CBA first quarter profit flat on weaker margins and deposit competition

Margins at the Commonwealth Bank (ASX: CBA) continue to be squeezed amid an intensifying battle for customer deposits, below-industry average growth rates for home loans, and higher provisions for bad loans.

CBA is the only Big Four Bank that adheres to traditional reporting periods (February and August). The other three release half-year results in May and full-year results in November. 

This is important to note because ANZ Bank (ASX: ANZ), National Australia Bank (ASX: NAB) and Westpac (ASX: WBC) all reported relatively strong FY23 results but issued cautious outlooks for FY24.

“The second half of 2023 presented a more challenging environment for Westpac and the broader industry. This is expected to continue into 2024.” – Westpac CEO Peter King

“Growth is slowing, competitive and inflationary pressures are elevated and asset quality is deteriorating." – NAB CEO Ross McEwan

“The external environment is likely to remain challenging. The full impact of higher interest rates is expected to continue to impact economic activity as well as household and business budgets.” – ANZ CEO Shayne Elliott

CBA's Q1 trading update validates this challenging environment, with flat profits, wage inflation and underwhelming growth for home loans.

CBA 1Q24 Overview

Earnings:

• Cash net profit of $2.5 billion, flat compared to a year ago and up 1.0% quarter-on-quarter

• Operating income flat as lower net interest margins offset volume growth

• Operating expenses up 3% due to higher staff costs

Volume growth:

Despite below-average growth from household deposits and home lending, businesses drove strong volume growth rates, aligned with trends observed at other major banks.

• Business lending up 11.2% year-on-year, with growth rates at 1.3 times system

• Household deposits up 5.7%, growth rates at 0.8 times system

• Home lending up 3.1%, growth rates at 0.7 times system

Note: The system multiple is a standardised measure used to compare growth rates across different banks. It is calculated by comparing the growth rate of a specific metric vs. the average growth rate of that metric across the entire banking system. For instance, a multiple of 1.2 implies that it is growing 20% higher than the average rate across the system.

Provisions and credit quality:

• Credit quality indicators 'remained sound' in the September quarter, with consumer arrears remaining at historically low levels

• Home loan arrears 'increased modestly' to 0.49% (up 2 bps) as higher rates impacted borrowers

• Credit card arrears increased by nine basis points with 'elevated arrears' observed in low-income segments

Capital and Funding:

• CET1 ratio up 46 basis points to 11.8% or a ~$7 billion surplus to APRA's minimum regulatory requirement

• Customer deposit funding remained flat at 75%

Morgan Stanley's Expectations

"We expect a modest earnings decline in 1Q24, which shouldn’t come as a surprise. However, the margin outcome will be in focus, while CBA's response to its recent mortgage market share loss will be a key issue in the months ahead," said Morgan Stanley analysts in a note dated October 22.

The key points from the note include:

• 1Q24 profit expectations: "We forecast cash profit of $2.51 billion ... with flat revenues and ~2.5% expense growth."

• Margins to fall: In 1Q24, we expect the margin to fall further as the lagged impact of deposit switching and higher term deposit rates emerges ... It would be unusual for CBA to provide any outlook commentary as part of the trading update."

• Weak housing loan growth trends: "CBA's Australian mortgage portfolio has contracted at the start of FY24, according to APRA data. We think this reflects CBA's decision to remove cashback earlier than peers and reduce mortgage discounting."

• Credit quality to remain sound: "We expect a slightly larger increase in (mortgage arrears) 1Q24, and we also forecast an impairment charge of just A$250m, which equates to an annualised ~11bp of loans."

Morgan Stanley was UNDERWEIGHT on CBA with a $84.50 target price.

Putting It All Together

CBA reported a September quarter result that was relatively weak at face value but in-line with analyst expectations.

The stock opened 1.0% higher as the market opened on Tuesday. Shares in CBA have been trading sideways over several timeframes: Up 0.3% in the past month, down 1.3% year-to-date and unchanged compared to where it was in June 2021.

CBA five-year price chart (Source: Market Index)

CBA currently trades at a price-to-earnings ratio of 17x compared to its peers Westpac (10.7x), ANZ (10.8x) and NAB (12.2x). With next to no growth prospects in a highly competitive industry, can it continue to maintain this premium?