Commonwealth Bank: it's possible to over-love a bank

About the author:

Azib Khan
Author name:
By Azib Khan
Job title:
Senior Analyst
Date posted:
09 August 2019, 6:31 PM
Sectors Covered:

  • CBA has reported FY19 cash NPAT of $8.706bn (including discontinued operations), which is 2% less than our expectation and also looks to be ~2% less than FactSet consensus. A fully franked final dividend of $2.31 per share has been declared, unchanged from pcp and in line with our expectation. 
  • We are forecasting a $2.5bn off-market share buyback in 2H20F. 
  • We believe CBA's result bodes well for the outlook of major bank earnings in terms of home lending growth and residential mortgage asset quality. 
  • We continue to view CBA's current share price multiples as stretched, and CBA remains our least preferred major bank for this reason.

Institutional lending contraction has its positives 

On a continuing operations basis, total operating income for FY19 was ~1% less than we expected and this was one of the reasons for the earnings miss.

While the NIM outcome for 2H19 was 1bp better than we expected, FY19 net interest income was 1% less than we expected largely due to the institutional lending book contracting significantly in 2H19.

While the contraction of this book has weighed on earnings, we view it as a positive from the perspective of return on tangible equity (ROTE) as the contraction has stemmed from portfolio optimisation initiatives and a focus on risk-adjusted returns. 

Housing outlook not as grim as bears might suggest 

CBA has said that it is seeing an improvement in the housing market including improved clearance rates, stabilisation of prices in Sydney and Melbourne, and slightly higher housing credit growth; and there is a pipeline of stimulus including tax cuts and infrastructure spending which has not yet flowed through.

It is also pleasing to see in CBA's result that 90-day home loan arrears improved by 2bps over the year.

We believe these factors are positive for CBA's earnings outlook. Furthermore, in terms of CBA's NIM, we do not expect contraction from 2H19 to 1H20F as we have detailed inside this report.

Expecting capital return

CBA's pro-forma CET1 ratio (which allows for completion of announced divestments as well as upcoming regulatory changes) was 11.8% at Jun-19, comfortably above APRA's 'unquestionably strong' benchmark of 10.5%.

CBA is now saying that it is well progressed with alternative transaction arrangements for the sale of CommInsure Life should the transfer of the BoComm Life stake take longer; in this regard, the Company has said that it believes it is in a "very strong position" to be able to update the market before the end of September 2019.

Our forecasts assume that the CommInsure Life sale will complete by end-1H20 and we expect capital return of $2.5bn in 2H20F in the form of an off-market share buyback (although other forms of capital return are possible).

Investment view and changes to forecasts 

We have reduced our cash EPS forecasts by 3.8% for each of FY20F and FY21F, largely due to lower operating income forecasts. Our target price, based on our DDM valuation, is unchanged (Morgans clients can login to view detailed reports and price targets). We retain a Hold recommendation. Key downside risks include a material increase in funding costs and significant asset quality deterioration. 

More information

Morgans clients can login to view our detailed report and 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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