Credit Risk Analysis of Cba
1. KEYS TO SUCCESS Operating in the ever challenging banking industry in Australia, Commonwealth Bank of Australia (CBA) aims to succeed through focusing on 5 main strategic areas: Customer service CBA believes that customer satisfaction is pivotal in creating value. Over the years, it emphasised employee training to deliver top-notch services to customers. CBA aims to add over 1000 employees to serve their growing customer base over the next 4 years.  It has also been awarded numerous awards for its excellence customer satisfaction.  Business banking CBA aims to be the leader in total capital solutions.
It introduced the contactless card payment facility and more user-friendly and reliable features in CommBiz to increase banking efficiency.  This increased its share of the total business lending market.  Technology and operational excellence CBA invested in Core Banking Modernisation as its new banking platform, and CommBiz, enabling 24-hour real-time banking and transaction. CBA also introduced the paperless end-to-end Home Loan process, improving cost efficiency.
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 Trust and team spirit CBA encourages staff participation while providing equal opportunity to all its employees.Staff turnover and absenteeism have declined significantly while average group satisfaction has increased.  Profitable growth through strategic management CBA focuses on its existing local customers while expanding internationally through a partnership with Vietnam International Bank, joint venture with China’s Bank of Communication and a branch opening in Mumbai, India.
 2. FINANCIAL RISK ANALYSIS In order to evaluate CBA’s financial performance, we will conduct an analysis on the financial statements, profitability, adequacy of future cash flows, and liquidity of CBA. 1. Interpreting the Financial Statements 1.Capitalisation and Leverage CBA has a current market capitalisation of $79,829M. With a substantial increase in leverage ratio from 2009 to 2010 as shown in Table 2. 1, CBA is a highly leveraged financial firm relying on a relatively thin slice of shareholder’s equity, $35.
2bn, to support $646,33bn in assets. 2. Profitability 1. Du Pont Analysis ROE measures the amount of profit generated by each dollar of equity. Its calculation is given by the formula below: ROE = Profit Margin (Profit/Sales) * Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity) As illustrated in Table 2. 2, CBA’s high net profit margin and low asset urnover, together with its highly leveraged position, contributed to the considerably high ROE over the last 3 years. Shareholder’s equity has also grown much faster than total asset from 2009-2010 implying that CBA is becoming more capital intensive.
A peer analysis is shown in Table 2. 3. In maintaining the highest ROE of the three banks, NAB, Westpac and CBA, CBA became the most leveraged of the three. With the average cost of its funding rising and its increasing reliance on overseas funding, CBA is now bolstering its balance sheet and holding back dividend growth as part of its short-term plan. 3. Cash Flow AdequacyCash flow ratios are calculated in Table 2. 4.
The large jump in CBA’s debt payback ratio of about 150% from 2009-2010 is a worrying sign. The debt payback ratio measures the proportion of debt to current period earnings. The ratio of 4. 13 is largely attributable to a 250% increase in short-term debt, due to a significant increase in the issuance of USD, EUR, and particularly GBP commercial paper, further aggravating the issue. Long-term debt increased by about 140%. The interest coverage ratio showed an improvement from 2009, a positive sign, particularly as the ratio reflects increasing earnings and decreasing interest expenses.With these mixed signals, we believe that CBA has barely adequate cash flows to meet its debt repayment and interest expense.
4. Liquidity Liquidity ratios are shown in Table 2. 5. The trend for the current ratio of CBA has been declining from 2008-2010. Although the decline has been slight, such a trend is cause for concern if it persists. Having a current ratio below 1 is also an extremely troubling sign as it indicates that CBA will not be able to meet its short-term obligations if they are demanded immediately. It also signals highly inefficient use of its current assets.
CBA’s cash ratio is exceedingly low. Its ratio of 0. 021 would mean that CBA is able to pay only 2. 1cents for every dollar of its liabilities. Based on our analysis, CBA’s liquidity appears to be very poor. 3. CREDIT RISK ANALYSIS 0.
3. 1. Business Risk 3. 1. 1. SWOT Analysis Strengths CBA owns the largest propriety distribution network franchise in Australia. It has an extensive branch network, convenient 24-hours phone and internet banking, and an ATM network.
