CBA to put bad year behind it

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Glenn Freeman: In this edition of "Ask the Expert" we're speaking Australian banks with our senior banks' analyst David Ellis.

Now, David, you're back after a few weeks out, so we haven't had the benefit of your insights for the recent weeks. But welcome back.

David Ellis: Thanks, Glenn. Thank you.

Freeman: Now, we've had some interesting developments within the – and when have we not – but within the banking space lately. And you've just recently put out a note talking about Commonwealth Bank which – you've really marked this upcoming earnings season which they are due to report in August is going to be quite a crucial turning point for CBA. Why is that?

Ellis: Well, they've obviously had a very challenging 12 months, 18 months with profits down in the 2018 year and this year 2019 we expect their profits to be down another 10 per cent or 11 per cent. So, on the face of it, that's not a good result, and it's not a good result. But a lot of the reason – the main reason for that decline in profits for this year is to do with significant customer remediation costs that have been recogniSed. Now, we don't expect those to repeat as much in 2020 and later years. So, we're looking forward, we're looking past the 2019 result and we can see a lot better times ahead for the Commonwealth Bank and starting with the 2020 financial year with a reasonably strong recovery in earnings in that year, which will flow through to modestly higher dividends, which of course a lot of our investors are very much interested in.

Freeman: Now, David, talking there about the costs, but it's also interesting to note the share price movement that they've seen since the end of last year, up 18 per cent. How does that juxtaposition occur?

Ellis: Well, obviously, during 2018, Commonwealth Bank and major bank peers share prices suffered heavily partly due to the Royal Commission and the outcomes coming from that. But we have seen a big turnaround in equity markets globally and in Australia since the end of 2018 and Commonwealth Bank has benefited from that and led the increase in the ASX 200 over that period. And it's primarily due to the recognition that the problems experienced in 2018 are not permanent and that Commonwealth Bank's very strong consumer and business banking franchise will deliver pretty solid earnings growth once the bank gets through the current problems with heightened regulatory oversight and additional cost from the customer remediation.

Freeman: And given the importance of mortgages within Australian banks and we've had – that's an area that's had a lot of movement lately or in the last 12 months. APRA regulations have changed and then changed back again. How has that played out? And it's interesting that CBA and Westpac still remain your preferred picks within the Australian banks.

Ellis: Yeah. Well, a lot has happened in the last six months that affects the mortgage market in Australia of course. We've had the surprise election result in May, and we've seen interest rates cut twice by the reserve bank. Now, the cash rate is at record low 1 per cent level. We've seen the major banks pass through about 42 basis points, 43 basis points of that 50 basis points of cut which is a positive. As you noted, APRA has eased certain restrictions on lending criteria, and we have seen stabilisation of house prices. So, they all combined to provide some positivity for the future, for the housing market. And of course, with Commonwealth Bank being the largest lender in Australia with the largest market share will benefit disproportionately on that; same with Westpac.

And I like Westpac. It's trading at around about 10 per cent below our fair value, whereas Commonwealth Bank is trading at our fair value, a little bit above our fair value. So, looking at the value basis, Westpac is our preferred major bank. But looking at quality, then Commonwealth Bank comes into the picture.

Freeman: And probably at the other end of the spectrum is the National Australia Bank. We've had some big news from them. It just come out just today that they've announced the appointment of a new CEO. I know it's very early days but what sort of an impact does this have across the business?

Ellis: Well, a positive impact, I think, is the short answer. Ross McEwan, he is well-regarded. His most recent roles were the CEO of the Royal Bank of Scotland in the U.K. and prior to moving to the U.K. he was head of the retail business of the Commonwealth Bank here in Australia. So, he has got a lot of experience in banking and particularly his role in the U.K. dealing with the fallout from the GFC, dealing with intense regulatory oversight, political complications. He is very well-regarded, and his experience would place him in good stead.

National Australia has experienced a really tough 2018 with the Royal Commission. And we saw that the result of that was the resignation of the CEO Andrew Thorburn and the announcement that the current Chairman, Dr. Henry, is intending to resign as Chairman. So, what we're going to see? We've got National Australia Bank, we'll have a new Chairman, Philip Chronican and a new CEO, Ross McEwan and I think those two executives complement each other. They've worked together in the past at RBS, Royal Bank of Scotland. Ross McEwan may not start until April 2020. And then, it will take at least one to two years to really get a good gauge of where they are making a difference and executing successfully and driving change and driving improvements across the business.

Freeman: Sure. We'll keep an eye out for the more detailed assessment of that which will be landing soon on the Morningstar website.

Ellis: Thank you.

Freeman: Thanks, David.

Ellis: Thanks, Glenn.

This report appeared on www.morningstar.com.au 2019 Morningstar Australasia Pty Limited

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