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Remediation costs dent CBA's 3Q update

Lex Hall  |  14 May 2019Text size  Decrease  Increase  |  
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The Commonwealth Bank’s strong balance sheet and market hegemony are enough to dispel a poor third quarter, says Morningstar’s David Ellis, who retains an upbeat long-term view.

In trading on Tuesday, the Commonwealth Bank (ASX: CBA) share price was down by 1.4 per cent at $72.48 on Tuesday – a 9 per cent discount to the $80 fair value estimate set by Ellis.

This decline comes amid an escalation in US-China trade tensions, along with a poor third quarter trading update – punctuated by higher remediation costs, lower revenue and higher expenses.

The bank posted cash earnings of $1.7 billion, a 28 per cent fall on the average of the previous two quarters. This fall was chiefly attributed to $500 million of aftertax customer remediation costs, or notable items.

Excluding the notable items, underlying cash profit was 9 per cent lower at $2.2 billion, “well below” Ellis’s expectation of $2.4 billion.

To date, CBA has incurred $2.17 billion in customer remediation and regulatory costs.

“Regulatory, prudential, royal commission and legal issues facing the bank continue to distract senior management from growing the business and increasing shareholder value.” 

Home loans ‘high quality’

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Despite the miss, Ellis retains a positive view on Australia’s biggest bank. He is unfazed by its exposure to home loans at a time when property prices are weakening.

“CBA has traded at a premium to major banks peers due to a lower financial risk and a long history of sustainable earnings and dividend growth despite slow system credit growth and pressure on funding costs,” Ellis says.

“Some market investors consider CBA’s strong emphasis on home loans a weakness, but we argue it is a key strength. In our view, concerns centred on a US-style housing crash are overdone.”

The bank’s home loan book is high quality, in Ellis’s view. As at December last year, the average loan/valuation ratio for the Australian portfolio was 51 per cent, based on current market values.

About 78 per cent of customers were ahead with their payments by an average of 35 monthly payments, including offset balances. And an allowance for interest rate rises of 225 basis points is built into serviceability tests, Ellis says.

The bank’s loan impairment expense rate – in short, loans that are unlikely to be repaid – is much lower than it was during the global financial crisis.

“In first half fiscal 2019, the loan impairment expense rate was 0.15 per cent of gross loans, down significantly from the previous peak of 0.73 per cent in fiscal 2009, at the height of the credit crisis.”

Another reason for Ellis’s upbeat view is the bank’s world-class standing in terms of capital requirements. Its common equity Tier 1 ratio of 15.8 per cent compares favourably with global peers, Ellis notes.

Other forecasts:

  • Fiscal 2019 cash profit of $8.8bn, down by 10pc
  • Fully franked dividend falls slight to $4.31 per share based on a high 86pc payout
  • Final dividend of $2.31 per share
  • Fourth-quarter net profit of $2.4bn

At current prices, the big four banks are trading at the following fair value discounts:



is senior editor for Morningstar Australia

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