CBA’s large scale and renowned brand enabled it to gain a strong market position in the banking industry and serve various customer segments.In order to remain competitive, CBA recognises customer satisfaction as its top strategic priority.  Weaknesses The acquisition of BankWest led to the decline of CBA’s capital ratio. During the Global Financial Crisis (GFC), CBA saw an increase in loan impairments that impacted on its profitability. With its sensitivity to the global economy, and its plans for international expansion, it is exposed to the growing uncertainty in the global market.  Opportunities The Australian superannuation industry is a growing market.With increasing demand for managed funds and superannuation products, total superannuation funds are expected to increase significantly in the near future.
Australia’s economy is improving after the GFC and demand for financial services is likely to increase with it. As CBA strengthens its maturity structure, whilst significantly increasing capital and liquidity over the course of the crisis and into the future, it is well-placed to take advantage of any opportunities that arise. CBA is further tapping into the strengthening Asian operation with its Asian partnership and joint ventures in Vietnam and China. 10] Threats CBA’s image has been greatly affected by the collapse of Storm Financial, attracting publicity and regulatory scrutiny. CBA continues to face strong competition from Australia’s local and foreign banks. Intense competition has affected CBA’s profitability and market share.  3.
2. Industry Risk We analysed the industry risk of CBA using the Porter Model, PEST Analysis and the Industry Life Cycle. 3. 2. 1. Porter Model The Porter Model incorporates five factors that determine the competition and thus profitability and attractiveness of an industry. Threat of new entrantsThe threat of new entrants is determined by barriers to entry.
With its large size, CBA realises huge economies of scale that newcomers are unable to achieve. CBA has further established strong relationships with its suppliers and customers, reaching out to customers, for example, by developing a wide network of branches and ATMs located all around Australia, making it difficult for new entrants to match its level of service. The legal barriers are high in the banking industry. The industry is tightly regulated with legislation, such as the Banking Act 1959, enforcement agencies and licenses that are required to operate.Overall, we believe that the barriers to entry are high and the threat of new entrants is low. Threat of substitutes There are few product substitutes for the unique products the banking industry offers, such as bank loans and mortgages. Customers may be less willing to accept substitutes as well, as they may prefer to transact with big banks, such as CBA, with better reputation and which are perceived to be safer.
The threat of substitutes is therefore, low. Bargaining power of suppliers There are various suppliers of funds to banks. Banks may draw on the interbank money market, borrow from the RBA and use its base of depositors’ funds.This reduces the overall bargaining power of suppliers as they substitute for each other. Each supplier, however, has varying levels of bargaining power. The RBA would have strong bargaining power compared to individual depositors who are weak due to the dispersed nature of the depositors’ base. We believe that the overall bargaining power of suppliers, under normal economic conditions, is medium.
In times of high uncertainty, bargaining power of suppliers would increase as suppliers of funds seek to conserve their capital, resulting in a scarcity of funds and a liquidity crunch.Bargaining power of buyers Borrowers are interest rate sensitive to banking and financial products, increasing their bargaining power. Borrowers tend to make prepayments on mortgages in periods of low interest rates for example. However, not many competitors offer the same level of services and range of products as CBA. The Big 4 are the main players in the banking industry, resulting in less choice for customers and lowering their bargaining power. Overall, the bargaining power of borrowers can be said to be medium. Intensity of rivalryAn analysis of S&P/ASX300 companies in the banking sector provides an indication of the industry growth rate.
As seen from Table 3. 1, although growth is generally forecasted to slow down in the next two years, growth rates can still be considered high. Players in the industry may therefore seek to expand their market share by targeting the growing areas of the industry rather than compete for each other’s market share, reducing the intensity of rivalry. The lion share of the market is concentrated in the hands of four major players, who are relatively equal in terms of market positioning.This would add to the intensity of rivalry among the four big banks as they compete to maintain their market position. Further, there is a low degree of differentiation among the products offered by the banks and low switching costs for customers. Intensity of rivalry would thus be high as banks compete to retain their customers by for example, offering lower rates and fees than competitors.
The overall intensity of rivalry in the industry is thus, high. In general, long-run profitability is attainable in the industry, making it attractive to outsiders.It is however, difficult for newcomers to penetrate the market and there are few substitutes that can replace the products offered by the industry. In conclusion, we believe that the banking industry is profitable, but competitive. CBA’s corporate strategy is to differentiate itself, as can be seen by the focus on customer service in its vision and presented strategy.  3. 2.
