Commonwealth Bank shares drop 8% after loan margins warning amid fierce competition

A stark warning by the nation’s biggest bank about fierce mortgage competition and low interest rates hitting margins triggered a sharp decline in CBA’s shares.

CBA, led by Matt Comyn, saw its shares dive after warning that ultra low interest rates and fierce mortgage competition was hurting loan margins. Picture: Britta Campion

Commonwealth Bank’s stark warning about fierce mortgage competition and record low interest rates hitting margins has reverberated across the banking sector, as investors question the industry’s earnings trajectory.

CBA’s first-quarter trading update and admission on margin pressure spurred a punishing day for the stock, which closed 8 per cent lower at $98.99, after earlier sinking to a four-month intraday low.

That’s the first time CBA’s shares have closed below the $100 threshold since September 22, and the trading update saw the other major bank stocks also post declines that outpaced a 0.7 per cent drop in the S&P/ASX200.

CBA’s market update pointed to several factors including a big swing to fixed rate home loans over variable, and heightened levels of competition causing “considerably lower” loan margins, meaning mortgages are less profitable for the bank.

Investors were also jittery because the 22 per cent jump in CBA’s unaudited cash profit to $2.2bn for the three months ended September 30, was weaker than expectations. It was up from $1.8bn in the same quarter last year, which was impacted by amounts set aside for Covid-19 loan losses.

Cash profit in CBA’s first quarter declined 9 per cent versus the average of the preceding two quarters.

CBA, which is the nation’s biggest home lender, saw mortgage growth amount to $10.1bn in the quarter, household deposits were up $20.4bn while business loans expanded by $3.1bn on “stable margins”.

The bank said its group net interest margin — what it earns on loans minus funding and other costs — was “considerably lower” in the first quarter of the fiscal year, impacted by switching to fixed rate mortgages, record low interest rates, intense competition for home loan customers and the holding of higher liquid asset balances.

In CBA’s 2021 financial year its net interest margin was 2.03 per cent, and it stood at 2.04 per cent for the latter half of that financial year. At the bank’s annual results in August, CBA did flag there were a number of headwinds for net interest margins including home loan price competition and the low interest rate environment.

Velocity Trade analyst Brett Le Mesurier estimated CBA’s net interest margin had declined markedly to 1.90 per cent in the first quarter.

“They’re contributing to poor (pricing and margin) outcomes for everyone by their actions,” he said of CBA’s quarterly results and margin decline. But Mr Le Mesurier does see the pressures starting to ease as banks raise fixed mortgage interest rates to reflect movements in bond markets.

“Theses pressures will abate because rising interest rates will increase the investment income on shareholder funds and lead to a reassessment of low fixed rate loans that have been offered. Such loans have probably had a material and adverse impact on net interest margin,” he said.

Bond market expectations around official interest rate rises have prompted the big four banks to raise fixed rate mortgage pricing over recent weeks. Westpac this week upped its fixed rates for the third time in a month, and National Australia Bank is now the only remaining major lender to have a fixed rate home loan below 2 per cent, according to RateCity.

JPMorgan analysts said the quarterly CBA trading update was “much weaker” than they had anticipated.

“We see likely material downgrades to pre-provision profit forecasts, reflecting heightened margin pressures, lower non-interest income, and higher cost growth,” they outlined in a note to clients.

Jarden analysts said CBA’s update showed the bank was caught up in home loan discounting pressures and they estimated CBA’s core net interest margins, excluding liquid assets, were sitting at about 1.96 per cent.

“While CBA‘s strong franchise and proprietary network have continued to see above system growth across all core businesses, they are clearly not immune to NIM (net interest margin) pressures impacting the sector,” the analysts said.

“While recent repricing in fixed rates, early signs of a moderation in fixed rate flow and a fading drag from the low rate environment should see things improve through FY22 (estimated), we see the lower starting point as a concern.”

CBA has previously flagged that every additional $10bn in liquid assets reduces net interest margin by about two basis points.

CBA’s quarterly income printed 3 per cent higher than the same quarter a year ago, although was 1 per cent lower than the quarterly average of the six months prior as CBA divested its Aussie Home Loans mortgage broking unit. Home and business lending grew at 1.2 times and 1.5 times average industry rates in the three months ended September 30.

The annual profit results of CBA’s three main rivals wrapped up last week when NAB reported full-year profits soared 77 per cent to $6.56bn, underpinned by robust lending growth.

Westpac’s results came under heavy analyst and investor fire due to a large decline in its net interest margin and questions being raised about the bank’s ability to meet its headline annual $8bn cost target.

EY’s analysis of the four big banks’ results showed a 55 per cent jump in cash earnings for 2021 to a combined profit of $26.8bn, compared to the prior year.

CBA chief executive Matt Comyn on Wednesday highlighted that the bank was well positioned for an economic recovery as the nation’s largest states continued to ease pandemic restrictions.

“Our focus on operational execution ensures we are well placed to provide this support as activity restrictions continue to ease,” Mr Comyn said. “This was reflected in strong, above-system volume growth in core markets in 1Q22, continued sound portfolio credit quality and balance sheet strength.”

He noted while CBA expected a significant drop in September quarter economic growth, the accelerated vaccination rollout suggested a “much brighter 2022” and the bank estimated a 5 per cent rise in gross domestic profit and a drop in unemployment to 4 per cent.

CBA’s credit provisions for loan losses were “broadly unchanged” at $6.2bn and the bank booked a loan impairment expense of $103m in the September quarter. CBA said consumer arrears on loans were lower in its first quarter, although a “modest uptick” was expected as economies reopened and the latest round of loan repayment deferrals rolled off.

Operating expenses rose 4 per cent over the three months to September 30 from last year, and 3 per cent up on the average of the prior two quarters partly reflecting higher staff costs. Excluding customer compensation and related costs expenses were 1 per cent lower than the average of the two preceding quarters.

CBA’s non-interest income — which largely reflects fees — was 8 per cent lower in the first quarter.

The bank’s capital position after its $6bn share buyback and final dividend payment remained strong, with its common equity tier one ratio at 11.2 per cent in October. That is above the banking regulator’s 10.5 per cent “unquestionably strong” threshold.

CBA said it expects a further boost of 39 basis points to 49 basis points to capital when it completes the sale of two business units. The divestments include the sale of its general insurance arm and separately offloading a 55 per cent stake in Colonial First State to private equity group KKR.