Analysis Of Stocks Of Financial Institutions: Key Financial Ratios And Business Risks

Key Financial Ratios

Discuss about the Analysis Stocks Of Financial Institutions.

The present report aims to conduct the fundamental analysis of stocks of some selected financial institutions. The analysis is carried out through examining the key financial ratios of the financial institutions and their significant business risks. The significant business risks examined are interest rate risk, credit risk, market risk, foreign exchange rate risk, liquidity risk, and capital adequacy. The financial institutions selected for the purpose are Bank of America, Australia and New Zealand Banking Group, Commonwealth Bank of Australia, Westpac Banking Group, Barclays PLC, Bank of China, Citigroup, HSBC Holdings PLC ADR and JPMorgan Chase and Co.

The major financial ratios that help in examining the financial position of a business corporation are profitability, liquidity, efficiency, market capitalization and return on equity. The profitability ratios assess the ability of a corporation to generate earnings in comparison to revenue. The liquidity ratios determine the cash position while efficiency ratios provide an analysis of utilizing effectively the assets and liabilities of a corporation. The market capitalization ratios determine the market value of a company while return on equity assesses the profit earned by a company on its equity value. The key financial ratios of the selected financial institutions are examined as follows:

The Bank of America is recognised as one of the leading bank of the country for meeting the personal financial needs of a business entity. The analyses of the profitability ratios of the bank such as gross margin, operating margin, return on invested capital, asset turnover has indicated that its profitability is increased in the last few years. The liquidity ratios such as financial leverage and debt/equity ratio indicates that the liquidity position of the banking corporation has decreased in the recent years. The financial leverage and debt/equity ratios have shown a decreasing trend from the year 2013-2016. The efficiency ratios such as receivables turnover, inventory turnover, fixed assets turnover and asset turnover of the banking corporation indicates the ability of the banking corporation. The efficiency ratios such as fixed assets turnover and assets turnover have shown an increasing trend and thus it can be said that the banking corporation possess larger ability to effectively use its assets and liabilities for generating profitability. The market capitalization ratio such as EPS (Earning per Share) have shown a decreased trend as analyzed from its negative growth over the past few years. The return on equity of the banking corporation has shown a decreasing trend in the past few years and has significantly decreased from 10.77 in the financial year 2007 to the financial year 2016.

Bank of America

The Australia and New Zealand banking Group is recognised as third largest bank of Australia in terms of the market capitalization. The profitability of the banking group in the past few years has shown a decreased trend which indicates its reduced profitability. The operating profit ration of group has reduced from 51.40 in the year 2014 to 39.84 in the year 2016. Also, the EBT margin of the group has also been decreased from 51.40 to 39.84 between the periods of 2014-2016. The liquidity analysis of the group through examining the financial leverage and debt/equity ratios indicates that it has strong liquid position with the increasing trend shown in these ratios from the year 2014-2016. The efficiency ratios such as fixed assets turnover and asset turnover have also maintained a static growth rate over the past few years not showing a major increasing trend. The market valuation of the group has also reduced as depicted form its EPS ratio that has reduced from 9.14 to 0.08 from 2014-2016.

The profitability ratios of Commonwealth Bank of Australia shows that it has realized larger profits in the past few years as its operating margin and EBT margin ratios shows a positive growth from 2014-2016. However, its return on equity ratio has recorded a slightly low growth in the past few years from 2014-2016 which can have a negative impact on its earning realization capacity in the future period of time. The efficiency ratios such as fixed assets turnover and asset turnover ratios have shown a declining growth trend in the recent years which indicates that it should improvise over its ability to use effectively its assets for improving its earnings realization. The market valuation as depicted from its EPS ratio has shown a considerable decrease which is a matter of great concern for the banking group. The liquidity position is also not too good as observed from the slow growth rate of its financial leverage ratio.     

The profitability ratios of National Australia Bank (NAB) Ltd such as operating and EBT margin shows a positive growth rate indicating the increase in its profit over the recent years. However, the return on equity shows a decreasing rate indicating that the bank must improve its ability to generate profits from the shareholders equity. The market valuation of the banking group has also reduced with the decrease in the EPS ratio of the bank over the past few years. The efficiency ratios analysis shows a decrease in the growth rate of ratios such as fixed assets turnover and asset turnover. The banking group also shows a decreasing trend of financial leverage position indicating that it is improving debt in its capital structure. The NAB is providing good returns as indicated from the increase in its returns from 3.60 to 5.23 in the last 5 years and thus it can be said that banking group is delivering good financial performance. As such, it is advised to the investors for holding or buying out its shares for realizing increasing returns in the future context.

