is materialising
The underlying expense growth run-rate from 1H18 to 3Q18 was disappointingly high at approximately 3%. This is despite the 1H18 cost base including a $200m provision charge relating to regulatory, compliance and remediation program costs. Cost growth in 3Q18 has been driven by increased provisions for regulatory and compliance project spend.
We suspect that much of this increase in provisions is the result of APRA's prudential inquiry into CBA.
Deterioration in certain asset quality metrics
The balance of 'corporate troublesome' exposures increased from $2.6bn at Dec-17 to $3.2bn at Mar-18. We understand that this increase was predominantly the result of one large corporate exposure being downgraded from watchlist to troublesome status. However, it appears that CBA has not had to materially increase the provision against this exposure.
There was also an uptick in home loan arrears over the quarter which CBA has said was driven by a small number of customers experiencing difficulties with rising essential costs and limited income growth.
The balance of group impaired assets was stable over the quarter.
Investment view and changes to forecasts
We have reduced our cash earnings per share forecasts by 3.2% for FY18F, 2.3% for FY19F and 2.2% for FY20F, largely due to lower income and higher expense forecasts. We have reduced our 12 month share price target slightly (Morgans clients can login to view). Key downside risks to our target price include a material increase in funding costs and greater-then-expected asset quality deterioration. We reiterate the risk of a cut to CBA's long-term credit rating.
While CBA remains our least preferred major bank we maintain our Add recommendation.
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