Commonwealth Bank of Australia’s cash earnings of $4.807 billion and dividend of $1.98 per share for the first-half of FY16 met Ord Minnett's expectations, but the results also highlighted declining returns for Australia's largest bank.
The bank delivered 6% growth in income on the same period a year ago, but this was offset by growth in expenses of 6%, and a rise in the number of shares on issue as the bank raised capital to meet new prudential regulations (in effect, banks are required to hold more capital against loans they make, reducing risk but also reducing returns). This meant there was no growth in earnings per share versus the first half of FY15.
In fact, since the first half of FY15, the bank's return on tangible equity has fallen from 24% to 21% – and we expect a further fall in the second half of FY16, with declines to a rate of around 19%. This will be largely due to the full effect of last year's capital initiatives, and subsequent rise in issued shares, with Commonwealth Bank's once sector-leading return on tangible equity now similar to that of Westpac Banking Corp.
In addition, Commonwealth Bank's pro-forma core equity tier-one ratio of 9.2% has not yet incorporated the impact (we estimate about 42 basis points, or 0.42 percentage points) of maturities of non-recourse debt through its Colonial unit in FY17 and FY18. The bank's decision not to offer a discount on the dividend reinvestment plan will also not help meet its capital needs, with the likely result being a plan participation rate of about 15–20% and a contribution of only 10 basis points, or 0.1 percentage point, to the core equity tier-one ratio.
Given the prospects for capital build-up in the banking sector as regulators tighten capital rules, Commonwealth Bank's strong balance sheet growth, and its bottom-of-cycle provisioning charge, we think there is a stronger chance of discounts to boost future dividend reinvestment plan participation and thus capital generation.