Australia and New Zealand Banking Group

The Westpac Banking Group has recorded a slight drop in its operating and EBT margin ratios over the last two years indicating that it should develop strategies for improvising profitability. The return on equity ratio of the Westpac is also showing a decreasing rate and thus it is recommended to improvise over is return on equity. The cash-conversion efficiency of the bank is also not too good as indicated from the decrease in its fixed assets turnover ratio in the past few years from 15.18 in 2014 to 12.61 in 2016. The financial structure of the bank also indicates that it is incorporating less use of leverage in its capital structure in comparison to equity as indicated from the decrease trend of financial leverage and debt/equity ratio in the past few years. The EPS ratio of the company is showing a decreasing trend indicating that it is providing considerable fewer returns to its shareholders in the recent years. The Westpac is showing increasing returns in the past five years from 6.89 to 10.85 indicating its strong financial performance. It is recommended to the investors to hold or purchase the shares of the banking group for realizing larger returns.

The Barclays PLC is showing an increasing in its profitability position with the positive growth rate depicted in its operating and EBT margin ratios from 2014-2016. The EPS ratio of the company is showing a decreasing trend indicating that is providing less return to its shareholders in the recent years. The bank is also adopting less use of leverage in its financial structure as indicated from decrease in its financial leverage ratio from 22.80 to 18.70 during 2014-2016. The banking group has shown a rise in its cash realization efficiency from the use of fixed assets as indicated from the increase in its assets turnover ratio in the recent years. The financial performance of the bank is also not too good as indicated from its declining returns in the past few years.

The Bank of China profitability position is somewhat decreased as indicated from decrease in its operating profit margin ratio from 50.60 to 45.49 during 2014-106. The payout ratio and the dividend yield of the bank are also on decline indicating less returns provided to the shareholders. The bank is also using less debt proportion in its capital structure as indicated from its financial leverage ratio. The fixed assets turnover ratio is showing a decreasing trend indicating that the ability of the bank to realize cash from the use of assets is on decrease. The market capitalization of the bank from 2014 to 2016 has shown a rapid decline from USD 184,330 to 141,480 indicating that its market value is on decrease. The investors are thus recommended to sell the shares as its market value is expected to show a negative trend in the future.

Commonwealth Bank of Australia

The analysis of profitability ratios of Citigroup Inc has indicated that its operating income has increased significantly from 2014-2016. The EPS ratio of the bank has shown an improvement in the recent years indicating that the bank returns to its shareholders have increased somewhat. The financial leverage of the bank is showing a decrease in the debt proportion in its capital structure from 2014-2016. The assets turnover ratio of the bank has also maintained a steady growth indicating that its efficiency to realize cash from the use of assets over the past few years is static. On the other hand, the HSBC Plc shows an increase in the operating margin ratio in the recent years indicating the growth in its profitability position. The dividend yield is on increase of the bank in the recent years. The financial leverage ratio has also shown a rise in the recent years indicating that it is utilizing less debt in its capital structure in comparison to equity. The fixed assets turnover ratio of the bank has shown an increase from 2014 to 2016 and thus its efficiency to realize cash from the use of assets has shown a positive trend. The market capitalization of the bank has also improved during 2014-2016 indicating that the investors should buy out its shares for achieving larger returns in the future context.

The profitability analysis of the JP Morgan has indicated that its profit margin has shown an increasing trend in the recent years. The bank is using less debt in its capital structure as its financial leverage and debt/equity ratio has reduced considerably over the past few years. The efficiency ratios of the bank have also reported a decrease indicating that its efficiency to realize profits from the use of assets has gradually declined. The market capitalization and its dividend yield has gradually increased from 2014-2016 indicating that investors should buy out its shares for realizing larger returns in the future.

