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Charlie’s going all the way with CBA

The Commonwealth Bank (CBA) clearly ticked one important box in my bullish Australia call yesterday. The CBA result was a test for CBA and the ASX200 as a whole. Not only did CBA pass that test, they scored top marks in my opinion, justifying their own premium rating and also producing some stunning ratios that must leave top-down Australia bears scratching their heads.

For all the sensational ‘BS’ written on Australian housing and potential bank debts over the past year, CBA lost just $107 million on a total mortgage portfolio of $343 billion. That’s a loss rate of just 0.03%, which would have to be the lowest in the global mortgage banking universe.

That low mortgage loss rate was achieved in a period of falling employment and falling house prices. Yet now we have entered a period of rising employment and rising house prices due to the impact of lower mortgage rates, higher rents and housing underbuild.

It’s Australia, mate

I have written hundreds of times over the years that foreign investors don’t understand the Australian psyche when it comes to home ownership. This isn’t the US where you just hand the keys back to the bank if you can’t pay the mortgage; in Australia the bank effectively owns you and the ramifications of declaring bankruptcy are draconian and also come with a social stigma.

This is why Australian households will sacrifice all forms of discretionary spending to service their mortgage. They will also take on second jobs to service their mortgage, which in my view makes Australian mortgage banks the lowest risk in the world. This theory has been proven time and time again in respect to Australian mortgage banks where loan losses NEVER reach the levels the doomsayers say.

The proof

Just have a look at this slide from the CBA results pack, remembering CBA is Australia’s largest mortgage lender.

[1]Keep these stats in mind: 58% of CBA’s mortgage book is owner-occupied, 87% is at variable rates, the average loan-to-value ratio is 44%, the average loan size is $221,000, 68% of all customers have made payments in advance of schedule, averaging seven payments in advance, while only 2.7% of the entire book is low documentation loans.

Is it therefore a surprise that the loan loss rate is only 0.03%? It shouldn’t be because this is all about credit quality and conservative mortgage lending which is 63% funded from CBA’s deposit base and generates a net interest margin (NIM) of 2.1%, which spits out high free cash that in turn is returned to shareholders in the form of high fully franked dividend streams.

Look at the dividend

CBA clearly delivered a final dividend surprise yesterday of 197 cents, but more importantly for shareholders, they revised their dividend payout policy as the table below confirms.

[2]The interim dividend increasing to “approximately 70% of the interim profit” is a positive development. Our analyst TS Lim currently forecasts the bank’s earnings per share in the first half of fiscal 2013 to be 233 cents, which would equate to an interim dividend in February 2013 of 163 cents.

You can still get the dividend

CBA is ‘cum’ the final dividend of 197c until Friday, which means the company will pay shareholders who buy CBA before the close of trade on Friday 360 cents fully franked in dividends over the next seven months. That is a 6.44% fully franked yield for seven months, a return that beats cash at the bank again!

If you look out 13 months, you can collect the 197-cent full-year dividend just announced, plus another 360 cents over the 2013 financial year, taking the 13 month yield to 9.9% fully franked. Collecting $5.57 fully franked in dividends from CBA over the next 13 months is clearly attractive.

You will read page after page of minutia analysis of the CBA result this morning. In my opinion, pretty much all of it is useless with the only variables to focus on being the two slides above.

While not cheap, on next year’s numbers CBA isn’t expensive either relative to the return on equity (ROE). In the 2013 financial year, we see CBA’s earnings per share (EPS) growing 5%, while dividend per share (DPS) jumps to 347 cents for a prospective yield of 6.2% fully franked. I tend to think that’s an appropriate yield for the strongest bank in the strongest country in the Organisation for Economic Cooperation and Development (OECD). The price to earnings ratio (P/E) is 11.9-times fiscal 2013 and the Price to Book two-times. Those ratios are also justified.

Isn’t it ironic

So when you are next at a dinner party and there’s a grey nomad gloating how much cash they are holding, tell them that the Commonwealth Bank just reported a record profit and paid a record dividend because they are making a 2.14% net interest margin out of holding their cash!

The one-year total return (pre valuing franking credits and pre today’s final dividend) in CBA shares is 16%, three times what your cash on deposit just paid you at CBA! And you can also tell them CBA shares are now only 10% below their all-time high of $62.16. Cash is king, hey?

Quality is NEVER cheap and I suspect CBA will test that all-time high over the next 12 months. That is particularly likely if we get some long overdue credit growth and a new home construction cycle as domestic confidence improves ahead of a change of federal government.

Note well, business confidence readings surged in Australia in July, all part of the underlying recovery in confidence I can feel building in Australia. That confidence will be helped by CBA today reminding all Australians (and offshore bears on Australia) we are the strong, not the weak.

Go Australia!

[3]Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.

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