Commonwealth Bank shares: interest rates continue to rise

Market stability amidst challenges

Commonwealth Bank of Australia (ASX: CBA) shares have remained essentially flat in 2023. Despite rising to as high as $111 in early February and falling to as low as $95 at various points throughout the year, the bank has shown resilience, boasting a market capitalisation of approximately $168 billion at $100 per share today.

Over the longer term, CBA shares have increased by 41.5% over the past five years, weathering the COVID-19 pandemic-induced market downturn. Despite a tightening monetary environment, several risks lie ahead.

Record profits amid rising interest rates

In its full-year results, Commonwealth Bank posted a record cash profit of $10.16 billion—a significant 6% increase within a year. However, these improved results could be a double-edged sword; the bank's profits were bolstered by rising interest rates that concurrently led to a sharp increase in bad debts.

Risks highlighted by CEO

CEO Matt Comyn has indicated that 'downside risks are accumulating as the lagged impact of rising interest rates begins to strain mortgage customers, compounded by other cost-of-living pressures affecting more Australians.' Loan impairment expenses surged by approximately $1.5 billion.

The bank's net interest margin increased by 17 basis points to a robust 2.07%. However, this may pose a political risk, as banks have drawn criticism from politicians for raising borrowing rates disproportionately compared to deposit rates. CBA has announced further share buybacks and declared a dividend of $4.50 per share for the year.

The future of CBA

With its Q1 trading update imminent, CBA shares are under scrutiny. Sporting a price-to-earnings ratio of around 17 and a dividend yield of 4.5%, the bank is valued at a premium relative to its peers. Given Australia's economic challenges, driving growth may prove challenging.

Competitor performance and market stress

In comparison, competitor Westpac recently reported a 26% increase in annual net profit to $7.2 billion. CEO Peter King described the result as 'very strong' and announced a $1.5 billion buyback. However, he also acknowledged a 'modest increase in stress' among customers due to rising rates, with the number in financial hardship now at 13,000.

Mortgage stress and rate hikes

According to the Australian National University's tax and welfare system model, even before the latest rate rise, 48.5% of Australian mortgage holders were allocating at least 30% of their disposable income to mortgage repayments, indicating financial stress. This proportion has soared from just 26.7% in 2019 to record levels.

Inflation and interest rates

Furthermore, with the Consumer Price Index (CPI) inflation rate at 5.4%, the Reserve Bank of Australia has lifted interest rates by 25 basis points to 4.35%, with another board meeting scheduled for 5 December. As the country's leading mortgage lender, Commonwealth Bank may see more customers struggle financially, even as the bank's profits climb.

A tipping point may emerge where bad debts surpass profit gains. However, it's noteworthy that CoreLogic data suggests the real estate market remains resilient. The national home value index rose by 0.9% in October, gaining momentum from September's 0.7% rise and now sits just 0.5% below the peak recorded in April 2022.

Macroeconomic risks on the horizon

At the macroeconomic level, RBA Assistant Governor Brad Jones has cautioned that 'the risks we are likely to face over the next decade differ from those of recent years'—including the threat of swift deposit withdrawals facilitated by social media and digital banking. Jones referred to the Silicon Valley Bank collapse earlier this year, which saw the bank lose 30% of its deposit base 'in a matter of hours, with a further 50% prepared to be withdrawn the next day.'