2. PEST Analysis The PEST analysis evaluates several factors that impact on an industry and its future growth potential. Political Australia is a country with political stability and regulations and laws in place to monitor the banking industry.International requirements such as Basel II ensuring sufficient liquidity in banks applies to the banking and financial industry in Australia as well. The political risk is low. Economical Australia has a stable economy, especially as seen during the GFC where it emerged relatively unscathed. The latest economic figures signalled positive prospects for Australia.
GDP growth was reported to be 3. 3% at an annual rate, surpassing 2. 9% forecasted by analysts.  Consequently, we believe that economical risk is low. Societal The education and income level of an individual is shown to materially influence the individual’s use of credit.Being a developed country where the population is largely well-educated, skilled and earning a reasonable level of income, the societal environment is favourable. Technological With recent advances in technology, such as the Internet, mobile technology and information technology, the impact of technology is now highly significant.
Technology development has wide implications for banking operations, which has seen the introduction of online banking and ATMS. The industry focus on technological efforts is therefore intense. In general, we believe that the factors affecting the banking industry are stable and constructive.CBA operates in an environment conducive for its future growth. 3. 2. 3 Industry Life Cycle We believe that the banking industry is in the growth shakeout and consolidation phase.
The industry is evidently growing, albeit at a slower rate, with reference to Table 3. 1, and is constantly changing. Many recent technological innovations had significantly revolutionised the way the industry operates. Banks would have to keep abreast with technological developments to take advantage of any future opportunities. The industry is also consolidating as evidenced by the recent mergers and acquisitions that have occurred, such as the merger between St.George and Westpac, and CBA and BankWest. There is potential for the industry to grow and expand, and for banks to increase their market share further.
3. 3. Management Risk The management of CBA is highly qualified and experienced. Ralph Norris, CEO and Managing Director, has a 30-year career in banking and was named New Zealand’s Executive of the Year twice.  The Board of directors is well-composed, with members having broad experience across various industries and knowledge and experience within the banking and finance industries.This would allow differing perspectives and insights to be shed on issues that the Board considers. All directors have a history of holding leadership positions in large companies and most have held directorships on listed companies.
 CBA has a structured and comprehensive risk management framework that contributes to its effectiveness in handling risks. Risk Management is governed from the Board level where the Risk Committee oversees credit, market, and liquidity and funding risks among others while strategic risks are considered by the full Board.The Risk Committee is responsible for formulating CBA’s risk appetite, setting risk management policies and defining risk limits to manage exposure and concentrations. The Committee also monitors the health of CBA’s risk culture.  The executive remuneration framework includes financial measures such as Total Shareholder Return.  The Total Shareholder Return for a 10-year period is given in Figure 3. 1.
Management performance may also be measured by other value-driven measures. Figure 3. 2 charts share prices against EPS. Table 3. provides the monthly share price history for the year. Finally, Figure 3. 3 shows the relative performance of CBA to the S/ASX 200 – Financials index for the past 6 months.
The exhibits and table demonstrate that CBA has a history of performing comparatively well and consistently. It has shown dramatic improvements over the years and appears to have rebounded since the global crisis in 2008. 4. CREDIT QUALITY – EXECUTIVE SUMMARY Based on our credit risk analysis, which includes the financial risk analysis, we conclude that CBA has a stable financial structure and good credit quality.CBA continues to deliver good financial results with its strong balance sheet and healthy operating performance. CBA’s profit margin in 2010 is 75. 61%, a 3% increment from 72.
45% in 2009. CBA’s ROE also rose 2% from 38. 78% to 40. 94%. Compared to its peers, CBA achieved the highest ROE in 2009. Our business risk analysis for CBA identifies a number of opportunities that CBA is well-placed to take advantage of. The industry analysis demonstrates that CBA operates in a highly competitive and economically-sensitive market.
