The Commonwealth Bank (CBA) delivered on market expectations with a rise in profit for 2013-14 to a record $8.68 billion and the full year dividend to a new peak of $4.01, but after the market reaction yesterday the question is what it now does for an encore, especially against the background of slower and lower economic growth over the next year.
I know it’s a question that’s been frequently asked of the CBA (and its peers) during the two year bank share rally, but it’s one that certainly resonated loudly yesterday because the bank experienced a very sharp slowdown in second half earnings, a point that escaped much of the early media commentary and analysis yesterday.
The CBA report showed that total operating income grew by a measly 0.3% in the six months, but it was up 3% when you strip out one-offs like the boost to first-half profits from the internalisation of management rights to its two former property trusts, and the fact there were three fewer business days in the second half of the year.
The second half slowdown was shown by a dramatic deceleration in net profit before tax – for the year it rose 11%, but in the second half it was only up 1%.
In the bank’s core business – retail banking – operating income rose 12% for the year, but only 8% in the second half. It did better though than many of the bank’s other businesses.
And staying with the half year-on-half year comparisons, business and private banking income fell 9% to $729 million, and in institutional banking there was a fall of 13% to $584 million. In Bankwest, earnings for the year rose 21%, but were down in the second half by 7%.
Those falls were driven by weak growth in lending and, most notably, a near-doubling in the amount of impaired loans.
Total impairments in the June 30 half year jumped 9% to $496 million from $957 million. Of these, business and private banking impairments jumped 91% to $166 million, while institutional impairments rose 90% to $40 million.
I reckon we may have seen the end of the contribution to bank profits from lower bad debt charges.
So with that background, it’s easier to understand why the share price eased – nothing unusual in that – investors have been buying on the prospect and selling on the announcement for years.
The shares ended down 1% at $80.88, down from the $81.69 on Tuesday (when they rose 1.3%) and well under the all time high of $83.92 on July 31 – and up from a low of just over $70 a year ago.
That’s a 20% rise from the low to the high in roughly a year.
A repeat of that in the coming year would see the share price nudge $100 – which would be a big ask even after the record experience in 2013-14.
CBA 5Y – Questions arise over CBA’s future growth
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But given what appeared in the profit and loss account in the second half, a repeat of the surge of the past year looks a bit remote.
Certainly the chance of the bank repeating a 14% rise in cash earnings in this half of 2014-15 (the same as it did in the first half of 2013-14) looks very remote.
There are a number of mild headwinds for the CBA and its peers to battle in the coming year.
Firstly there’s the weak growth and sluggish labour market to surmount, then there’s the growing probability that the housing finance boom will be weaker than we saw in the year to June 30 – with signs of demand plateauing as building approvals ease.
With the economy slowing, bad debt provisions will start rising – in fact the CBA result showed a modest increase in bad debt charges for the year (but a 9% fall in the June half year).
And then there’s the Murray inquiry into the financial system, with the possibility it will recommend policy changes in bank structures – with the more speculative areas of investment banking being ring fenced from the rest of the bank (as is happening in some offshore markets), pressure on the banks to lower charges and fees for superannuation products, and in the case of the CBA more inquiries into its dud financial planning division’s activities, and the possibility of extra costs to repay investor losses.
There’s also the chance of rising legal action in other areas – such as the class action launched this week on late fees for credit cards.
And there’s also the continuing unease in the community and government generally about the size and profitability of the banks.
The banks, led by the CBA, strongly oppose any higher capital charges to protect taxpayers from being called upon to bail out a bank if one gets into trouble.
That’s the ‘too big to fail’ argument, and a lot of influential people from key regulators (led by the Reserve Bank) and policymakers reckon there’s a threat to the wider economy.
The banks, led again by the CBA, are not making it any easier for themselves by strongly opposing the idea of a fee on deposits, to be paid annually, to build a special reserve which would handle guaranteed deposits in the event of a bank failing.
So in some respects, the record result is politically inconvenient for the CBA and banks generally.
Looking at the result, the largest division, the retail banking arm, posted a 12% annual rise in profits, helped by its dominant position in the home mortgage market.
The CBA in fact writes one in every four mortgages, and it protected that market share and kept it steady throughout the year (that’s what the recent rate cuts on fixed interest home loans was all about, not offering a bargain to home buyers).
In a sign of the softer revenue conditions now facing banks, however, total income from banking activities rose by just 1% in the latest half.
But as reported yesterday, the banks cost to income ratio fell by 70 basis points to 42.9%, delivering an estimated $280 million in savings over the year.
The CBA and its peers will have to focus more on cost cuts (given that boosting non interest fees and charges will be under pressure from the class action into late fees).
We shouldn’t underestimate the impact of the growing pressure on banks to hold larger capital buffers as regulators seek to make the financial system safer.
In the half, the CBA’s top-tier capital as a share of assets increased by 1.10 percentage points to 9.3% of assets. That remains well above the 8% wanted by regulators, but the pressures remain.
The bank though makes a good return – 18.7% in the latest year. It reported 21.5% in 2005-2006, and 21.7% the year after (before the GFC), fell to 15.8% in 2008-09 as the loan losses surged in the GFC, but climbed back up to 19.5% after the GFC pressures started easing.
Since then the capital pressures have risen, so the 18.7% in 2013-14 is a very good outcome.