The interest rate risk represents the most significant risk faced by the banking industry. The Bank of America has measured its interest rate risk by identifying the potential changes in the interest income incurred due to fluctuations in the market interest rates. The bank has analyses the future risks associated with its net interest income through developing forward-looking contracts of net interest income. The interest rate sensitivity as analyzed under various conditions through expecting future business growth and the direction of future interest movements. The bank then continually reviews its balance sheet position for maintaining an exposure to changes occurring in the interest rates. The balance sheet incorporates assumptions about the following interest rate situations such as loan, deposit growth, product re-pricing. Thus, it can be said that the bank faces significant interest rate risk being managed through the use of forward contracts. The Australia and New Zealand banking Group (ANZ) manages the interest rate risk through the use of VaR and scenario analysis. This helps the bank to integrate risk management policies for stabilizing the optimal net interest income. The NAB does not face significant interest rate risk. The NAB faces interest risk due to changes in interest rates and has also faced negative interest rates curves in some countries where it operates. The Westpac Banking Group also faces significant interest rate risk due to the financial instruments in its balance sheet such as loans and deposits. It monitors the interest rate risk through the use of financial derivatives. The Barclays PLC also faces significant interest rate risk due to short-term borrowing rates and floating liabilities.

National Australia Bank (NAB) Ltd

The Bank of America manages its credit risk through purchasing the credit protection for the funded as well as unfunded portion. The bank has added the credit exposure within the banking industry for obtaining credit protection. The banking group is also using credit derivatives for hedging the credit risk and thus the significant loss or profit arising from credit instruments is offset by the related exposures. The ANZ has adopted a comprehensive top-down framework for managing the credit risk that helps it to minimize the chances of occurrence of financial loss resulting from its failure to comply with its contractual obligations. The NAB has also managed adequate credit policies for managing credit risk through developing Credit Assurance unit. The Westpac is a global bank and as such faces large risk of maintaining its credit position to meet its financial liabilities on time. The Barclays also faces significant credit risk across its various financial instruments as it has to meet the repayment obligations of its clients. The Bank of China has adopted the use of credit authorization and post-loan management for managing the credit risk.

The market risk is the risk impacting the value of assets and liabilities due to changes in the market conditions. The financial instruments of the Bank of America such as loan and deposit products are subject to economic value changes on the basis of market conditions. The bank in order to mitigate the various market risks such as interest rate, foreign exchange, credit and equity reports its trading positions at the fair value. The market risk is also hedged through the use of derivatives such as options, futures, forwards and swaps. The market risk of ANZ arises from the changes in its interest rate, foreign exchange rates, credit spreads, volatility and correlations in its balance sheet. It has adopted the use of market risk management and control framework for qualifying the market risk that helps it to allocate an adequate amount of capital to manage these risks. The Commonwealth bank uses value-at-risk (VaR) strategies for mitigating the traded and non-traded market risk that uses potential loss through analyzing the historic market movements. The bank faces both types of market risk such as traded and non-traded that is assesses periodically through VaR. The NAB faces significant market risks due to changes in market conditions such as change in interest rate, foreign exchange movements and is monitored through the use of Value at risk (VaR). The Westpac operates on a global scale and thus faces larger market risk on account of interest rate fluctuations and foreign currency movements that it need to manage adequately. The market risk of Barclays results from exposure of its operations to foreign market conditions and is managed through the use of hedging policies. The Bank of China develops market risk management policy for measuring the market risk. The Citigroup reviews the market risk through developing significant policies and procedures for managing the market exposures.

Westpac Banking Group

The foreign exchange risk of Bank of America represents the risk faced by the bank due to fluctuations in the current holdings and future cash flows that are denominated in foreign currencies. The major financial instruments that are exposed to this risk are foreign currency denominated loans, securities, future cash flows, debt and interest rates. The risk is managed through the use of hedging instruments such as foreign exchange options, swaps, futures, forwards, debt and deposits. The NAB also faces significant foreign exchange risk due to currency movements, profits and losses and assets and liabilities due to participation in the global financial markets. The foreign currency movements posses a large foreign exchange risk for Westpac due to its foreign subsidiaries operations. The foreign exchange risk is faced by the Barclays due to its operations in the foreign countries. The HSBC faces foreign exchange risks due to overseas payments and the use of foreign currency denominations in imports and exports. It manages the risk though developing effective strategies for minimizing foreign exchange risk through reducing the exposure. The bank uses hedging strategies for reducing the foreign exchange currency risks.

