How Commonwealth Bank dished out the dividends and can promise more

Commonwealth Bank chief executive Matt Comyn delivered an up-tempo outlook for the bank and national economy.

Commonwealth Bank has proved the market wrong with a bumper result, offering a profit increase that beat analyst forecasts, a rising dividend and an outlook that ­suggests banks can outperform against a backdrop of increasing interest rates.

More than 800,000 shareholders who receive an average dividend income of about $2800 each annually from the stock will benefit from the higher than expected interim dividend of $1.75 a share, compared to $1.50 this time last year.

Crucially, CBA is offering this dividend yield of more than 5 per cent on a reduced payout ratio, which is now down to 70 per cent – in other words, it is going to be ­sustainable.

Not that long ago, banks had payout ratios testing 100 per cent.

The powerful profit improvement – up 23 per cent to $4.75bn – tells us two things.

First, the bank is run better than the market had priced in – ­remember, broker consensus estimates had assumed the stock would have to drop to reach price targets. Instead, it gained about 6 per cent post results.

Second, in pulling this profit out of the hat during a dismal ­period for Australian business, the bank has shown it can still grow within the confines of the domestic market even if it is the biggest lender in the nation.

The outstanding feature of the result was the rewards of a move to build market share while key ­rivals were floundering – home lending was strong and business lending grew at what is tagged as 1.7 times system. That means CBA created exceptionally strong fee volumes from this area that will underpin further momentum in the months ahead. Brokers and analysts had largely missed this key growth factor while over-estimating the costs the bank might incur in recent months – as remediation costs declined, the overall cost-to-income ratio now sits at a respectable 46 per cent.

The bank also announced an on-market buyback, which will do its bit to buoy the share price.

But the key point in the results presentation from CBA chief executive Matt Comyn was an up-tempo outlook for the bank and national economy – and since the bank is the biggest financial stock on the ASX, the two items are to some extent interchangeable.

Comyn and chief financial officer Alan Docherty spent a considerable amount of time explaining how the bank plans to deal with its soft spot – a decline in ­margins.

Net interest margins have been cooling and dropped under 2 per cent, but there is an explanation. Fixed-rate home loan activity simply went through the roof last year as the wider public finally ­realised the time to fix loans would never be better.

Fixed loans and switching ­activity explain the bulk of the margin reduction.

But Docherty reckons that, sometime in the next six months, the fixed-rate switching will peak as the majority of those who would switch will have locked in their rates and this will cool the margin squeeze. This time frame is a tad longer than some analysts had suggested, but it does not change the broader narrative.

In contrast, a new front is set to open among the major banks to attract depositors as rates inevitably start to rise. They are already moving up quickly in commercial markets and CBA economists believe we could see the first official rate increase in August.

As rates rise, all bank margins will start to improve.

As it happens, CBA gets a whopping 73 per cent of its funding from deposits – up from near 50 per cent a decade ago – and that means when rates do start to rise it will be the bank that is in the box seat to gain from rising rates.