Shares of Commonwealth Bank of Australia (ASX: CBA) have entered a trading halt this morning after the bank confirmed a major capital raising that has kept investors on their toes this week.
Australia's largest bank expects to issue as many as 71 million new shares to existing shareholders in an attempt to raise $5 billion in new capital to meet tighter standards issued by the Australian Prudential Regulation Authority (APRA) recently. Investors will be given the opportunity to buy 1 new share for every 23 they currently own at a price of just $71.50, which represents a 10.5% discount to yesterday's dividend-adjusted closing price.
Notably, these shares will not receive the dividend payable for the full-year ended 30 June 2015.
The deal will be structured as a pro rata renounceable entitlement offer which will give the bank a pro forma CET 1 ratio of 14.3% on an internationally comparable basis and 10.4% on an APRA basis following the capital raising, compared to a ratio of 12.7% and 9.1% as at 30 June 2015, respectively. The bank said this would put it in the top quartile of international peers, as recommended by the Financial System Inquiry.
It also comes in the wake of a $3 billion capital raising announced by Australia and New Zealand Banking Group (ASX: ANZ); a massive $5.5 billion rights issue announced by National Australia Bank Ltd. (ASX: NAB) earlier in the year; and a hybrid issue by Westpac Banking Corp (ASX: WBC).
The Results
Although the capital raising will dominate today's news headlines, it was by no means the only highlight from the earnings report. Indeed, Commonwealth Bank posted the largest earnings result ever recorded by an Australian bank with a cash profit of $9.14 billion, up 5% on the prior year, while it also announced a final fully franked dividend of $2.22 per share, taking its full-year dividend to $4.20 per share.
While the earnings result was largely what the market had expected; investors should note that much of this growth came in the first half of the year, with results slowing considerably in the second half.
Indeed, the bank's net interest margin (NIM) – a key measure of a bank's profitability – fell by 5 basis points to 2.09% year on year which the bank attributed to "negative impacts of the falling cash rate environment and an increase in liquid assets", although bad debt charges did remain steady.
Unfortunately however, the bank's return on equity (ROE) retreated 50 basis points year-on-year to 18.2%. This is certainly something that investors will need to keep an eye on – especially with the bank raising new capital and increasing its share count by approximately 4.3% (which could see the ROE fall even further).
The Outlook
Investors will likely be encouraged by the outlook provided by management which cited near-term risks as a result of ongoing volatility in the global economy, but an otherwise "positive view of the Australian economy" in the long run.
It also said that the RBA's monetary policy settings have stimulated residential construction activity and that business credit quality is solid, as is the household sector's savings rates. "Household credit quality remains high, though the banking sector and our regulators are conscious of the potential impacts of a sustained period of low interest rates, and are therefore taking measured action."
The Key Takeaway
Commonwealth Bank's shares will remain in a trading halt until Monday, or at least until the institutional component of the entitlement offer is complete, so investors will have some time to process today's results (although the market's response is not likely to be pretty when they do re-open for trade).
Although the bank reported a record profit result, investors need to recognise the headwinds that are facing the sector. Indeed, bad debt charges appear to have hit a low and could soon reverse course – ultimately hindering the banks' ability to grow earnings – while competition within the sector is constricting the banks' net interest margins.
At the same time, the tougher capital restrictions will no doubt impact the banks' returns on equity and potentially their ability to grow dividends. If dividends fall, you can expect the shares to follow in a big way.
While I wouldn't suggest that selling out of the banks completely is a good move, investors might want to consider limiting their exposure to the sector and diversify their funds to take advantage of some of the market's other, potentially more rewarding alternatives.
