FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation Executive Summary This report will aim to highlight the profitability of National Australia Bank (NAB) and Westpac in terms of Return on Equity (ROE) between 2003 and 2007. Using a Dupont analysis, ROE will be decomposed into Return on Assets (ROA) and the Equity Multiplier (EM). Additionally, it will further look at the various risk exposures that these banks may face such as credit risk, liquidity risk, capital risk and operational risk. Furthermore, this report will also compare the performance and risk exposures between the two banks over the past 5 years. Westpac’s Bank Performance Analysis ROE
Figure 1 - ROE
25.00% 21.98% 20.00% ROE 15.00% 10.00% 5.00% 0.00% 2003 2004 15.65% 17.02% 17.97% ROE 20.11%

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Figure 1 summarizes Westpac’s Return on Equity (ROE) from 2003 through to 2007, which is one of the key determinants of profitability. Generally, one can observe an upward trend in value throughout the past 5 years, starting at 15.65% in 2003 and finishing at 21.98% in 2007. Furthermore, ROE has increased by a total of 6.33% over the last 5 years, averaging 1.5825% per year. From a shareholder’s perspective, it can be viewed that Westpac has performed consistently well and has been more profitable throughout the specified period. In order to further analyze Westpac’s increasing trend in terms of its ROE, it is essential to conduct a Du Pont analysis that decomposes ROE into specific sub-sections.

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation ROA
Figure 2 - ROA (as well as AU and ER)
9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 8.44% 7.47% 6.60% 5.21% 6.83% 5.36% 5.82% 6.52% ,

ROA, AU, ER

7.85% 6.29% ROA AU ER

1.04% 2003

1.09% 2004

1.17% 2005 Year

1.22% 2006

1.07% 2007

A major sub-section of the ROE is the Return on Assets (ROA), which shows the proportion of net income in terms of average total assets. Figure 2 expresses the trend in Westpac’s ROA over the past 5 years. This has increased gradually from 2003 to 2006, starting at 1.04% and ending up at 1.22%. However, from 2006 to 2007 it dropped by 0.15% to 1.07%. This movement can be explained by further decomposition of the ROA into the difference between Asset Utilization (AU) - the proportion of revenue in terms of average total assets, and the Expense Ratio (ER) - the proportion of expenses in terms of average total assets.

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9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00%

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Figure 3 - AU and its components
8.44% 6.83% 5.46% 7.47% 6.11% 7.05%

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ROA – Asset Utilization (AU)

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7.85% 6.68% AU int inc/avg. TA non-int inc/avg. TA

6.60% 5.17%

%

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1.43%

1.37% 2004

1.36% 2005 Year

1.39% 2006

1.17% 2007

2003

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation Figure 3 reveals an increasing trend in Westpac’s AU ratio from 2003 to 2006 from 6.6% to 8.44%, followed by a slight decline to 7.85% in 2007. It can be observed that from 2003 to 2006, the main component that has lead to the gradual increase in AU is the interest income component (interest income/average total assets), which is also shown in figure 3 above. This has increased from 5.17% to 7.05% between 2003 and 2006. Between 2006 and 2007, the non-interest component of AU dropped by 0.22%, contributing to the decline in AU in this period. ROA – Expense Ratio (ER)
Figure 4 - ER and its components
7.00% 6.52% 6.00% 5.00% 5.21% 5.36% 4.85% 4.04% 3.12% 1.87% 3.45% 4.92% 5.82% 6.29%

ER

4.00% 3.00% 2.00% 1.00% 0.00% 0.23% 2003 0.17% 2004

int exp/avg. TA non-int exp/avg. TA

%

1.73%

1.70%

1.67%

1.38% 0.00% 2007

provision for LLL/avg. TA

0.07% 2005 Year

0.00% 2006

The linkage between the components of AU and ER to the overall changes in ROA The reason that ROA increased between 2003 and 2006 is because Westpac had stronger Asset Utilization relative to its Expense Ratio in this period. Although both ER and AU increased in this period, the increase in AU was 0.53% greater than the increase in ER. This was highlighted primarily by the interest component of AU, which increased 0.15% more than ER’s interest component between 2003 and 2006. Furthermore, the non-interest component of AU decreased by 0.16% less than the non-interest component of ER for Westpac between 2003 and 2006. These factors, combined with the fact that the provision for loan and lease losses component of ER fell by 0.23% between 2003 and 2006, contributes to the fact that ROA increased within this time frame.

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Figure 4 demonstrates the increasing trend in Westpac’s ER between 2003 and 2006 from 5.21% to 6.52%, followed by a slight decline to 6.29% in 2007. One can see that between 2003 and 2006, one of the main components that has lead to the gradual increase in ER is the interest expense component (interest expense/average total assets), which is also shown above. There has been an increase from 3.12% to 4.85% between 2003 and 2006. Simultaneously, the other contributing component is the provision for loan and lease losses (LLL)/average total assets, which fell from 0.23% to 0.00% in this period. Between 2006 and 2007, the non-interest component of ER dropped by 0.29%, whilst the interest component only slightly increased by 0.07%, contributing to the overall decline in the ER in this period.