The general macroeconomic environment in Australia is stable and conducive for growth.We have identified CBA to be in the growth shakeout and consolidation phase of the industry life cycle. The management risk is considered to be minimal for CBA as it has an experienced and highly qualified management team. CBA was rated AA by Fitch Ratings and Standard ; Poor’s with a stable outlook while Moody’s rated CBA as Aa1 with a negative outlook due to the current economic downturn.  With its strong market position and well performing financials and operation, we believe that CBA can continue to grow profitably and expand globally. APPENDIX Table 2. 1: Leverage Ratio |? 2010 |2009 |2008 | |LEVERAGE RATIO | | |? | |Total debt (in Millions) | 107,039 | 62,894 | | | | | |55,778 | |Total equity(in Millions) | 35,201 | 31,426 | | | | | |27,428 | |Debt/ Equity Ratio |3.
4 |2. 00 |2. 03 | Table 2. 2: CBA Cohort Year Analysis over 3 years |? |2010 |2009 |2008 |+/- (%) 09-10| |PROFITABILITY RATIOS – DU PONT |$M |$M |$M | | |Net income |14,411 |12,186 |11,704 | | |Total Operating Income |19,059 |16,818 |14,341 | | |Profit Margin |0. 56126 |0. 724581 |0. 816122 | | |? | | |? | | |Total Operating Income |19,059 |16,818 |14,341 | | |Total asset |581,406 |565,100 |456,027 | | |Asset Turnover |3.
28% |2. 98% |3. 14% | | |ROA (Profit Margin*Asset Turnover) |2. 8% |2. 16% |2. 57% | | |? | | |? | | |Total asset |581,406 |565,100 |456,027 |2. 8% | |Total equity |35,201 |31,426 |27,428 |12% | |Total asset/Total equity (Equity Multiplier) |16.
517 |17. 982 |16. 26 | | | | | |? | | |Net income |14,411 |12,186 |11,704 | | |Total equity |35,201 |31,426 |27,428 | | |ROE (ROA* Equity Multiplier) |40. 94% |38. 78% |42. 67% | | Table 2. : Industry Peer Comparison based on 2009 Financial Data |? |WBC |CBA |NAB | |DU PONT Analysis (2009) |$M |$M |$M | |Net income (Net Interest Income) |11,646 |12,186 |12,068 | |Total Operating Income |13,267 |16,818 |12,962 | |Profit Margin |0.
88 |0. 72 |0. 3 | |? | | |? | |Total Operating Income |16,505 |16,818 |12,962 | |Total asset |589,587 |565,100 |654,120 | |Asset Turnover |0. 03 |0. 03 |0. 02 | |ROA (Profit Margin*Asset Turnover) |2. 46% |2.
16% |1. 84% | |? | | |? |Total asset |589,587 |565,100 |654,120 | |Total equity |34,637 |31,426 |37,815 | |Total asset/Total equity (Equity Multiplier) |17. 02 |17. 98 |17. 30 | |? | | |? | |Net income (Net Interest Income) |11,646 |12,186 |12,068 | |Total equity |34,637 |35,047 |37,815 | |ROE (ROA* Equity Multiplier) |33. 2% |34. 77% |31.
91% | Table 2. 4: Cash Flow Ratios |? |2010 |2009 |2008 | |CASH GENERATION – CF RATIOS |$M |$M |$M | |Total debt |107,039 |62,894 |55,778 | |EBIT |25,904 |23,886 |24,890 | |Debt payback ratio |4. 13 |2. 3 |2. 24 | |? | | |? | |EBIT |25,904 |23,886 |24,890 | |Interest expense |18,603 |19,956 |19,667 | |Interest coverage (times) |1. 39 |1. 2 |1.
