Commonwealth Bank’s (ASX: CBA) first-quarter fiscal 2027 cash profit of about $2.8 billion was flat on the second-half quarterly average. Income growth of 3% was driven by loan growth, but was matched by 3% higher expenses, while loan impairments rose to AUD 300 million.

Why it matters: The update is largely as expected. Home loan growth is slowing, net interest margins are steady, and credit quality is normalizing from low levels. Home loan applications fell 16% versus a year ago, consistent with our forecast for housing credit growth to slow to 3% in fiscal 2027, down from 6% last year.

  • Business loans in the first quarter are up 14% annualized, running well ahead of our fiscal 2027 forecast of 7%. Investment in more bankers is paying off, but we expect growth to slow as business stress rises.
  • Costs are the watchpoint. Expenses are up 5% versus a year ago, above our low-single-digit medium-term assumption and peers’ guidance of 0%-3% growth in fiscal 2027. We think management is investing to support revenue, but if growth slows as we expect, we see room to rein in spending.

The bottom line: We maintain our $108 fair value estimate for wide-moat Commonwealth Bank. Shares remain materially overvalued, trading more than 50% above our valuation.

  • A forward P/E around 25 and a 3% dividend yield are hard to justify against mid-single-digit earnings growth and peers on 15-18 times.

Between the lines: Underlying NIM was broadly stable, as deposit hedge earnings offset lending competition and a shift to higher-cost deposits. We still expect rational pricing to prevail over time as competitors earning near their cost of equity pull back.

  • Credit stress is rising from low levels but remains manageable. Softer house prices, rising unemployment, weaker economic growth, and higher energy costs could push bad debts back toward long-term averages.
  • Loan impairment expense of 0.11% of loans annualized is up from 0.08% in fiscal 2026 but still below our 0.15% medium-term forecast.

Commonwealth Bank well-placed to navigate changes in economic conditions

Commonwealth Bank of Australia is the largest of Australia’s four highly profitable, wide-moat-rated major banks. It offers a full suite of banking services in Australia and New Zealand. In the long run, the bank has consistently increased shareholder wealth in favorable economic times. The loan book’s large weighting to home loans and the high proportion of customer deposits reduces risk on bad debts and sudden changes to funding costs.

While Australian housing is expensive and debt/household income ratios are high, we remain comfortable for several reasons. Tight underwriting standards, lender’s mortgage insurance, low average loan/valuation ratios, a high incidence of loan prepayment, full recourse lending, and a high proportion of variable rate home loans combine to mitigate potential losses from mortgage lending.

With cash rate increases to combat high inflation, the risk of higher credit losses has increased. It could also reduce demand for credit. Tax changes which restrict negative gearing and reduce capital gain tax discounts are also expected to be a headwind for mortgage growth. We expect modest credit growth and steady margins over the medium term. Operating expenses will continue to rise due to inflationary pressure and the bank investing to capture growth opportunities, this despite productivity improvements being realized.

Bad and doubtful debts expense peaked in first-half fiscal 2009. Elevated loan losses in fiscal 2020 were entirely due to loan loss provisions. With large provision balances, and economic conditions improving, loan losses are expected to be moderate in the short term.

A string of divestments plus strong organic capital generation see the bank retain a strong capital position even after completing share buybacks.

Bulls say

  • Commonwealth Bank of Australia’s well-managed net interest margins, sound asset quality, and strong balance sheet continue to consistently deliver solid financial results.
  • Costs have been increasing due to inflation and investments in technology, but in the longer term, we expect tighter control to support earnings.
  • Strong organic capital generation leave the bank well placed to make market share gains while still paying attractive dividends to shareholders.

Bears say

  • Increased regulatory, political and public scrutiny could erode the bank’s pricing power and over time, its wide economic moat.
  • Commonwealth Bank is a major beneficiary of transaction account funding, and competitors paying much higher rates could encourage more customer switching and increase the average cost of funds. AI tools could also make it easier for customers to compare and switch.
  • Slow GDP growth and highly indebted households could see credit growth slow further.