By Paul Rickard

It has been a tough few weeks for bank shareholders, with Australian banks getting caught up in the global sell down of financial stocks. Driven mainly out of Europe, there is concern about the exposure banks may have to the oil and energy markets, ongoing challenges coming out of Greece and Italy, and a general flight to security, with a move out of so called “higher risk assets”.

Australian banks aren’t immune from this sell down. Notwithstanding their superior return on equity, they are perceived as “expensive” by some global investors due to their higher price/book ratios. And then there is the real cost, which is a blow out in credit spreads. With offshore borrowing providing about 30% of their funding needs, higher credit spreads translate to pressure on the net interest margin.

Finally, there is the ongoing (and largely misinformed) discussion about whether Banks may need to raise more capital. 

As a result, the financial index component of the S&P/ASX 200 is down by 16.06% since the start of January, compared to the broader market’s 9.81%. Part of this movement has been driven by professional investors initiating short positions. The latest ASIC figures published yesterday, which are based on trade data from last Thursday, show that bank short positions are up. They are not overwhelming, but they are higher than normal.  ANZ Bank, for example, has 67.7m shares sold short (worth about $1.5bn), but this only represents 2.32% of its total share base.

Bank Short Positions 

So in this environment, it was pleasing to see Commonwealth Bank come back to form.  After a very disappointing June half year, yesterday’s result for the December half demonstrated many of the hallmarks that have led to CBA’s premier rating, and why returns in banking are still attractive. Admittedly, market expectations were low going in, but it was no surprise that the market gave it the tick of approval. On a day that the market lost more than 1%, CBA added $1.33 or 1.83% to close at $74.20.

What I liked about the result

The headline result  for cash NPAT of $4.804 bn was ahead of the consensus forecast of $4.75bn, and represented an increase of 4% on the corresponding period in 2015;

A market leading ROE (Return on Equity) of 17.2%. While down 1.4% on the corresponding period (due mainly to the increase in the capital base), way ahead of its peers - domestically and globally;

Flat jaws on a headline basis, with operating income up 6% and operating expenses up 6%. Adjusting for the FX impacts, arguably slightly positive jaws, with operating income up 5% and underlying expenses up 3.8%;

Group NIM unchanged from the previous half of 206bp, despite quite strong volume growth;

The cost to income ratio in the retail bank down to 32.8% (from 33.6%);

Strong retail deposit growth of 10%, lifting the share of the loan book that is funded by customer deposits to 64%;

Credit quality remaining strong. While the loan impairment expense was up 28% to $564m, forward consumer credit indicators remain sound and there is no material pick up in the exposure to the mining and resource industries;

Management’s relatively comfortable position (or lack of concern) about changes in the wholesale funding markets; and

Of course, the unchanged fully franked dividend of 198c per share. 

What I didn’t like

Struggles in the West, with profit from Bank West down 1%;

Some pressures in the corporate markets, with the Net Interest Margin in Australian business lending down from 204bp to 197bp;

A disappointing result from the Institutional Banking & Markets Group, with operating expenses up 12% and cash NPAT down 6%; and

Market share losses, with the home loan share down to 25.1% in the December half from 25.4% 12 months earlier.

Where to from here

You can’t stand in the way of the train, and if overseas markets continue to mark down bank share prices, Australian bank share prices will follow suit. However, local bank investors should take heart from this result and should consider using these market conditions as an opportunity to increase their exposure to bank stocks. And on this result, the Commonwealth Bank will continue to trade at a material premium to its competitors - particularly the ANZ and National Australia Bank.