Lex Hall: Hi, I'm Lex Hall and welcome to the Morningstar series, "Ask the Expert." Today, I'm joined by Morningstar's senior banking analyst Dave Ellis. We're going to talk about the Commonwealth Bank (ASX: CBA), how it fared in reporting season and catch up on what the future holds for Australia's largest bank.

G'day, Dave.

David Ellis: Hi, Lex.

Hall: I wanted to start with a comment that CBA's chief executive Matt Comyn made when CBA reported. He said the bank is making very good progress on becoming a "simpler and a better bank". What do you make of that statement?

Ellis: Well, they've been in the process of selling or divesting certain what are known as non-core businesses. So, we've seen the Commonwealth Bank's life insurance business being quarantined. And that sale is not complete yet, but it is expected later this year. We've seen the sale of Commonwealth Bank's global asset management business. It was announced – the completion was announced just the day or two before the results were released. And of course, just as importantly, the bank's financial planning business, financial advice businesses are also under review, and the intention is for some of those businesses to be exited in the next 12 months or so.

Hall: Let's have a look at the result. In particular, the bank took a 4.7 hit to profit. You described the result as messy. How do you think retail investors should interpret that?

Ellis: Well, the word messy comes back to this point about the simplification of the business. So, in the financial results there's discontinued businesses, there's continuing businesses, there's one-off remedial costs that were incurred. So, there's a lot of moving parts in the result. And that's why we're looking at the underlying fundamentals. So, it wasn't too bad when you exclude or look through the bits and the moving parts. One of the disappointments was expenses growth. So, expenses growth was higher than expected and revenue growth was a bit weaker or softer than expected.

Hall: Those expenses, are they related to the fallout from the royal commission?

Ellis: Yes, yes. There's a lot of money being spent, a lot of resources being invested in compliance, risk…

Hall: Across the board in all banks, I suppose.

Ellis: All banks, yes.

Hall: And what about – so for CBA, how much is that part of their messy result?

Ellis: Well, separately, there were one-off remediation costs and that did include some compliance, extra compliance costs have around about 700-odd million dollars.

Hall: Is that paying customers back for shortcomings and mistakes that the…

Ellis: Part of that, part of that is, particularly in the financial advice or financial planning businesses. So, where it hasn't – where the banks can't prove that service has been provided to financial advice clients over a long period of time, where the banks can't identify that it's actually been delivered, the advice been delivered, and they are refunding those fees.

Hall: OK. How does it rank as a dividend stock?

Ellis: Well, it's a very strong dividend payer, not just because of its yield. So, the dividend yield is a little bit over 5 per cent. So, that grosses up to about 7.5 per cent, which is obviously an attractive dividend yield. But the most important part is the sustainability and the security of that dividend in the future. And that's where I think you can rank or rate Commonwealth Bank as a strong dividend payer. It's got surplus capital. It'll have more surplus capital over the next 12 months as some of these asset sales complete. And I think we'll see some capital management initiatives in the next 12 months, maybe late this year or early next calendar year, where they will be substantial returns of capital to shareholders in addition to the ordinary dividend. And my guess is, it probably will be done by a structured off-market share buyback.

Hall: OK. I wanted to conclude on another interesting remark in your report, and that is, CBA's strong emphasis on home loans. Now, you say that critics have always sort of cited this as a weakness, whereas you argue that it's in fact a strength. How do you justify that?

Ellis: Well, for a long time, a lot of so-called commentators and so-called experts have projecting and predicting the collapse in the Australian residential housing market, particularly offshore or international…

Hall: A US-style crash.

Ellis: Yes. Now, for a whole range of reasons I don't think that is a likely outcome in Australia. We have seen, of course, house price, average house price, correction over the last two years. So, Sydney house prices have fallen from peak in 2017 into troughs in 2019 or around about 14 per cent. A lot of commentators thought that – they were expected that house price falls to continue to maybe 20 per cent or 30 per cent. But that doesn't look like the case. House prices, or the housing market seems to be stabilizing. I never believed or thought we would see a severe housing crash in Australia. So, equally as important is that home loan losses, so the loan losses from home loans in Australia are ridiculously low. So, they run – they've got a 30-year average of about 2 to 3 basis points per year now. That is effectively a rounding error. So, loan portfolios, home loan portfolios, in Australia for decades have been very strong and have been secure and the banks have not lost much money at all on home loans.

So, that's the point I'm making - some people view the Commonwealth Bank's exposure and major banks' exposures to home loans as a risk, a key risk, but I see it as a key advantage because looking at history and looking forward, my take on the future is that home loans will continue to be a low-risk, high-profit business for the major banks and Commonwealth Bank in particular with the No 1 market share in home loans in Australia.