Earlier this week, when Commonwealth Bank (ASX: CBA) reported its first-quarter results for FY22, the market responded in swift fashion with a brutal sell-off.
Shares in CBA recorded their single-largest drop in a trading session for 20 months, with the stock tanking over 8%. The last time this occurred was at the height of the COVID market crash in March, 2020.
As the most-held stock by value across the entire SelfWealth community, we’re taking this opportunity to look at three key takeaways from CBA’s quarterly report.
Margin pressure on a number of fronts
The headline focus in CBA’s report was commentary indicating net interest margins (NIM), the difference between what a bank pays depositors and what it charges customers, were “considerably lower” for the quarter. Although Commonwealth Bank does not specify the figure in its quarterly updates, some analysts believe NIM may have slumped from 2.04% to the ‘low 1.90s’.
Commonwealth Bank is not alone on this front. Recently, the rest of the ‘Big Four’ have pointed to margin erosion. However, the extent of the drop, and what it signals, are the key takeaways.
Fierce competition in the home loan market is squeezing margins for banks. Borrowers have also taken advantage of rock-bottom interest rates to lock-in low fixed-rate loans, with CBA writing these lower-margin loans to maintain growth. This has ‘diluted’ the proportion of variable-rate loans normally found on the Big Four’s books, and which traditionally represent a bigger contributor to NIM over time.
Meanwhile, with the RBA distancing itself from any rate rise in the near-term, banks are facing growing pressure amid the limbo. Higher liquid assets and the end of the Reserve Bank’s Term Funding Facility (TFF) have also weighed. Previously, the banks were able to take advantage of three-year money at rates of 0.25% under the TFF, but this was wrapped up earlier this year.
Investors will be watching NIM closely, but for the banks, some are going it alone in raising fixed rates and dropping variable rates to entice customers and claw back margins once the rate cycle begins. Some investors believed this issue was confined to the likes of Westpac (ASX: WBC), however, CBA’s results clearly highlight this is a sector-wide challenge.
Should CBA still command a large premium?
Before its most-recent report, CBA was trading at a price-to-book ratio of nearly 2.5-times. In comparison, peers like Westpac and ANZ (ASX: ANZ) have been trading at a value of less than half this, while National Australia Bank (ASX: NAB) also trades at a significant ‘discount’.
Even international peers such as JPMorgan (NYSE: JPM) and Bank of America (NYSE: BAC) trade between 1.5-times and 2-times book value, meaning Commonwealth Bank has attracted, and still does attract one of the highest price-to-book values of any bank across the world.
While that ratio has eased following recent results, CBA’s significant premium is one that has drawn attention. Investors may be asking themselves whether the nature and size of this premium is still justified in light of shrinking margins like its peers. This also applies more broadly to the sector when analysing pre-provision profits, with PE values at their highest levels in decades.
What’s more, the forward price-to-earnings multiples on CBA’s major rivals in WBC, ANZ and NAB are between 14-times to 16-times. In comparison, CBA has been trading on a multiple around 22-times. Despite this premium, Commonwealth Bank’s revenue and earnings growth excluding provisions over the last three years, down 1% and 7% respectively, are comparable with NAB and ANZ.
CBA has long been a favourite of the investment community, viewed as the most resilient bank across the nation – it still delivered above-sector mortgage growth and large cash profit growth in the quarter. But will that be enough to maintain the magnitude of its valuation premium?
Are the ‘green shoots’ being overlooked?
For all the attention on the headwinds facing Commonwealth Bank, the nation’s largest bank is seeing better fortunes in its business lending division. Loan volumes within this segment increased by $3.1 billion, growing at 1.5-times system growth and with margins maintained.
With the bank forecasting “a strong recovery in economic growth by the end of the year and throughout 2022”, notwithstanding a sharp drop in Q3 arising from east coast lockdowns, CBA’s business division is exposed to this backdrop. It predicts GDP to grow 5% over the coming year, and the unemployment rate to drop to 4% – both of which might normally be associated with operating conditions favourable to lending activity.
Elsewhere, consumer arrears have shown improvement, even as lockdowns crippled wage earners across New South Wales and Victoria in the third-quarter. Although the value and mix of CBA’s provisions for loan losses remains unchanged at $6.2 billion, only 1% of the bank’s portfolio of customers temporarily deferred loans, and impairment expenses for the quarter tallied $103 million – highlighting a steady decline since the height of last year’s uncertainty.
Last but not least, even in the face of competition in the home loan market, CBA has still delivered above-average system growth in mortgages, coming in at 1.1-times growth in the most recent quarter. This is down on the 2-times system growth in home loans from the prior corresponding period, but it is credited as offsetting lower margins.
For now, however, will the market find confidence to look beyond the margin squeeze?
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