Company Overview: Commonwealth Bank of Australia is a provider of financial services, including retail, business and institutional banking, funds management, superannuation, general insurance, broking services and finance company activities. The Company's segments include Retail Banking Services, which provides home loan, consumer finance and retail deposit products; Business and Private Banking, which provides banking services to relationship managed business and agribusiness customers; Institutional Banking and Markets, which services its corporate, institutional and government clients; Wealth Management segment, which includes global asset management, platform administration, and general insurance businesses; New Zealand, which includes the banking and funds management businesses operating in New Zealand; Bankwest, which offers a range of deposit products, and IFS and Other Divisions, which includes the Asian retail and business banking operations.


CBA Details

Resilient Performance in FY 18 despite Challenges: Commonwealth Bank of Australia’s (ASX: CBA) stock moved up by 2.49% in last five days despite the bank delivering a 4.8% fall in the FY18 cash net profit after tax on the prior year to $9,233 million in terms of continuing operations and a 4% fall in statutory net profit after tax. The cash net profit was impacted due to a number of one-off items that include a $700 million non-tax deductible expense for the AUSTRAC civil penalty after the bank admitted to 5 breaches of anti-money laundering and counter-terrorism funding laws. During 2018, one off items also include the Return on equity on cash basis, that fell by 160 basis points to 14.1% due to the combination of lower profits and higher levels of equity as the Bank is working towards APRA’s ‘unquestionably strong’ capital target, which is effective from 1^st January 2020. Further, one off items included the earnings per share on cash basis, that was 528.6 cents, which is a fall of 6.2% on the prior year. Excluding one-off items, cash NPAT grew 3.7% and the investors were encouraged by the fact that without the one-off expenses, the bank would have reported a $10.01 billion cash profit. Moreover, in 2018, operating income excluding one-off items rose 3.4% to $25,670 million driven by a 4.5% rise in net interest income, with higher funds and insurance income partly offset by a reduction in other banking income. Net interest income excluding one-off items grew due to 2.3% growth in average interest earning assets and a 2.2% increase in NIM (up 5 basis points). NIM expanded 5 basis points to 2.15% primarily due to the benefit from repricing of interest-only and investor home loans, the funding benefit from deposit repricing and an increased proportion of low cost funding through transaction deposits which was partly offset by the impact of the major bank levy and higher wholesale funding costs. The bank’s Funds management income in 2018 grew 9.3% to $2,091 million driven by a rise in the amount of funds invested leading to positive net flows and positive market returns on invested funds. Further, there is lower remediation costs as the Advice Review program is nearing completion, which is partly offset by a reduction in rates charged on funds invested, due to customers switching to less specialized, and lower fee, fund types. Additionally, in 2018, the operating expenses excluding one-off items rose 3.1% to $10,547 million on the prior year, majorly driven by higher risk and compliance costs, rise in capitalized software impairments, primarily driven by a decision to implement a new institutional lending platform and rise in amortisation of software assets.
 

FY 18 Financial Performance (Source: Company Reports)

Disinvestments to focus on the core banking businesses: CBA has previously called out the sale of the life insurance business in both Australia and New Zealand. The bank has completed the sale of the Bank’s New Zealand life insurance business on 2nd July 2018, which resulted in an increase in the bank’s pro-forma CET1 ratio (APRA) of 27 basis points. The bank has planned to complete the sale of its Australian life insurance business and its non-controlling investment in BoComm Life by December 2018. However, it is subject to regulatory approval, which will provide a further expansion of approximately 56 basis points. Moreover, CBA has announced the demerger of the Wealth and Mortgage Broking operations, and very recently also announced that the bank will be exiting South Africa. These steps are really going to enable the bank to focus on the core banking businesses in Australia and New Zealand.

