Crunch time for the Commonwealth Bank

Rarely in our history has the largest firm in the land been under so much pressure and it’s only going to get tougher.

A Commonwealth Bank branch in Brisbane. Picture: AAP

Rarely in our history has the largest company in the land been placed under so much pressure. The major threats to the Commonwealth Bank of Australia are not the extraordinary 2017-18 losses that have arisen from bad management, rather they are the challenges the bank faces over the next two or three years. And the provocative token rise in the 2017-18 dividend makes me fear that the CBA board and top management has become isolated from the forces around it and has not learned from its past mistakes.

This represents a real danger for both shareholders and the total community. Australia needs a strong banking system and a strong Commonwealth Bank. Given the hazards ahead, we can be thankful that the CBA starts in a strong financial position and that the base business of the CBA performed well in the 2017-18 year, although there was clear weakness in the second half.

But that’s history because the company faces a complete change in its operating environment. To retain its top position in the ASX will require management efforts of herculean proportions. Maybe CEO Matt Comyn can navigate the shoals but when he and his board spat in the eye of the government, the regulators and the non-shareholding wider community with a token dividend rise, my fears rose sharply.

So, let’s document some of the challenges the CBA faces in the next two or three years. First deeply embedded in its board and management organisation will be ASIC’s “corporate cops” looking to making a name for themselves by making sure that all CBA decisions put customers first.

The “cops” will start from the (false) premise that all CBA people are crooks and its “the cops” job to stop them robbing customers.

The new breed of ASIC people, inspired by the Federal Treasurer, believes shareholders have enjoyed 20 years or incredible growth because shareholders ranked first in decision making and that today’s dividend lift has confirmed that CBA has not learned a thing.

Accordingly, CBA people must be “taught a lesson”. I could be wrong and perhaps the “corporate cops” can be muzzled with long lunches but I doubt it.

Whether it is CBA directors, top and middle management, technology people or those in the branches, all will soon know that “Big Brother” could be watching. The “corporate cops” won’t be everywhere but no CBA employee can be sure just where they will be and when they will strike. That will slow decisions down and customers will notice it.

And this is happening at a time when the bank must slash its costs and reduce its staff to adjust to the new technologies and artificial intelligence. Big investments are required. If the CBA falls behind in the technology race it will be overrun by newly emerging, specialised fintech companies and competitors, including any smaller banks (and they are all smaller), who get the technology right.

Global management consultant A.T. Kearney did a special report on the Big Four banks and, while not commenting on share prices, pointed out that CBA had ridden the retail/housing boom better than any other bank and 60 per cent of its business was in retail --- much greater than any other of the top four banks.

That game is now changing. In Sydney apartment prices are down 20 per cent and dwellings in many inner suburbs are down 10 to 12 per cent and still falling. Melbourne and Brisbane apartments have fallen by similar amounts and in Melbourne dwelling prices have started to noticeably weaken. APRA now requires the CBA, and the other banks, to change their lending rules. There must be a much closer monitoring of income and expenses and clamps on interest-only loans. And the corporate cops will be watching that customers are not sold “inappropriate” loans. Unless everyone recognises the dangers, and Matt Comyn is very skilled, then the dominoes will start wobbling.

If lending continues to be curbed:

• That means CBA loan growth will be reduced.
• That means price of dwellings will fall further in the vulnerable parts of the market --- usually higher priced homes.
• That means that some (not all) of the rash loans of the boom will start to unravel.
• That means that capital city economic activity, which is currently booming will slow.

The fact that the CBA was in good shape at June 30, 2018 will help but the tests are to come. The CBA is not alone facing this problem but it is the biggest.

To date, when a home borrower runs into problems, particularly an investor, the dwelling can be sold and the loan cleared. In a domino situation where dwelling prices have fallen, selling can create a loss and an allegation that the loan was made to the customer recklessly or inappropriately. The ASIC “corporate cops” will be all over it.

Meanwhile, the area of growth that the CBA believed one day it could tap was wealth management. It seems that the CBA and most of the other banks did not have the management skills to make wealth management work. Untangling that whole situation will not be easy.

And, potentially, CBA faces a problem with its bank depositors. In the latest result low interest rates have caused “lazy” customers to leave their money in transaction accounts so the CBA enjoys “free” money. That may continue but in interest bearing deposits there are danger signs. When interest rates fell, all the banks reduced home loan rates but made sure they lifted their margins by reducing deposit rates even further.

The banks, and particularly CBA, found that they offered lower rates their customers did not flee. So, in so many categories, CBA deposit rates are lower than anyone else and the harvesting of depositors cash has been a boost to profits, although the bank in recent times has been losing market share. The problem is that starting up deposit accounts with another bank is time consuming and difficult.

What we will see, in all areas of banking, is that when banks leave a gap in the market new entrants will come in using high technology. This is certainly happening in some areas of business and dwelling finance but to my surprise it is also happening in bank deposits. A small listed company called Trustees Australia has an operation called Cashwerkz which registers the depositors identity and then the depositor can deposit with any of the banks in the scheme --- there is only one entrance point and all deposits are registered in the name of the depositor. Cashwerkz have $300 million in deposits but it’s exploding. At this stage there are only 12 banks available --- Macquarie, ME Bank, ING, Bankwest (CBA), NAB, Bank of Sydney, AMP Bank, ANZ (for advisers), Qudos Bank, Auswide Bank, the Capricornian and BOQ Specialist. Six more are coming.

For one year deposits ING is tops at 2.85 per cent while the CBA offers just 2.3 per cent. Both are government guaranteed up to $250,000. That’s a huge gap.

But its only one of the challenges facing CBA.