The liquidity risk of Bank of America arises from its inability to support the present and future cash flows through maintaining adequate funds. The bank for managing its liquidity risk maintain access to varied funding sources such as stable deposit base and align with various incentives and risk policy. The bank has developed a liquidity buffer system that incorporates global sources of liquidity that are readily available to be used by the bank in the form of high-quality liquid and unencumbered securities. The ANZ manages its liquidity risk through developing a metrics that helps in prioritizing over its short and long-term liquidity risks. The group faces liquidity risk due to its inability to meet payment obligations such as paying the depositors or in maturity of wholesale debt. The Commonwealth bank also faces significant liquidity risk that is managed through the use of liquidity and funding risk management framework. The NAB also faces significant liquid risks due to external market and economic events. The risk is governed through the adoption of Group Asset and Liability Committee (GALCO) that develops strategies for meeting the liquid risks. The Westpac have large liquidity risk due for meeting its daily operations on a global scale. The head office of Bank of China is responsible for managing the overall risk related to liquidity. The Citigroup manages liquidity risk through properly developing its deposits and funding activities.

The Bank of America conducts an Internal Capital Adequacy Assessment Process (ICAAP) periodically for analyzing the future capital needs and resources. The ANZ faces capital adequacy risk due to the significant loss it can face from maintaining an adequate capital level due to loss of confidences of investors, non-compliance with legislations or reduce goodwill. The bank capital management plans emphasize on protecting the interest of creditors, depositors and investors for managing this type of risk. The NAB has established minimum regulatory capital requirements as per the Basel Capital Framework for maintaining an adequate capital structure. The rest of the Banking Groups manages its capital risk through maintain an adequate proportion of debt and equity and also analyzing the future needs of capital requirement in advance. The JP Morgan has developed capital management policy for managing the capital structure risks.

Name	Ticker	Domicile	Industry Group	Currency	Business Country	Uncertainty	Ranking
Bank of America Corporation	BAC	United States	Banks – Global	US Dollar	United States	High	9
Australia and New Zealand Banking Group Ltd	ANZ	Australia	Banks – Global	Australian Dollar	Australia	Medium	4
Commonwealth Bank of Australia	CBA	Australia	Banks – Global	Australian Dollar	Australia	Medium	1
National Australia Bank Ltd	NAB	Australia	Banks – Global	Australian Dollar	Australia	Medium	3
Westpac Banking Corp	WBC	Australia	Banks – Global	Australian Dollar	Australia	Medium	2
Barclays PLC	BCY	United Kingdom	Banks – Global	Euro	United Kingdom	High	7
Bank Of China Ltd H	BACHF	China	Banks – Global	US Dollar	China	High	8
Citigroup Inc	C	United States	Banks – Global	US Dollar	United States	High	6
HSBC Holdings PLC ADR	HSBC	United Kingdom	Banks – Global	US Dollar	United Kingdom	Medium	5
JPMorgan Chase & Co	JPM	United States	Banks – Global	US Dollar	United States	High	10

Bank of America Corporation: https://media.corporate-ir.net/media_files/IROL/71/71595/BOAML_AR2016.pdf

Australia and New Zealand Banking Group Ltd https://news.iguana2.com/anz/ASX/ANZ/459865

Commonwealth Bank of Australia https://www.commbank.com.au/content/dam/commbank/about-us/shareholders/pdfs/annual-reports/annual_report_2017_14_aug_2017.pdf         

National Australia Bank Ltd https://www.nab.com.au/content/dam/nabrwd/About-Us/shareholder%20centre/documents/2016-annual-financial-report.pdf

Westpac Banking Corp https://www.westpac.com.au/content/dam/public/wbc/documents/pdf/aw/ic/2016_Westpac_Annual_Report

Barclays PLC https://www.home.barclays/content/dam/barclayspublic/docs/InvestorRelations/AnnualReports/AR2016/Barclays%20PLC%20Annual%20Report%202016.pdf

Bank of China Ltd H https://pic.bankofchina.com/bocappd/report/201703/P020170331589265982242.pdf          

Citigroup Inc https://www.citigroup.com/citi/investor/quarterly/2016/ar15c_en.pdf

HSBC Holdings PLC ADR https://www.hsbc.com/investor-relations/group-results-and-reporting/annual-report

JPMorgan Chase & Co https://www.jpmorganchase.com/corporate/investor-relations/document/2016-annualreport.pdf