22 November 2019
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Forget AUSTRAC, CBA result is good news for bank shareholders

Paul Rickard
10 August 2017

By Paul Rickard

Commonwealth Bank’s AUSTRAC fiasco has become a classic media beat-up. Led by the anti-business ABC, supported by some Fairfax cheerleaders, and then the usual cabal of Canberra politicians, this story has been done to death. CBA has been tried, found guilty, and hung by the media before it is yet to even file a defence. This is not the making or breaking of the Australian banking industry.

Sure, CBA deserves a material fine, some Executive heads need to roll, and it is quite proper that the CBA Board has slashed bonuses and set up an independent Board Committee to oversee the remediation programme. Further, the Bank hasn’t handled the incident well, starting from a fumbled response last Friday when the story broke, selective media interviews on Sunday (rather than a full press conference), and the lack of contrition in its response.

It is this lack of contrition that really gets the public mad, and comes after earlier failings with life insurance, financial planning and Storm Financial. Facts such as the CBA making 4,000,000 suspicious transaction reports each year to AUSTRAC -  12,000,000 over the period in question - fail to get a mention because the public is so annoyed with the banks inna general, and CBA in particular. Instead, the media multiply the number of offences (circa 53,000) by the maximum fine to beat the story up and come up with an absurd statement that the fine could be in the “trillions of dollars”. Even claims of “billions” are arrant nonsense.

As an ex CBAer, I am going to be accused of being “part of the family” and having lost perspective on this issue. But unless there has been a cover-up by management or they negligently dismissed advice to fix the problem, I don’t think so. It is possible that overseas regulators such as the US Federal Reserve might show an interest and conduct their own investigations, which may lead to other fines, however I think this is unlikely.

Investors should keep perspective and focus on CBA’s bottom line. Yesterday’s full-year profit result ticked most of the boxes.

CBA’s Profit Result

CBA reported a cash profit of $9.88bn for the full year, up 4.6% on the prior year and about $100m better than market forecasts. For the June half year, the cash profit was $4.97bn, up 7.1% on the corresponding period in 2016.

Highlights of the result included:

  • Stable Net Interest Margin (NIM) in the second half of 2.11% (same as first half);
  • Improved Return on Equity for the half year of 16.1% (16.0% in the first half);
  • Higher than expected final dividend of $2.30 per share (compared with $2.22 in FY16). For the year, total dividend of $4.29 compared with analysts’ forecasts of $4.25;
  • Positive jaws - for the year, operating income grew by 3.8%, while operating expenses grew by 2.4%, for an increase in underlying operating performance of 4.8%;
  • Group’s capital ratio (CET1) rose, largely due to organic growth, to 10.1%;
  • In the Retail Bank, a cost to income ratio of 30.8%;
  • Home loans distributed through proprietary channels rose to 57% (broker channel down to 43%); and
  • Impairment expense remains low at 15bp. For the half year, $496m compared with $599m in the first half.

On the other side of the ledger, weaker parts of the result included:

  • An underwhelming performance from Bank West. Negative jaws and an increase in loan impairment losses led to a fall in cash profit of 9.8%;
  • Disappointing performance from the Wealth Division, although the second half was an improvement on the first half. Increased income protection claims led to a fall in insurance income;
  • Market share falls in most products, although home loans grew a little faster than system; and
  • Interest only loans represent 39% of the home loan book, well above APRA’s target of 30%.

The Bank also announced that it is in discussions with third parties about its life insurance businesses in Australia and New Zealand (operated by CommInsure and Sovereign respectively), which may lead to divestment in due course.

Bottom Line

Looking ahead to the next financial year, CBA faces some financial headwinds:

  • The Federal Government banking levy, which CBA says will cost the bank $369m pre tax, or $258m post tax;
  • The crazy South Australian banking levy. At 6% of the national total, this could be another $22m pre tax ($15m after tax). If WA or other states choose to follow suit, this could yet become material;
  • A fine from AUSTRAC. I reckon that this will be closer to $100m than $1,000m - time will tell. The real cost for the CBA will come in the extra ongoing compliance costs as it beefs up resourcing and systems to prevent breaches happening again.

However, the capital cloud has been lifted, the net interest margin has stabilized (showing the pricing power of the banking majors), interest rates will head higher, which will be a positive for margin, bad debts remain under control, and there is still an enormous opportunity to take out cost.

At $81.11, CBA is not cheap and is trading at a premium to its rivals. However, with the earnings and dividend clouds removed and a reasonable expectation that they can be maintained if not increased in the years’ ahead, a 5.3% fully franked dividend yield (7.5% grossed up) looks tempting. CBA is in buy territory.

CBA trades ex the $2.29 dividend on Wednesday 16 August. A 1.5% discount will apply to shares issued under the dividend re-investment plan. Shareholders can elect to participate in the scheme if they notify the Registry by Friday 18 August.

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