27 | Note: EBIT is calculated as Net profit before income tax with interest expense added back. Table 2. 5: Liquidity Ratios ? |2010 |2009 |2008 | |LIQUIDITY RATIOS |$M |$M |$M | |Current Assets | | |? | |Cash and liquid assets |8,711 |9,684 |7,282 | |Receivables due from other financial institutions |9,766 |13,986 |6,731 | |Assets at fair value through Income Statement: | | |? |- Trading |18,775 |20,988 |19,168 | |- Other | – |60 |274 | |Derivative assets |27,363 |25,536 |19,287 | |Available-for-sale investments |5,408 |5,826 |3,937 | |Loans, bills discounted and other receivables |105,879 |97,803 |92,205 | |Bank acceptances of customers |11,569 |14,726 |18,278 | |Other assets |4,390 |3,371 |3,833 | |Assets held for sale |49 |370 |412 | |Total current assets |191,910 |192,350 |171,407 | | | | | | |Current Liabilities |? |? |? |Deposits and other public borrowing |307,844 |305,170 |240,871 | |Payables due to other financial institutions |12,422 |14,942 |17,625 | |Liabilities at fair value through Income Statement|3,953 |2,578 |1,893 | |Derivative liabilities |23,689 |29,442 |19,367 | |Bank acceptances |11,569 |14,726 |18,278 | |Current tax liabilities |1,016 |835 |708 | |Other provisions |660 |404 |469 | |Debt issues |39,644 |15,852 |16,208 | |Bills payable and other liabilities |10,651 |7,883 |6,236 | |Total current liabilities |411,448 |391,832 |321,655 | |? | | |? | |Current ratio (Current assets/Current liabilities)|0. 47 |0. 9 |0. 53 | |? | | |? | |Cash ratio (Cash and other liquid assets/Current |0. 021 |0.
025 |0. 023 | |liabilities) | | | | | | | | | Table 3. 1: Bank Sector Analysis [pic] Source: FinAnalysis Note: Forecasts figures are supplied by Thomson Financial, other data is from the latest annual accounts. Figure 3. 1: 10-Year Total Return [pic] Source: FinAnalysis Figure 3. 2: Price against EPS [pic] Source: FinAnalysis Table 3. : Monthly Price History from Jan – Oct 2010 |Date |Open |High |Low |Close |Volume | |01/10/2010 | | | |50.
90 | | |30/09/2010 | | | |51. 17 | | |31/08/2010 | | | |50. 30 | | |30/07/2010 | | | |52. 56 | | |30/06/2010 | | | |48. 4 | | |31/05/2010 | | | |51. 37 | | |30/04/2010 | | | |58. 51 | | |31/03/2010 | | | |56.
29 | | |26/02/2010 | | | |53. 92 | | |29/01/2010 | | | |53. 23 | | Source: FinAnalysis Figure 3. 3: Relative Performance of CBA to S/ASX 200 – Financials [pic] Source: FinAnalysis ———————-  CBA Results Presentation for full year ended 30 June 2010, Slide 13.  CBA Annual Report for full year ended 30 June 2010, Pg 4.  CBA Annual Report for full year ended 30 June 2010, Pg 5.  CBA Institutional Banking and Markets dated March2010, Slide 4.
 CBA Annual Report for full year ended 30 June 2010, Pg 5.  CBA Institutional Banking and Markets dated March2010, Slide 6.  CBA Annual Report for full year ended 30 June 2010, Pg 5.  Datamonitor CBA SWOT Analysis Report dated March 2010.  Datamonitor CBA SWOT Analysis Report dated March 2010.  Datamonitor CBA SWOT Analysis Report dated March 2010. 11] Datamonitor CBA SWOT Analysis Report dated March 2010.
 Commonwealth Bank of Australia, http://www. commbank. com. au/about-us/our-company/strategy/default. aspx, accessed 4 Oct 2010.  SMH, 1 Sep 2010, Australia’s economic growth accelerates, http://www. smh.
com. au/business/australias-economic-growth-accelerates-20100901-14mad. html, accessed 4 Oct 2010.  Commonwealth Bank of Australia, http://www. commbank. com. au/about-us/our-company/management/default.
aspx, accessed 4 Oct 2010.  CBA Annual Report for full year ended 30 June 2010, Pg 65.  CBA Basel II Pillar 3 Disclosure as at 30 June 2010, Pg 13.  CBA Annual Report for full year ended 30 June 2010, Pg 72. 18] CBA Annual Report for full year ended 30 June 2010, Pg 10.  Data extracted from the 2010 Full Year Annual Report of the Commonwealth Bank of Australia.  Data extracted from the 2010 Full Year Annual Report of the Commonwealth Bank of Australia.
 Data extracted from UNSW Library FINANALYSIS database using 2009 financial data for Westpac, National Australia Bank and Commonwealth Bank of Australia as 2010 Annual Reports are not yet released for Westpac and NAB.  Data extracted from the 2010 Full Year Annual Report of the Commonwealth Bank of Australia.  Data extracted from the 2010 Full Year Annual Report of the Commonwealth Bank of Australia.