Strong Balance Sheet: During FY18, CBA’s Bank’s Liquidity Coverage Ratio was 131%, up from 129% at 30 June 2017 and is well above the regulatory minimum of 100%. CBA continues to satisfy a significant portion of its funding requirements in 2018 from the growth in customer deposits, that accounted for 68% of total funding and increased from 67% at 30 June 2017. The Bank’s Net Stable Funding Ratio (NSFR) is of 112% that rose up from 107% at 30 June 2017 and is also well above the regulatory minimum of 100% that applied from 1st January 2018. The rise was mainly due to a more NSFR efficient customer deposit mix. Further, CBA has the leverage ratio of 5.5% on an APRA basis, that rose up from 5.1% at 30 June 2017, benefitted on the back of a 7% increase in capital levels driven by both organic capital generation and the Additional Tier 1 CommBank PERLS X Capital Notes issuance, and a 1% reduction in exposures. Moreover, CBA’s CET1 ratio (APRA) is of 10.1%, compared with 10.4% at 31 December 2017 and 10.1% at 30 June 2017. The bank has maintained capital ratios well in excess of regulatory minimum capital adequacy requirements lately. The bank has witnessed 30 basis points fall in the June 2018 half year due to a number of unfavorable one-off impacts, including higher Operational Risk Weighted Assets (RWA) due to APRA’s requirement to increase the Operational Risk Regulatory Capital by $1 billion (RWA $12.5 billion), effective from 30th April 2018 (-28 basis points), and the movement of the Wealth Management Advice business into the regulatory group (-5 basis points). Further, other unfavorable one-off impacts included the AUSTRAC civil penalty (-7 basis points), the maturity of the final tranche of Colonial Debt that is subject to transitional relief (-7 basis points), and the capital contribution into BoComm Life (-5 basis points) (which will be fully reimbursed on completion of sale to Mitsui Sumitomo Insurance Co. Ltd). Additionally, the bank’s organic capital generation remained strong at 32 basis points, which is partly offset by various other movements (-10 basis points). In addition, the impacts of disinvestments was partly offset by the implementation of AASB 9 (-18 basis points) and AASB 15 (-3 basis points), which resulted in 2018 pro-forma CET1 ratio of approximately 10.7%.


Balance Sheet Strength (Source: Company Reports)

Strategic Decision taken by CBA to ensure strength in capital, funding and liquidity: CBA has taken a number of strategic decisions to maintain the strength in capital, funding and liquidity. The bank has issued new long-term wholesale funding that has a weighted average maturity (WAM) of 9.0 years, which brought the portfolio WAM to 5.1 years (up from 4.1 years at 30 June 2017). As a result, the annual funding requirement for future years is reduced (as average annual maturities are lower), which reduced the associated refinancing risk from potentially unfavorable funding conditions. Further, CBA replaced the short-term for long-term wholesale funding actively, with long-term wholesale funding now accounting for 67% of total wholesale funding (up from 60% at 30 June 2017). Moreover, the level of liquid assets and customer deposit growth has been appropriately managed by the bank to strengthen the funding and liquidity positions as reflected by increases in the Liquidity Coverage Ratio (“LCR”) and Net Stable Funding Ratio (“NSFR”). CBA has taken a conservative view in the application of the AASB 9 Accounting Standard and focused on capital generation in order to achieve APRA’s ‘unquestionably strong’ capital target. Overall, CBA continued to strengthen the bank’s funding position in 2018 by taking advantage of favorable global funding conditions and increased the term of long-term wholesale debt. This strategic decision will, over time, reduce the annual funding requirement and the associated refinancing risk.

Banking Sector Leader in the digital space: Currently, CBA has more than 6.5 million Australians who are using the bank’s digital applications like the bank’s mobile app, Netbank; and the bank has more than five million people logging in every day.

Dividends over the years: CBA has declared a final dividend of $2.31, that brought the total dividend for the year 2018 to $4.31 which was equivalent to 80.4% of the CBA’s cash profit. Excluding the AUSTRAC civil penalty, the bank’s dividend payout ratio was 74.9% of cash NPAT, which is within the Bank’s target ratio of 70% to 80%. Thus, the bank aimed at maintaining the continuous stream of dividends over the years.


Dividends (Source: Company Reports)

Positive Outlook on Banking Sector: CBA is positive on Australian economic situations as the bank is seeing GDP growth above trend, while there is continuous fall in unemployment, and the inflation has remained low. The long term prospects remained strong as there have been some big shifts in the economy over recent years. Further, CBA is seeing investments in infrastructure, good potential from the growth in population, and some of the Asian neighbors and this continues to drive a good focus on growth in the local Australian economy.

Stock Recommendation: Meanwhile, CBA stock has risen 6.21% in three months as on August 10, 2018 but is trading at a reasonable P/E of 14.11x. CBA has strong network with more than 1000 branches across the country.  The bank has shown resilient performance in FY 18 despite multifarious challenges. Further, the macro environment is also shifting to be more favorable for banking sector now as opposed to first half of calendar year 2018, which will benefit CBA. Based on the foregoing, we give a “Buy” recommendation on the stock at the current price of $ 74.940.
 

CBA Daily Chart (Source: Thomson Reuters)

 
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