‘Dividends are not annuities,’ noted CBA chief executive Ian Narev at the bank’s 2016 result presentation. It's an important point to remember whether you’re investing in banks or other companies. You invest in companies for the value they can create, and dividends are just one of the means by which companies can deliver that value to shareholders. If the value creation stalls, then ultimately so to might the dividend.
Loans up 8%; interest income up 7%
Impairments jump 27%, to 0.19% of loans
Cash EPS down 1%; dividend flat
Despite Narev's thinly veiled warning, CBA's dividend is probably the safest among the big four banks. Both its final dividend and full-year total of $4.20 per share were unchanged. With cash earnings per share 1% lower, the payout ratio crept up from 75.1% to 76.5%, but that's well within the board’s target of 70–80% – which is more than NAB and ANZ can say. These might sound like small victories, but it was a decent result from CBA given the tough conditions.
|Year to 30 Jun ($m)||2016||2015|| /(–)
|Net interest income||16,935||15,827||7|
|Profit before impairments||14,318||13,585||5|
|Profit before tax||13,062||12,597||4|
|Cash EPS ($)||5.55||5.61||(1)|
$2.22 (no change), fully franked,
Increases in funding costs and strong competition in both the retail and business banking segments pushed down CBA’s net interest margin slightly, from 2.09% to 2.07%. However, an 8% increase in loans – led by the retail banking business – meant that total income rose 5%.
Total operating expenses, meanwhile, increased by 4%, so that profit before impairments rose 5%. A 27% rise in the impairment charge, however, brought the rise in cash earnings down to 3%.
The impairments charge represented 0.19% of average gross loans, up from 0.16%. Nevertheless, this remains near historical lows and we’d expect them to average 0.4–0.5% over the cycle after factoring a few bad years. In 2009, for example, impairments were 0.68% of average loans.
With home loans comprising 51% of its assets, house prices are obviously a major impact on CBA. As you can see in Chart 1, arrears have been increasing in recent years, particularly for more recent vintages.
When asked about this during the result presentation, CEO Ian Narev mentioned that this was primarily related to customers in Western Australia and Queensland. These states have been hit hardest by the mining bust, where rising unemployment and declining wages have made it harder to service mortgages even with falling interest rates.
It’s also worth noting that only $69bn – just under 7% of CBA’s total exposures – relate to commercial property. $47bn of this exposure is to debtors with below-investment grade credit ratings but this isn't necessarily as bad as it appears as this category also includes those who aren’t given ratings by the ratings agencies.
This is relevant given the discussion in the media about the potential oversupply of apartments in the eastern seaboard, particularly in Melbourne and Brisbane. 20% or $14bn of CBA’s commercial property exposure relates to residential loans, primarily to apartment developers in Australia’s major cities (see Chart 2). The remainder represents loans to listed property trusts and other owners of office towers, industrial and retail properties.
With the banks tightening credit to foreign purchases of new residential property, new taxes being imposed by state governments, and slowing wage and population growth, we’ll be monitoring the impact of any apartment oversupply and/or failures to settle by apartment purchasers. If provisions increase materially, then dividends could be affected.
The additional shares on issue due to last year’s capital raising meant cash EPS declined slightly, to $5.55 per share, and also pushed CBA’s return on equity down by 1.7% to 16.5%. That would fall to around 14% after we factored in impairments at our assumed average rate for the cycle, but that's still an impressive figure and well above the equivalents for its major competitors Westpac, ANZ and NAB.
Helped by its capital raising, CBA’s common equity tier-one capital is 10.6%, which is also above its big bank competitors. According to Ian Narev – and considering the upcoming 1% decline in this figure as a result of APRA requiring the banks to hold more capital against their mortgage assets – this qualifies CBA as ‘unquestionably strong’.
We tend to agree with him but we'll await APRA’s final decision as to whether CBA and the other big banks will be forced to raise even more capital to qualify as ‘unquestionably strong’.
As we’ve noted before, increased capital requirements and regulatory costs, provisions at cyclical lows and slower credit growth mean all the big banks are going to find it tough to raise earnings and dividends over the next few years. Nevertheless, CBA’s dominant retail franchise means it remains Australia’s best bank and deserving of the higher valuation placed on it by the market. HOLD.
Note: The Intelligent Investor Equity Income Portfolio owns shares in Westpac and Commonwealth Bank. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.