Commonwealth Bank: Update supports good value thesis
About the author:
- Author name:
- By Azib Khan
- Job title:
- Senior Analyst
- Date posted:
- 08 November 2018, 1:45 PM
- Sectors Covered:
- 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.
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.
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