CBA compiles a handsome half

Commonwealth Bank has delivered a very solid if not spectacular half amid low credit demand and still rising funding costs. The results also reveal a company building an impressively sustainable future.

It is an interesting reflection on the times, and on expectations, when a 6 per cent increase in a bank’s cash earnings causes analysts to describe the result as a ‘’cracker’’ and the sharemarket to lift.

However, in the context of the very subdued demand for credit and continuing pressures on average (as opposed to marginal) funding costs and on margins, Commonwealth Bank’s December half result is, if not quite a ‘’cracker", then certainly a very solid performance built around some very clean numbers.

The result was built around a strong performance from CBA’s core retail banking business, with cash earnings up 13 per cent on the previous corresponding half and 10 per cent on the June half-year.

The "re-pricing" of home loans (holding back some of the Reserve Bank’s rate cuts last year) and strong growth in consumer finance more than offset the impact of the lower margins on deposits in a falling rate economy and in a very competitive environment for deposit funding.

The margin within the retail bank, while at 249 basis points still well below its pre-crisis level of 283 basis points, was five basis points higher than in the first half of the last financial year and 10 basis points higher than the June half of last year.

There has been a lot of speculation in recent weeks that easing funding cost pressures could see the big banks moving out of sync with the Reserve Bank to reduce home loan rates. The CBA result doesn’t provide much obvious support for that thesis.

While the cost of new funding, relative to the swap rate, has fallen recently, CBA says its average long-term funding costs won’t peak until December this year. Its weighted average cost of funding is still rising, with falling wholesale funding costs offset by the sharp rise in the cost of deposits.

Overall the group net interest margin was up four basis points from the June half but two below that generated in the previous December half, with the seven basis points increase from CBA’s asset pricing and mix offset by a seven basis point rise in funding costs.

The retail bank wasn’t the only part of CBA that had a good half. Its institutional banking and markets division profited from the far more settled conditions in the half, lifting its earnings by 14 per cent relative to the June half last year and 6 per cent relative to the previous December half.

The wealth management division, too, had a solid half-year. Its earnings were 3 per cent ahead of those generated in the June half and 10 per cent ahead of the December half of 2011.

What would make Ian Narev particularly happy was that while the group’s income was up 5 per cent its operating costs were up only 3 per cent, with his cost-to-income ratio continuing to improve and now at 45.1 per cent, compared with 46.2 per cent in the preceding half and 45.8 per cent a year earlier.

As with all the major banks, Narev is looking to be very disciplined on costs in an environment where there is only meagre volume growth – interest-earning assets grew only 1 per cent between the June and December halves and 3 per cent December-on-December.

CBA is the best-performed and most highly-rated of the Australian majors but the flat-lining environment and the steadily rising capital and liquidity it is holding as the new prudential requirements phase in are gradually eroding a still-stellar return on equity.

Pre-crisis CBA generated a return on equity of almost 22 per cent. In the December half the group’s ROE slipped from 18.6 per cent in the June half to 18.1 per cent. A year ago the ROE was 19.5 per cent. The latest ROE is still a very handsome rate of return but it is trending down towards the mid-teens.

With a tier one common equity ratio of 10.6 per cent (up from June’s 9.8 per cent and 9.3 per cent a year ago) and the group holding $128 billion of liquid assets ($115 billion in June and $93 billion at December 2011) it isn’t surprising that the ROE is being pushed down.

In CBA’s case, at least, however, the market does appear to be looking past simple returns to the quality of the numbers and the lower risk profile generated by the additional capital and liquidity. CBA is also a peer-leading 63 per cent deposit-funded.

An interesting aspect of the result is that Narev appears content to simply hold market share, or even relinquish at the margin, which means there has been virtually no growth in the group’s funded asset base.

He’s more focused on improving the productivity of what he has, not just in terms of costs but in the cross-selling of financial products on the back of still-improving customer satisfaction levels. All the majors are pursuing not-dissimilar strategies but CBA holds the mantle of industry leader and Narev continues to grind out steadily improving metrics and to win the sharemarket’s applause.