CommBank's earnings were meagre, and its return on investment has slipped

Commonwealth Bank may have posted a record profit for an Australian bank and cemented its position as industry leader but Ian Narev wasn’t brimming with enthusiasm for the performance.

Comments like: "this is a predictable result" and "this is a good result given the uncertain environment" and "revenue growth was subdued" and "lower credit growth and greater pressure on market-sensitive businesses" and "we will retain conservative business settings" were reflective of the generally modest and cautious tone of CBA’s presentation.

And with good reason. On a cash basis CBA lifted earnings a meagre 4% on total income which grew only 2% over the year to June. Its second half earnings were actually 1% lower than those generated in the first half.

While its return on equity was 18.6%, which is likely to prove sector-leading again, CBA’s ROE has slipped from 19.5% last year and is now well down on the 21.7% level at which it peaked ahead of the global financial crisis.

As NAB’s third-quarter update yesterday showed, it is difficult to grow income and earnings meaningfully in an environment where credit growth is running in the low single digits and about a third of the levels experienced pre-crisis. It doesn’t help that banks' markets-related businesses are under pressure from the difficult conditions.

The strategy for the major banks has shifted very discernibly from top line and volume-driven growth to introspection and a focus on costs and credit quality.

In CBA’s case, operating costs were up 3% but impairment charges down 15%.

With funding pressures still acute and no obvious catalysts for a change to the risk-averse stances of consumers and businesses the outlook for the near term, at least, is for more of the same.

Despite all the controversies around the major banks’ retention of some of the Reserve Bank’s reductions in official interest rates the funding squeeze on the banks is real, driven by increased wholesale funding costs and the competition for deposits. If the majors are profiteering from their oligopoly, as some politicians keep claiming, they aren’t very good at it.

CBA’s net interest margin of 206 basis points in the second half was six basis points lower than in the December half and 11 basis points lower than the same half last year, despite the retentions and some re-pricing of its business lending. Year-on-year the reduction in net interest margin was a more modest three basis points, although the contraction in the Australian business was five basis points.

Part of the explanation for the relatively stagnant performances of the majors is their defensiveness, which is understandable given the continuing fragility and risks within the global economy and financial system.

It was a notable feature of the CBA result that there was only modest balance sheet growth (about 5%) and that in most of its key business lines it was content to simply hold share or even allow it to slip a little. Its focus continues to be on shoring up its balance sheet and its composition.

It continues to shift the mix of funding away from wholesale to deposits – 62% of CBA’s funding is now provided by deposits – while also lengthening the maturities of the wholesale book. The average maturity of CBA’s new issuances in the year to June was 5.2 years compared to the overall average maturity of 3.7 years.

It is also holding a lot of returns-sapping liquidity – $135 billion compared with $101 billion in June last year and $86 billion in 2010 – and has a conservative tier one capital ratio of 10%. As a sector, the Australian banks have positioned themselves as strongly as they can to respond to another outbreak of global crisis.

The other feature of CBA’s result is that the group, which has a technology lead over its peers, is continuing to invest heavily – it spent almost $1.3 billion last financial year after investing $1.2 billion the previous year and $1 billion in 2010.

The goal of the investment program isn’t just to drive productivity gains, which it is doing, or to enable the development and faster rollout of new products, which is occurring, but also to in effect "future proof" CBA from the rapid evolution of banking technologies and the threat that could be posed in the form of new and innovative entrants.

This article originally appeared on Business Spectator.