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Commonwealth Bank provided a third-quarter FY20 trading update. Cash net profit of $1.3bn came in below the run-rate required to achieve Ord Minnett’s $3.3bn second-half forecast. However, CBA set aside a larger $1.5bn provision for COVID-19 than our $800m estimate and remediation costs of $125m were also above our $75m assumption for the second half.

 

The bank also announced the sale of 55% of Colonial First State (CFS) wealth management to global investment firm KKR.

 

Setting aside these issues, revenue looked better than we expected on solid net interest income, although capital showed similar weakness to what we saw in the ANZ Banking Group (ANZ, Hold) and National Australia Bank (NAB, Accumulate) first-half FY20 results.

 

CBA’s provision build-up was broadly consistent with that of Westpac (WBC, Hold), with the bank adding a $1.5bn COVID-19 provision in the quarter. Although the provision was built bottom-up, it is broadly equivalent to the midpoint of CBA’s ‘downturn’ and ‘prolonged downturn’ scenarios. Both the extent of the provision top-up and the newly established level of provision coverage are at the top end of the peer range.

 

Our cash net profit forecasts have been lowered 3% in FY20, due to remediation costs, but increased 1% in FY21 and FY22. We have cut our DPS forecasts further, but we assume CBA will pay a final dividend.

 

CBA is trading on a stretched valuation that, in our view, fails to reflect the challenging top-line environment driven by its heavy exposure to retail banking, while potential cost savings are already captured in our earnings forecasts and look to be more than factored into the share price.

 

The bank remains strongly capitalised versus its peers, however, and the 30–40-basis-point uplift from the sale of CFS will reinforce this position. In addition, CBA’s market-leading franchise has strong footholds in most business segments, and the bank is defensively positioned from a capital and provisioning standpoint, although investors are being asked to pay a very large insurance premium for these qualities.

 

On balance, we maintain our Hold recommendation, while our target price has increased to $57.40 from $56.90.

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