Fitch Ratings says the Commonwealth Bank of Australia’s full-year results to 30 June 2018 (FY18) broadly support the agency’s expectation that earnings pressure would emerge for Australian banks during 2018. An increase in wholesale funding costs led to a reduction in CBA’s net interest margin in 2H18, loan growth continued to slow and continued investment into the business and compliance contributed to higher expenses. Mortgage arrears also trended upwards due to some pockets of stress, and while they have not translated into higher provision charges as yet due to strong security values, continued moderation in Australian house prices may result in higher provisioning charges in future financial periods.
Most of the earnings issues appear applicable across the sector and are likely to remain into 2019, placing pressure on profit growth for all Australian banks. Increased regulatory and public scrutiny of the sector may make it difficult for the larger banks to reprice loans to incorporate the increase in wholesale funding costs, meaning net interest margins are likely to face some downward pressure. Loan growth is likely to further slow as the housing market continues to moderate, while compliance costs continue to rise due to the scrutiny on the sector.
The most prominent scrutiny is the royal commission into misconduct in the banking, superannuation and financial services industry, which has already identified a number of shortcomings within the industry. We expect the release of the interim royal commission report, due to be published by the end of September 2018, to give a better view of how widespread these shortcomings are and what impact they may have on the credit profile of Australian banks.
CBA’s FY18 results show a level of resiliency despite these issues. The bank reported cash net profit after tax from continuing operations declined 5% to AUD9.2 billion in FY18, but this was driven by a number of one-off charges, including a AUD700 million fine to settle a civil case in relation to breaches of anti-money laundering and counter-terrorism financing requirements. Cash net profit after tax from continuing operations rose by 4% to AUD10.0 billion when the one-off items were excluded.
Balance-sheet metrics remain consistent with Fitch’s expectations. The bank reported a stable common equity Tier 1 ratio of 10.1%, which incorporates the AUD1 billion additional operational risk charge (essentially an increase of AUD12.5 billion in operational risk-weighted assets) put in place following the publication of the independent prudential inquiry report in May 2018. The divestiture of a number of assets planned for FY19 as well as CBA’s ability to generate capital through retained earnings mean the bank is well-positioned to meet the regulator’s “unquestionably strong” capital requirements ahead of schedule. CBA’s liquidity coverage ratio (131%) and net stable funding ratio (112%) both increased due to an improvement in the bank’s deposit mix towards more stable deposit types and a lengthening in the average term to maturity of its wholesale funding.
Fitch continues to monitor CBA’s progress in remediating shortcomings in its operational risk controls and governance identified in the May 2018 independent prudential inquiry report as risks around this process were a key driver of Fitch’s revision of CBA’s Outlook to Negative. CBA noted in the FY18 results announcement that the remediation program has received approval from the Australian Prudential Regulation Authority and that it aims to make significant progress in implementing the program over FY19. However, CBA also noted that full remediation would be a multiyear process for the bank.
