Commonwealth Bank: Premium relative to peers remains unjustifiably large
About the author:
- Author name:
- By Azib Khan
- Job title:
- Senior Analyst
- Date posted:
- 18 November 2021, 9:30 AM
- Sectors Covered:
- Commonwealth Bank's (ASX:CBA) 1Q22 unaudited cash NPAT is ~9% lower than our expectation largely due to the net interest margin (NIM) being significantly lower than our expectation, non-interest income softness and higher-than-expected operating expenses.
- Our view is that CBA’s stock has been trading on a significant premium relative to peers, and we believe this premium remains significant despite CBA’s share price fall in the last trading session. In our view, the 1Q22 trading update emphasises that the current extent of the premium is unjustified.
- While WBC has also experienced significant NIM contraction, our view is that WBC’s stock has been far from being priced for perfection. We also believe that the NIM headwind from Australian home lending competition coming through for CBA is greater than that coming through for WBC. Furthermore, the cost outlook for WBC is more attractive than that for CBA in our view. For these reasons, we believe the extent of CBA’s P/NTA premium over WBC – currently ~85% – is very difficult to justify, particularly bearing in mind that these two major banks have similar loan book compositions and a similar return on tangible equity (ROTE).
- We have downgraded our cash EPS forecasts for CBA by 9-11%. Retain Reduce recommendation.
Significant NIM contraction the lowlight of the 1Q22 trading update
We calculate that the Group net interest margin (NIM) contracted by 14bps from 2.04% in 2H21 to 1.90% in 1Q22. Excluding liquid assets, we calculate that the NIM contracted by 7bps over the same period.
Excluding liquids, we infer that the NIM contraction was driven predominantly by home lending competition and mix. It appears to us that this headwind is stronger for CBA compared with WBC.
We particularly think this is the case as CBA has said that domestic business lending continued to grow above system in the quarter on stable margins, whereas WBC’s group margin contraction was also attributable to contraction in business lending spreads.
The increase in liquid asset balances in the Sep-21 quarter is unrelated to the RBA’s Committed Liquid Facility (CLF) and appears to be the result of a transient surplus funding position stemming from Term Funding Facility (TFF) drawdowns and customer deposit growth.
We expect some reduction in CBA’s liquid asset balances in the Dec-21 quarter as the surplus funding is used to replace maturing term wholesale funding. Despite our view that liquid assets are likely to reduce in the Dec-21 quarter, we expect further headline margin contraction from 1Q22 to 2Q22.
Adding headcount to process lower margin volumes?
Excluding remediation costs, CBA’s operating expenses increased 3% on a runrate basis from 2H21 to 1Q22. CBA has said that this was mainly due to higher staff costs from lower annual leave usage, and increased staffing levels in response to higher volumes and to help deliver on strategic priorities.
It appears that the intensity of home lending competition is now at the point that not only is it resulting in significant margin contraction, but it is also resulting in increased staffing levels to process lower margin volumes.
We believe that we are now seeing the peak intensity of home loan competition and we do not expect further intensification from here.
Credit quality sound
CBA has disclosed a credit impairment charge of $103m for 1Q22, equating to an annualised 5bps of average gross loans and acceptances. Following provision releases in 2H21, total credit provisions were broadly unchanged over 1Q22.
CBA has said that its current level of credit loss provisioning reflects both sound portfolio credit quality and a cautious approach to provisioning as the economy recovers from restrictions related to COVID-19.
Investment view and changes to forecasts
We have reduced our cash EPS forecasts by 10.7%/9.4%/9.2% for FY22F/FY23F/FY24F respectively largely due to lower net interest income, lower non-interest income and higher operating expenses.
Our target price, based on our DDM valuation, is reduced to (login to view).
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