Commonwealth Bank of Australia flags $375 million in penalties on regulatory humiliation

Australia’s largest bank, the Commonwealth Bank of Australia (ASX: CBA) this morning reported a cash profit of $4.73 billion for continuing operations on underlying operating income of $13.03 billion.

The group will pay an interim dividend of $2 per share on earnings of $2.72 per share, which represents a payout ratio of 74%. The annual yield should be in the region of 5.6% plus the tax effective benefits of franking credits.

The cash profit was down 1.9% versus the prior corresponding half-year period after allowing for financial provisions made for penalties as a result of allegations against it by the money laundering regulator AUSTRAC.

If you exclude the $375 million that CBA has provisioned for the AUSTRAC humiliation, then cash profit was up a decent 5.8% at $5.11 billion.

CBA reported that the $375 million provision was based on “a reliable estimate of the civil penalty a court may impose in the AUSTRAC proceedings”. CBA has probably made the estimate based on AUSTRAC’s statement of claim against the bank, alongside legal advice and as such it should be reasonably accurate.

The bank is facing several other regulatory headaches though. Including allegations from ASIC that CBA engaged in “unconsionable conduct” in attempting to manipulate the bank bill swap rate as a key inter-bank lending and reference rate for money market or other debt products.

Recently, the Federal Court imposed penalties of $10 million on Westpac Banking Corp (ASX: WBC) and National Australia Bank Ltd (ASX: NAB) for their roles in manipulating BBSW.

These kind of fines are a drop in the ocean for CBA though, and its biggest regulatory problem remains the requirement to maintain or lift its capital adequacy provisions as a percentage of liquid capital held in reserve against risk-weighted loans or other assets.

APRA’s demand that the banks should be “unquestionably strong” continues to drag on the bank’s return on equity (a key measure of profitability) as idle capital kept in reserve cannot be lent out at highly profitable rates of return.

Recently, CBA sold its troubled life insurance business to international insurance giant AIA Group for $3.8 billion in an attempt to jettison some of its more capital-intensive businesses measured against profits delivered.

Moreover, the bankers are now even considering selling CBA’s highly profitable funds management business Colonial First State in a move that would provoke controversy given the strong reputation of the fund manager.

On the upside the bank’s net interest margin grew 6 basis points to 2.16% (the spread between what it pays on what it borrows, versus what it makes on what it lends) and likely has room to move higher with lending rates that probably bottomed over the past 12 months.

Lending rates also tend to rise faster than deposit rates and a rising interest rate environment should be a net positive for banks that generally lend long (via home loans) and borrow short such as the CBA. Over the medium term then CBA remains a sound investment for income seekers as the leader of a banking oligopoly in Australia.

If you’re not ready for retirement yet though, the banks may offer limited capital growth over the next 5 to 10 years, especially when compared to the blue-chips of tomorrow.

For example in May 2016 when I suggested cloud accounting business XERO FPO (ASX: XRO) could be a blue chip of tomorrow shares sold for just $16.20.

Today they sell for $33 and Xero recently struck an agreement with the NAB that will let small businesses make payments from within the Xero platform, rather than via NAB’s internet banking platform.

In return Xero may be able to skim a few basis points in fees from each payment. As such it seems some tech companies could deliver more growth by working with banks that are amenable to saving investment costs via short-cuts to technology improvements.

Of course I own shares in Xero so I may be biased, but if income isn’t your sole priority it may be worth checking out 3 more tech-based businesses that could be the blue-chips of tomorrow, not today…

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Motley Fool contributor Tom Richardson owns shares of Xero. The Motley Fool Australia owns shares of Xero and National Australia Bank.

You can find Tom on Twitter @tommyr345

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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