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Why Commonwealth Bank has smashed the market

Commonwealth Bank (ASX: CBA) has set another bar in Australia’s banking sector as it reaffirms its top-dog status with a third-quarter $1.9 billion profit.

In an unaudited trading update, the CBA announced a net profit of $1.9 billion for the three months ended March 31. A year earlier the company announced $1.7 billion profit, a huge jump by any anyone’s standards. What has changed?

Interest rates have dropped seven times since November 2011, which has given the CBA and other banks like Westpac (ASX: WBC) the option to withhold the cuts and spin off extra profit. However, it was the CBA’s dominance as the top mortgage lender that helped the banking giant secure a 12% profit increase.

In the six months ended December 2012, the big four banks reported record cash profits totalling more than $13.4 billion. ANZ (ASX: ANZ) and NAB (ASX: NAB) impressed shareholders and dividend investors alike, however the profits have largely been derived from cost-cutting and interest rates changes. Removing bad debts has also important in delivering results.

To meet tight international banking standards, the CBA and other banks have to support lending with a viable amount of equity. The CBA said 65% of all its lending was now funded by deposits — this puts pressure on margins, especially when interest rates are dropping and the banks must lure in depositors with lower yields.

Yesterday, the ABS released financial lending statistics for March which showed that personal finance was up but commercial lending lagged. PriceWaterhouseCoopers said “credit growth for business seems to have stalled once more in recent months” and added that the “business sector might be struggling a little more than is generally understood”. This is a key market for all Australian banks, particularly as the mining investment slows.

Foolish takeaway

For the big banks, domestic growth has run its course and shareholders will be wise to take note. They will struggle to keep growing amid slowing economic growth and a drop in mining investment. From a year ago revenue has been largely flat, which shows that they’re not creating new business but simply trimming the costs. Perhaps the only way forward is offshore, ANZ has already moved to capitalise on the rise of Asian economies and in the long-run this could prove to be a decision that sets it apart from its rivals.

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The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool contributor Owen Raszkiewicz owns shares in ANZ.

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