Commonwealth Bank: Q1 Result 2015

Commonwealth Bank is on track to become just the third Australian business to generate profit of $10bn (anyone guess the first and second?). The bank announced a 9.5% increase in cash profit to $2.3bn and, if it maintains this pace, will be the only non-mining firm to crack the $10bn profit mark (yep, a clue).

This is even more remarkable when you consider that business lending was slow, net interest margins actually shrank and the long dominant home loan lending business lost market share to competitors. With credit growth slow, all banks are competing fiercely for new business.

So how did CBA do it?

As they have for the past few years, diminishing bad debts helped swell profits. Loan impairment expenses peaked in 2009 and have fallen steadily since. At just 13 basis points today, impairment expenses are the lowest they have been for 20 years. Lower costs were the other plank of the result, particularly wholesale funding costs.  

Despite slowing economic growth and a sharp downturn in mining activity, home loan arrears were flat and credit card arrears were low. There are no early warning signs of pain ahead and all signs point to continued loan growth.

Profitability, however, could be tempered by regulators as they tamper with capital ratios. CBA's tier-1 capital ratio fell from 9.3% to 8.6%, the fall almost entirely accounted for by dividend payments. This highlights a key risk being ignored by investors: changes to capital ratios could dent dividend payments that have driven share price growth.

Trading on a PER of almost 16 and 2.7 times book value, CBA isn't cheap. The big four do not face imminent collapse tomorrow but it is hard to justify high valuations today.  With the share price up marginally since Commonwealth Bank: Result 2014 (Hold - $81.04), HOLD.

Note: The model Income Portfolio owns shares in Commonwealth Bank. The maximum recommended portfolio limit for the banking sector is 20%, though conservative investors might consider a limit of less than 10% at current valuations, particularly if you have other large exposures to residential property.

Note: BHP and Rio are the only other businesses to report profits of over $10bn. But you knew that already.