Commonwealth Bank: Update supports good value thesis

About the author:

Azib Khan
Author name:
By Azib Khan
Job title:
Senior Analyst
Date posted:
08 November 2018, 1:45 PM
Sectors Covered:

Key points

  • CBA has announced 1Q19 unaudited cash earnings of ~$2.50bn, which is broadly in line with our expectation.
  • The trading update is consistent with our view that CBA is offering good value at the current share price. However, we prefer WBC and NAB over CBA. 

Revenue to benefit in 2Q19 from recent home loan repricing

While the Company has said that the Group NIM reduced from 2H18 to 1Q19, it should be noted that CBA's recent increase of 15bps in all Australian variable home loan rates became effective on 4/10/2018; meaning that 1Q19 earnings did not benefit from this repricing. The net interest margin, operating income and cash earnings will receive a boost from this repricing in 2Q19.

Household deposit growth was strong at 8.9% annualised over 1Q19, and we understand that a key driver of this growth has been transaction deposits. We therefore believe the NIM is benefitting from a favourable change in funding mix and we expect this benefit to continue to flow through to NIM in 2Q19. At the same time, we believe there are emerging signs that front book home loan discounting in Australia has peaked which is positive for the NIM outlook. 

Credit quality remains sound

Credit quality has remained sound in overall terms. The 1Q19 credit impairment charge of $216m equates to 11bps of GLA, compared with 13bps in 2H18. Corporate troublesome exposures reduced over 1Q19 and 90+ day home loan arrears also reduced over this period. However, gross impaired assets increased from $3.2bn at Jun-18 to $3.4bn at Sep-18 due to an increase in home loan impaireds and a small number of individual corporate impairments.

The Pillar 3 report shows a $106m increase in residential mortgage impaireds over this period. However specific provisions for residential mortgages were up a much more modest $21m. We understand that the increase in home loan impaireds has been driven by an increase in hardship cases and this has not resulted in a meaningful increase in provisions.

In the Pillar 3 'Corporate' category, impaireds were up $159m over the quarter, however the specific provision balance for this category was down $20m. 

Scope for capital management

CBA has reported that its CET1 ratio was 10.0% at Sep-18. Previously announced divestments are expected to provide an uplift of ~120bps to the CET1 ratio, resulting in a Sep-18 pro-forma CET1 ratio of 11.2%.

We are forecasting a CET1 ratio of 11.3% at end-FY20 which creates scope for capital management given that APRA's 'unquestionably strong' CET1 benchmark is 10.5%. 

Investment view and changes to forecasts

We have reduced our cash EPS forecasts by 2.7%/2.5% in FY20F/FY21F respectively, due largely to the expected sale of CFSGAM which, for the purposes of our forecasts, we assume will be completed on 1/7/19.

We retain an Add recommendation. We have revised our 12-month target price, based on our DDM valuation (Morgans clients can log in to view). Key downside risks include a material increase in funding costs and greater-than-expected asset quality deterioration.

More information

Morgans clients can login to view our detailed report and revised share price target for Commonwealth Bank (CBA). Alternatively, please contact your Morgans adviser or nearest Morgans office for access.

Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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