CBA's balance sheet conservatism pays dividends

If Ian Narev had a checklist to measure the performance of the various Commonwealth Bank business units, just about all his boxes would be ticked.

There wasn’t really a stand-out performance within the CBA interim result today. Solid performances across the board contributed to the 14 per cent increase in cash earnings.

A macro view of the result would say that CBA generated respectable rather than outstanding growth at an income level, while continuing to push operating costs and impairment expenses down. This offset the impacts of a low-credit growth environment and competitive pressures that trimmed three basis points from its net interest margin relative to its June half-year result.

During Narev’s tenure, factors within the group’s control keep improving incrementally. The bank has been able to maintain solid revenue growth and expand its loan books despite the subdued external environment.

An 8 per cent increase in revenue relative to the previous corresponding period (six per cent when compared to the June half) out-stripped the 6 per cent increase in costs (5 per cent relative to the June half). Impairment expenses edged down 26 per cent (two per cent against the June half).

CBA’s cost-to-income ratio, at 42.9 per cent, was 90 basis points lower than in the December half last year and 50 basis points lower than in the June half. Its ratio of impairment expenses to average loans and acceptances was only 16 basis points compared with 22 basis points a year ago and about 85 basis points at the height of the financial crisis.

It was notable, however, that the rate of impairment essentially flat-lined in the half, suggesting that may not be a significant source of improved profitability in future. All the majors are experiencing levels of impairments that are, by historical standards, quite low, which may be a function of the weak demand for business credit in recent years.

CBA has invested massively in its technology platforms over recent years – it spent nearly $600 million in the latest half – to drive costs down and customer satisfaction up. It continues to produce returns in the form of lower costs and higher revenues.

Despite the weak demand for credit, particularly from business, CBA has been able to expand its balance sheet with its interest-earning assets growing 9 per cent when compared with the previous December half and 5 per cent relative to the June half. It experienced above-system growth in home and business lending.

It has also experienced solid growth in customer deposits to help fund its increased lending. Deposits now represent 63 per cent of its funding base.

It has been a feature of CBA’s recent results that they haven’t been driven purely by introspection, but that there has been a balance of cost-reductions, credit quality improvements and balance sheet and income growth.

Within the result, CBA’s domestic banking divisions generated 10 per cent growth (7 per cent against the June half) while institutional banking, wealth management and New Zealand produced double-digit growth.

Wealth management’s earnings were 19 per cent higher than a year earlier and 14 per cent higher than in the June half. Narev would have been pleased with the 37 per cent lift in Bankwest’s earnings.

The strength and quality of CBA’s earnings translates to an 18.7 per cent return on equity (its ROE was 18.2 per cent last financial year). While still below the 20 per cent-plus levels achieved before the financial crisis, it will inevitably attract accusations of profiteering and provide ammunition for those who want to see the major banks’ profitability and competitiveness reined in by the financial system inquiry.

That return on equity is being achieved within highly conservative balance sheet settings. CBA has, on an internationally harmonised basis, a Basel III common equity tier one capital adequacy ratio of 11.4 per cent and is carrying $137 billion of liquidity, which makes it even more impressive.

CBA’s interim dividend of $1.83 a share is 12 per cent higher than for the same half last year and in line with the 70 per cent payout ratio the group moved to in 2012 in response to shareholder pressure for more income.

The returns to shareholders will form a plank of the major banks’ defence of their profitability. Narev, pointedly, referred to the “more than 800,000 Australian households” who own CBA shares directly and the “millions more”’ who own their shares via superannuation funds.

It isn’t difficult to make an argument – and it is an argument the majors will inevitably make – that imposing special levies/taxes on the majors would equate to imposing new taxes on Australian’s savings, as well as punishing the banks for the relative effectiveness and conservatism of their management.