By Paul Rickard

Make no mistake – Commbank is still Australia’s leading bank and a long way ahead of the other major banks. However, yesterday’s full year result was only a "6 out of 10”, a bare pass by Commonwealth Bank standards, and a sign that Commbank is losing some of its “can”.

The market liked the fact that there was no deterioration in CBA’s credit quality – with loan impairment expenses in FY 15 at an historic low of 16 basis points, the same as in FY 14. Clearly, ANZ’s quarterly update that showed an increase in provisions was a bit of an aberration. The $5 billion capital raise had also been well telegraphed.

With CBA in a three-day trading halt for the capital raise, the other major banks largely kept pace with the overall market. In a bleak day that saw the S&P/ASX 200 lose 1.67%, after starting higher, Westpac fell away to lose 1.44%, ANZ 1.90% and NAB 1.97%.

Perhaps the most important statement for shareholders was CBA’s commitment to maintain its dividend policy on the expanded capital base in FY 16.

Just a “can”

We will come back to the dividend policy and the capital raise and first consider CBA’s performance. While there was a number of one off factors in the result – stronger trading income from the markets business, a blowout in insurance claims, and the huge cost of the advice remediation program – CBA’s much prized “positive jaws” is under threat. Positive jaws, or income growing at a rate that is faster than the rate of expense growth, has been one of the key differentiators that has set CBA apart and resulted in it being priced at a premium to its competitors.

CBA was able to point to positive jaws over the full year – adjusted underlying operating income grew by 6%, while adjusted underlying expenses grew by 2.9%. However, if we compare the second half with the corresponding period in FY 14, on a division by division basis, the jaws are neutral to slightly negative. As the following table shows, the retail bank, which is responsible for 42% of group profits, grew income at only 3% while expenses rose by 6% - negative jaws


CBA’s second half performance wasn’t that strong!

Headwinds

CBA is facing a number of headwinds, many of which it has in common with the other banks. Firstly, there is margin pressure, with group NIM (Net Interest Margin) falling by 3 basis points from 204 basis points for the December half to 201 basis points for the June half. Next, there is very little volume growth. While CBA has done well on the deposit side and argues that it is not chasing higher risk loans, it has lost market share in home loans, credit cards, personal loans and business lending.

And then there is the juggling act about how much productivity improvement (read cost savings) can be generated, without impacting service and customer satisfaction. CBA has excelled in this area over the last few years, in part due to its investment in technology, but this is clearly getting harder. The group’s cost to income declined by only 10 basis points in FY15.

Finally, there is the cost of the advice remediation program and other compliance initiatives. The former is unique to CBA and is reputed to have more than 500 staff or consultants working on it. CBA said that it spent $347 million on compliance programs in FY15.

Capital raise 

Following ANZ’s decision to tap the market last week to raise $3 billion, Commbank really didn’t have much choice but to follow suit and will raise $5 billion through a fully underwritten pro rata renounceable entitlement offer. The $5 billion will satisfy the change in the mortgage risk weights that APRA has mandated from 1 July 2016.

Shareholders will be entitled to buy 1 new CBA share for every 23 shares they hold, at a price of $71.50. These shares won’t receive the next dividend payable in October ($2.22 per share), and so the subscription price represents a discount of 10.1% to the theoretical ex rights price of $79.55.

Retail entitlements will start trading on the ASX on Monday 17 August and cease trading on 1 September. Shareholders have three options: take up the new shares by paying $71.50 for each new share; sell the entitlements on the ASX, which will trade under stock code CBAR; or do nothing. If they do nothing, their entitlements will be “auctioned” through an institutional bookbuild, and the proceeds will be paid to them by the bank. The timetable is as follows:

CBA is due to resume trading on Monday. It will trade ex- entitlement, cum dividend, before trading ex-dividend on Tuesday.

A premium price?

Over the last decade or so, Commbank has consistently traded at a premium to its peers. At times, this premium has been almost 35% (as measured by respective PE ratios), but typically has been around 20%. Recently, this premium has started to narrow.

Yesterday’s result will confirm this narrowing. The result was ok, but not outstanding. Commbank has a clear lead in technology, customer satisfaction, business mix and organization, and will now be well positioned in regard to capital. However, the headwinds represent material challenges.

Shareholders will take note of CBA’s statement in regard to its dividend policy. Notwithstanding that the number of shares on issue will increase following the capital issue by 4.3%, CBA has committed to maintain its dividend payout ratio in FY16. While a dividend cut (in cents per share) can’t be ruled out, if it is maintained at 420 cents per share, this will represent a fully franked dividend yield of almost 5.3% (on the theoretical ex-rights price of $79.55).  

Disclosure: The author and his SMSF own Commonwealth Bank shares.