Credit risk and Profitability

You are required to use 2 Australian commercial banks, you may choose to use the same banks as you used in Group Assignment 1 or different banks . The time period of analysis is from 2008 to 2010. Part I. Loan Composition and Credit Risk (50% of marks) Compare and discuss loan composition and loan credit (default) risk of the banks Below are some considerations you might like to make (this is not an exhaustive guide )2 0 Loan composition 0 Compare the types of loans made by each bank, & analyse how these loans changed over the sample period 0 Consider the types of loans made by industry, geographical location and the maturity of the loans for each bank 0 Have the banks increased or reduced lending in some areas or industries? 0 Credit Risk 0 Use different methods of measuring credit risk (quality) of loans for each bank, such as I Provisions for loan impairment to total (gross) loans I Loan impairment expense to provision for loan impairment 0 How has credit risk (quality) of loans changed for each bank over the sample period? 0 Compare & discuss changes in loan composition & credit risk for each bank over the sample period Hint: Details of loan, bill discounted and other receivables (including advances ) composition and provisions for loan impairment (and other proxies for credit risk) are usually provided in the notes to the financial statements. You may need to read through annual reports for a comprehensive understanding of the strategies & considerations made by the banks during the sample period. Part II. Credit risk and Profitability (50% of marks) Compare and discuss the implications of credit risk for profitability of the banks 0 Some relevant measures you may like to consider: I Provisions for loan impairment to total operating income I Provisions for loan impairment to pre-provisional net income (net profit) or I Loan impairment expense to net income (net profit) before loan impairment expense 0 Compare and discuss how the banks? loan profitability has been affected by the loan composition and credit risk o How has loan profitability changed for each bank over the sample period? 0 Why do you think this has changed? 0 Did market conditions have a large impact on the banks profitability and loan composition?Part II. Credit risk and Profitability (1300 words)Compare the two Australian Banks, Commonwealth Bank (CBA) and Westpac Corporation (WBC)Introduction Define credit riskCompare and discuss the implications of credit risk for profitability of the bank. How has loan profitability changed? Why has this changed? Market conditions (level of default) Change in bank structure Financial regulationsUse ratios (define each ratio?) Provisions for loan impairment to total operating income Provisions for loan impairment to to pre-provisional net income Impairment expense to net income before loan expense Net income ratio (change of loan profitability) Leverage?a borrower?s leverage or capital structure ? the ratio of debt to equity- affects the probability of its default. Because large amount of debt such as bonds and loans increase the borrower?s interest charges and pose a significant claim on its cash flows. Default Level RAROC (adjusted) = RAROC adjusted ?(One-year net income on a loan)/(Loan (asset)risk or capital at risk ) ? a return adjusted for risk ? used to evaluate (and price) credit risk based on market data ? Loan will only be approved if the RAROC is sufficiently high relative to a benchmark ROEWESTPAC CORPORATION (WBC) COMMONWEALTH BANK (CBA) $M $M $M $M $M $M $M $M $M LOAN CLASSIFICATION 2007 2008 2009 2010 LOAN CLASSIFICATION 2006 2007 2008 2009 2010 Australia australia overdrafts 3,045 2,973 3,880 3,550 overdrafts 16,155 20,047 17,829 19,924 credit card outstandings 7,310 7,536 9,429 9,596 housing Loans 163,839 186,926 261,504 292,140 overnight and at call money market loans 280 297 231 223 Credit Card Outstandigns 7,185 7,555 9,055 10,200 acceptance of finance 21,847 24,499 49,103 43,672 Lease financing 4,532 4,239 4,572 4,657 term loans 184,160 214,541 339,153 366,076 bilsl discounted 3,640 5,868 10,936 14,379 finance leases 4,345 4,900 5,468 5,029 term loans 68,577 83,431 107,337 101,794 margin lending 4,939 3,833 3,900 3,521 other lending 1,339 1,076 1,616 1,288 other 3,105 4,293 4,907 2,287 other securities 11 13 524 564 total aus 229,031 262,872 416,071 433,954 total aus 265,278 309,155 413,373 444,946overseas (NZ) overseas overdrafts 1,254 1,200 1,122 926 Overdrafts 1,605 716 744 652 credit card outstannding 937 885 969 951 Housing Loans 28,931 28,817 30,702 31,433 overnight and at call money market loans 1,341 1,787 1,356 1,175 Credit Card Outstandigns 533 538 573 589 term loans 42,571 38,558 42,307 40,397 Lease financing 531 563 541 570 other 735 897 326 336 bilsl discounted 33 total other overseas 5,780 4,388 5,692 4,627 term loans 20,027 23,916 27,079 23,052 redeemable preference share financing 1,194 1,194 744 total os 52,618 47,715 51,772 48,412 other lending 183 25 16 27 other securities 303 300 total os 53,340 56,069 60,399 56,323less provisions for imparment 1,233 1,713 4,924 5,428 unearned income 1,920 2,229 2,217 2,382 3,153 3,942 7,141 7,810net 315,465 361,282 466,631 493,459CREDIT QUALITY 2007 2008 2009 2010 CREDIT QUALITY 2006 2007 2008 2009 2010 total australia not due not impaired 362,297 420,665 560,705 585,352 not due not impaired 259,158 302,156 399,075 428,464 past due but imparied 11,315 13,977 14,339 17,423 past due but imparied 5,722 6,379 10,686 11,861 past due and impaired 539 1,194 3,854 4,659 past due and impaired 398 620 3,612 4,621 total 374,151 435,836 578,898 607,434 total aus 265,278 309,155 413,373 444,946 total impairment 1,369 1,967 4,392 4,723 os carry value 372,782 433,869 574,506 602,711 not due not impaired 51,291 53,440 56,918 53,320 past due but imparied 2,026 2,566 2,904 2,513 past due and impaired 23 63 577 490 total os 53,340 56,069 60,399 56,323total 318,618 365,224 473,772 501,269PROVISIONS 2007 2008 2009 2010 PROVISIONS 2006 2007 2008 2009 2010 total provisions 1,369 1,945 4,384 4,711 total provisions 1,217 1,233 1,713 4,924 5,453 total charge 931 3,238 1,456 total charge 398 434 930 3,048 2,379 prov for impairment loan 406 594 collect prov %gross loan 0 0 0 1 1 impairment on loan/avg loan 0 0 0 0 total prov/total charge 3 3 2 2 2LOANS WRITTEN OFF 2007 2008 2009 2010 LOANS WRITTEN OFF 2006 2007 2008 2009 2010 australia 355 394 1,550 1,202 australia nz 6 75 350 146 sovereign other os 10 2 23 3 agriculture 8 1 3 2 10 total ? ? ? ? bank & financial 1 5 110 383 real estate 11 21 24 40 167 presonal 388 408 364 496 651 IMPAIRMENT 2007 2008 2009 2010 asset financing 42 49 49 58 72 prov for impair (aus) 90 331 1,082 1,300 other comm and ind 36 30 34 255 604 prov for impair (OS-NZ) 22 56 124 270 total 486 509 479 961 1,887 prov for impair (other-OS) 36 26 22 52 overseas total provisions for impairment 1,558 2,174 4,734 5,061 sovereign agriculture 7 bank & financial 4 86 50 real estate 2 22 25 presonal 7 7 13 14 18 asset financing other comm and ind 4 3 5 60 86 total 11 10 24 182 186less recovered 127 103 77 73 77 total net impairments 370 416 426 1,070 1,996:

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