Running Ahead

Commonwealth Bank delivered a strong first-quarter FY18 trading update, with cash earnings of $2.65bn exceeding the required run-rate to reach first-half FY18 consensus earnings of $5.09bn. The result was aided by low impairment charges – 11bp of gross loans – but we also estimate pre-provision profit is running ahead of the consensus run-rate. We maintain our Hold rating on CBA and have raised our target price slightly to $77.00 from $76.50.

 

  • Reading between the lines, strong quarterly average revenue growth of 4% on second-half FY17 appeared to be driven by margin expansion, given modest loan growth and mixed non-interest income. We have assumed a similar NIM performance to that of National Australia Bank (NAB, Hold) and Westpac (WBC, Hold) – up 6bp in second-half FY17 excluding Markets. However, CBA’s trading income, which was flat in the quarter, was more resilient than that of the other major banks, perhaps reflecting its higher proportion of trading income taken through reserves rather than P&L.
  • Cost growth was high at a 4% quarterly average in second-half FY17, in line with revenue growth. This reflected provisions for estimated future project costs – but not potential penalties – related to regulatory actions, and which we assume are non-recurring. We have assumed these do not recur and so our cost growth outlook then moderates.
  • Proceedings commenced by the Australian Transaction Reports and Analysis Centre (AUSTRAC) continue to weigh heavily on CBA’s share price. Until these issues are resolved, we have assumed the bank will retain a relatively high common equity tier-1 (CET1) ratio – above 11% – potentially limiting the short-term prospects for capital management.
  • CBA’s CET1 ratio was flat quarter-on-quarter and asset quality was also healthy, as we have seen for most banks during this reporting season. CBA disclosed a further 70bp pro-forma benefit from the sale of its insurance business, although, as have noted, the AUSTRAC proceedings may prevent any capital management in the short term.

Since February 2016, CBA’s valuation premium to its major bank peers has narrowed considerably. Whether this will widen in the short term will ultimately depend on the size of any penalties resulting from the AUSTRAC proceedings and how long a resolution of the regulatory issues will take. 

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