- As part of its 3Q19 trading update, CBA has announced cash NPAT from continuing operations, excluding notable items, of ~$2.2bn. This is softer than we expected largely due to rebasing of non-interest income.
- Our recommendation is downgraded to Hold due to a combination of a lower target price and share price strength over the last month.
Rebased fee income disappoints
On a run-rate basis, non-interest income was down 10% from 1H19 to 3Q19, which was a disappointing feature of the update. This reduction was partly driven by the rebasing of fee income as part of the Bank's 'Better Customer Outcomes' program.
This is the first time we recall formally hearing about such a program (even though the Company today said that the rebasing under this program commenced in 1H18), and the extent of rebasing announced today was surprising to us.
The Company has said that since 1H18 it has introduced a range of new customer initiatives, including fee removals, fee reductions and pre-emptive fee alerts, for the benefit of customers.
These are expected to result in total annual income forgone across continuing operations of $415m, of which $275m will be recognised in FY19 ($180m already recognised in the 9 months to 31 March 2019).
While this rebasing predominantly affects non-interest income, we understand it has also reduced net interest income by ~$50m pa (~1 basis point of NIM) due to a change in the calculation of interest on credit cards.
Remediation costs double our expectations
Customer remediation-related costs for 3Q19 totaled $500m post tax, which is double our expectation.
We believe the outcome supports our view that the banks which have attracted more negative publicity in recent years are likely to incur higher remediation costs.
We remain mindful of NAB for this reason. Back on CBA, the Company today said that "the Bank believes it has adequately provided for currently known banking and wealth customer remediation".
Contingent liabilities posing threat to potential surplus capital?
The Company has said that its CET1 ratio was 10.3% at Mar-2019. We continue to view CBA as being on track to achieve APRA's 'unquestionably strong' CET1 benchmark of 10.5% by 1/1/2020, particularly bearing in mind that announced divestments will provide an uplift of ~120bps subject to regulatory approvals.
The Bank now expects the divestment of CommInsure Life to complete in 1H20 (compared with 2H19 previously).
While we expect the Company to have ~$5.5bn of surplus CET1 capital at end-FY20 (assuming no impact on this position from proposed RBNZ capital rules), we are mindful that some of this surplus capital may be chewed up by matters being classified as contingent liabilities.
It is perhaps a warning sign that an entire slide today was dedicated to such matters.
Investment view and changes to forecasts
We have reduced our cash EPS forecasts for FY19/FY20/FY21 by 9.1%/6.2%/5.5% respectively. Our recommendation is downgraded to Hold.
Our target price, based on our DDM valuation, is reduced (available here Morgans client only).
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