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Morningstar | Commonwealth Bank Pauses on Simplification Strategy. FVE AUD 80 Unchanged

Wide moat-rated Commonwealth Bank of Australia surprised with the decision to suspend demerger plans for its wealth management and mortgage broking businesses. The demerger has been deferred due to higher priority given to implementing the recommendations of the Royal Commission. Near-term priorities of the bank are implementing enhanced and complicated compliance systems, refunding customers and remediating past wrongs. Notwithstanding the complex remediation process, the bank remains committed to ultimately exiting the wealth management and mortgage broking businesses.

But a longer-term rethink of the demerger merits could see the businesses retained. Currently, the wealth management and mortgage broking businesses, known as “NewCo”, makes a cash NPAT of around AUD 280-300 million a year, and based on a 12-13 multiple is worth about AUD 3.5 billion. The bank is spending considerable amounts on remediation and process improvement and if successful, the group could get significant leverage from a future well run profitable and efficient wealth management operation. The final report of the Royal Commission did not call for integrated wealth businesses to be forcibly broken up, providing a window of opportunity.

The bank has incurred a massive AUD 1.46 billion in cumulative remediation and program costs including, AUD 1.22 billion relating to the wealth management businesses. Total cost includes AUD 610 million paid or provisioned for customer refunds to address issues such as advice quality, fees where no service was provided in the advice business. Consumer products being rectified include “credit card plus”, CommInsure Life insurance and loan protection insurance, banking fees and interest. A further AUD 650 million has been incurred in program costs and internal process improvements relating to the customer refunds. A AUD 200 million indemnity has been provided for further uncompleted wealth management remediation issues and program costs.


National Australia Bank recently announced the delay of the demerger/sale process for its MLC Wealth business and with a new Chairman elect and eventually a new CEO NAB may similarly reassess the sale of its wealth business. Currently, National Australia bank expects to demerge the MLC wealth business in fiscal 2020.

Commonwealth Bank management and the board may hold on to the wealth business post the remediation clean-up. Ironically, a fallout of the Royal Commission is a far tougher regulatory environment for financial advisors and the wealth management industry. This could raise the cost of good quality financial advice to such an extent that it becomes cost-prohibitive for the wider universe of investors. Good quality financial advice may only be available for the very wealthy. This is not a good outcome for Australia’s rapidly growing cohort of retirees, irrespective of whether they are self-funded within or without the SMSF sector, or members of industry funds or retail funds.

Our fiscal 2019 cash profit forecast for Commonwealth Bank remains at AUD 9.7 billion and a fully franked dividend of AUD 4.33 per share. Total lending growth is soft at about 2% year on year, but home growth is better at about 4% year on year. Retail deposit growth is stronger at about 5% year on year. The softer first half fiscal 2019 net interest margin, or NIM, of 2.10% is expected to be short-lived, as NIM picks due from variable home loan rate increases in October 2018 and a modest easing in short-term wholesale funding costs. Intense competition for high-quality owner-occupier home loan borrowers and the ongoing switching of higher-margin interest-only loans to lower-margin principal and interest loans will continue to drag on margins.

Even though there has been a decline in average house prices, loan quality remains strong with the first-half loan loss rate of 0.15% expected to replicate for full year fiscal 2019. Group home loan 90 plus day arrears rates declined modestly to a low 0.67% at Dec. 31, 2018 from 0.70% at June 30, 2018.

The banking regulator, Australian Prudential Regulation Authority requires the major banks to achieve a common equity Tier 1 capital of at least 10.5% by Jan. 1, 2020. The bank remains in a strong capital position with the common equity Tier 1 capital ratio of 10.8% at Dec. 31, 2018 and 12% on a pro forma basis incorporating previously announced asset sales that are scheduled to complete during 2019. First-half fiscal 2019 organic capital growth was 0.66% with shares required to satisfy the dividend reinvestment plan, or DRP, bought on market, the first time in four years the DRP has been neutralised. We expect an off market tax effective structured share buy back to be announced after the sale of the Colonial First State Global Asset Management business to Mitsubishi UFJ is completed mid calendar 2019.