The Commonwealth Bank’s (ASX: CBA) full year profit of $10.2 billion was just shy of Morningstar’s $10.3 billion forecast, however, the outlook remains bright for the bank.

It’s an assessment made by Morningstar bank analyst Nathan Zaia. The profit result was marred by higher-than-expected operating and bad debt expenses as the market outlook remains challenging.

“There were signs of downside risks building as rising interest rates have a lagged impact on mortgage customers and other cost of living pressures becoming a financial strain for more Australians,” CBA CEO Matt Comyn said when announcing the bank’s result this week. But with the bank’s “strong balance sheet” the bank chief added that the bank is “well placed to support its customers and manage headwinds”.

It seems the banks can also manage these headwinds for investors. The bank’s dividend yield of just under 4.5% left “little room for disappointment”, noted Zaia.

Indeed, full-year dividends of $4.50 per share increased 17% on last year, even beating Morningstar’s $4.40 per share forecast. But with rising bad debts and margins peaking, can the bank major sustain these juicy dividends.

Zaia believes CBA is well positioned to continue delivering on the dividend front.

“The outlook for dividend growth remains positive in our view, with the bank sitting on $3.1 billion in surplus capital, above the top-end of its target range”.

Moreover, the bank's common equity Tier 1 ratio of 12.2%, or 12.0%, comfortably exceeds the 10.25% regulatory minimum.

Other parts of the business remain challenging for the bank. Its net-interest-margin fell 5 basis points compared with the first half amid strong competition in home lending and customer deposits. However, its 2.05% margin still supports the bank’s ability to deliver strong profits.

While higher funding costs will impact the bank’s ability to be aggressive on the home loan pricing front, Zaia noted that the bank was the first to cancel cash back offers and lift its home loan rates independent of cash moves.

“As a market leader, in terms of market share and operating efficiency, we think it's logical for wide-moat-rated banks to lift rates and see if peers follow,” Zaia said.

How bad are bad debts?

As noted earlier, bad debts are trending upwards revealing emerging household stress. This could be amplified with the mortgage cliff looming with borrowers on low interest rates soon to confront a higher interest rate environment.

Assessing the bank’s numbers, its 30-day arrears rose to 0.92% of loans, up from a bottom of 0.82% a year ago. But according to Zaia the figures are not alarming with those arrears’ numbers still much lower than the 1.25% recorded in fiscal 2020. He notes that stress is yet to flow through to 90-day arrears which fell to 0.47% from 0.49% a year ago adding that for comparison, over fiscal 2017 to 2019, 90-day arrears sat between 0.6% and 0.7%.

Comyn also stated the number of cases in hardship are still 27% below pre-COVID-19 average levels.

Moreover, the bank’s data revealed that the percentage of customers in advance and with offset balances are unchanged from the second half. However, there are signs that some households are struggling to meet their repayments given increase in interest only loans, 10% of loans compared with 9% six months prior.

In his investor presentation, Comyn highlighted that the bank is actively engaged with its customers who are struggling also revealing that there has been an increase in hardship support.

Ultimately, Zaia believes the future remains bright for CBA.

“We believe the bank is well provisioned on the bad debt front and is also sufficiently capitalized to be supporting dividend growth. The bank’s dominant market position, strong profitability and still sound loan book will steer CBA through a challenged outlook.”