Commonwealth Bank: Quality but overvalued

About the author:

Azib Khan
Author name:
By Azib Khan
Job title:
Senior Analyst
Date posted:
12 November 2020, 1:42 PM
Sectors Covered:
Banks

  • We have downgraded our cash EPS forecasts by 3.8%/4.8% for FY22F/FY23F respectively following CBA’s 1Q20 trading update.
  • While we continue to believe that CBA has a relatively high quality retail franchise and a relatively good risk profile, we continue to believe that CBA is expensive relative to the other major banks. Our recommendation is downgraded to Reduce (from Hold).

Sector-leading collective provision coverage

CBA has announced unaudited 1Q20 cash NPAT of ~$1.8bn. On a run-rate basis, this is 7.5% softer than what we were forecasting for FY20, however, 1Q20 has been impacted by a collective provision top-up that we do not expect to be repeated in coming quarters. We have not materially changed our FY21F cash EPS. The 1Q21 credit impairment charge is $550m. Of this $550m charge, $395m was due to a net increase in the collective provision (CP).

CBA’s CP coverage of credit risk weighted assets has increased from 144bps at 30/6/20 to 156bps at 30/9/20 and this is the highest CP coverage of the major banks alongside NAB.

Expecting modest NIM contraction going forward

Income was flat from 2H20 to 1Q21 on a run-rate basis, with net interest income flat and non-interest income up 1%. CBA’s home loan growth and domestic business lending growth were both above system over the quarter. The 1Q21 net interest margin (NIM) is lower than 2H20 although CBA has not provided any NIM figures.

The NIM contraction was largely attributable to a lower interest rate environment as well as unfavourable lending margins (including the mix effects of growth in lower margin fixed rate home lending and a reduction in higher margin consumer finance balances) and higher liquid assets. CBA’s Liquidity Coverage Ratio (LCR) averaged 146% in 1Q21 (compared to what we consider to be a more normal level of 130%), however we note that the spot LCR as at 30/9/20 was 125%. If this normalisation of the LCR is sustained in 2Q21 then we expect this factor to be supportive of the NIM in the next quarter.

While we expect the low interest rate environment and the front to back book mortgage pricing impact to remain substantial NIM headwinds, we expect the following NIM tailwinds to be strong enough to largely offset these headwinds over the next 12 months: strong growth in at-call deposits; access to the RBA’s Term Funding Facility (TFF); and downward pressure on savings and term deposit rates.

Expenses a weak area of update

Operating expenses are a disappointing element of the trading update, with expenses up 2% from 2H20 on a run-rate basis (excluding customer remediation provision charges in 2H20). CBA has said that this increase in operating expenses was the result of increased investment spend and higher staff costs due to continued impacts from COVID-19.

Investment view and changes to forecasts

We have reduced our cash EPS forecasts by 3.8%/4.8% for FY22F/FY23F respectively largely due to lower NIM forecasts and higher operating expense forecasts. Our recommendation is downgraded to Reduce (from Hold). Our target price, based on our DDM valuation, is reduced (login to view updated target price).

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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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