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation The 2006 to 2007 period appears to portray a different story altogether. In contrast, the ROA decreased because Westpac’s AU fell by 0.36% more than its ER, even though both AU and ER decreased in this period. This was caused by the fact that Westpac’s interest component of AU fell by 0.37%, whilst their interest component of ER actually increased by 0.07%. The movement of these variables in opposing directions has lead to a 0.44% difference between the interest components of Westpac’s AU and ER in 2007. Alternatively, there was a 0.22% drop in Westpac’s non-interest component of AU. Consequently, the amalgamation of these factors has lead to the overall decrease in AU in relation to ER, leading to a decrease in ROA between 2006 and 2007. Equity Multiplier (EM)
EM ROA ROE 2003 15.81x 1.04% 15.65% 2004 15.39x 1.09% 17.02% 2005 15.40x 1.17% 17.97% 2006 18.21x 1.22% 20.11% 2007 21.06x 1.07% 21.98%

Figure 5

Figure 5 above conveniently summarizes the EM, ROA and ROE for Westpac in the last 5 years. The Equity Multiplier (EM) shows the amount of financial leverage or the amount of average total assets in relation to average total equity. Westpac’s EM decreased between 2003 and 2004 from 15.81X to 15.39X. However, between 2004 and 2007, there has been an increasing trend as Westpac’s EM has substantially risen by 5.25 units to a final value of 21.06X in 2007. This is because Westpac’s total assets have risen by an average of 14.5% in the last 5 years, whilst Westpac’s total equity has only risen by an average of 7.45% over the last 5 years. After analyzing ROA and its components, it is now essential to acknowledge the combined effect of ROA and EM on ROE. Firstly, it is imperative to note the following relationship; ROA multiplied by EM is equal to ROE. Between 2003 and 2004, the increase in Westpac’s ROE can be explained by the increase in its ROA of 0.05%, outweighing the decrease in its EM of 0.42 units. Between 2004 and 2006, the increase in ROE is a combined result of both the increase in ROA by 0.13% and the increase in EM by 2.82 units between 2004 and 2006. Between 2006 and 2007, Westpac’s ROE has risen from 20.11% to 21.98% because the increase in its EM had a greater effect than the fall in its ROA. More specifically, the EM has sharply risen by 2.85 units outweighing the 0.15% reduction in ROA.

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Earnings Base (EB)

The EB is defined as the proportion of average earning assets in terms of average total assets, representing the amount of a bank’s assets that are earning interest. This relates to profitability because the higher the proportion of assets generating interest, the higher the potential net interest income, meaning the more profitable a bank is with the assets it has available. By referring to figure 6, one can observe that Westpac’s EB over the last 5 years has had an upward trend, increasing from 83.07% in 2003 to 88.06% in 2007. Hence, this rise depicts an increase in Westpac’s profitability,

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EB Burden Ratio

2003 83.07% 0.44%

2004 84.31% 0.36%

2005 85.28% 0.34%

2006 87.71% 0.28%

2007 88.06% 0.21%

Figure 6

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation which is in line with the general positive movements in both ROA and ROE over the specified period. Burden/Average Total Assets (Burden Ratio) Whilst the EB ratio incorporates interest income, the Burden Ratio is more concerned with noninterest items and their corresponding profitability. The Burden Ratio is defined as the burden (noninterest expense – non-interest income) expressed as a proportion of average total assets. The lower the burden ratio, the more profitability a bank can exude as non-interest expenses outweigh noninterest income by a smaller amount. By looking at figure 6, Westpac’s Burden Ratio has decreased from 0.44% in 2003 to 0.21% in 2007. Thus, this is another factor that portrays Westpac’s increase in profitability and an overall higher performance. Westpac’s Risk Exposure Evaluation Over the past 5 years, Westpac Banking Corporation (WBC) has faced several risk exposures that may have repercussions on the bank’s general performance in the future. The types of risks that best capture Westpac’s exposure in quantitative terms are credit risk, liquidity risk, capital risk and operational risk. Credit Risk
Figure A- Credit Risk

1.50%

0.50% 0.00%
N loss / Avg. Tot et LN &LS

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2003 2004 0.13% 0.04% 0.94% 2005 0.15% 0.04% 0.86%

1.00% %

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2006 0.53% 0.01% 0.51%

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2007 0.46% 0.01% 0.50%

Year

0.19% 0.04% 0.96%

From figure A, it is evident that the LN & LS allowance/ total LN & LS has decreased at an increasing rate from 2003 through to 2006. This movement can be mostly seen in between the years of 2005 and 2006, where it dropped by a relatively high 0.35%. The reason for this drop is evident through the dramatic increase of net loans and leases that Westpac has accumulated over time. More specifically, net loans and leases have been increasing at an average rate of 14%p.a.

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LN &LS Allowance to total LN &LS

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R ecoveries / Avg. Tot LN &LS

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation However, the LN & LS allowance/total LN & LS appears to have stabilized in the following year, hovering at a level of 0.50%. This is the case due to the notion that both the allowance and the total amount of LN & LS are increasing at relatively close rates i.e. at 14.1% and 16.2% respectively. The above figure clearly portrays that the net loss/average total LN & LS has an inverse relationship with the LN & LS allowance/total LN & LS. As opposed to the LN & LS allowance/total LN & LS, the net loss/average total LN & LS has increased at an increasing rate from 2003 through to 2006. The most dramatic increase can be seen between the years of 2005 and 2006 that is 0.38% rise, equal to 3.5 times its previous value of 0.15%. This is a direct result of a substantial 302.72% increase in net credit losses, causing the ratio to increase significantly. From 2006 to 2007, due to the fact that credit losses and average total loans and leases increased at relatively close rates, 0.23% and 16.64%, the net loss/average total LN & LS appears to have stabilized. Furthermore, it can also be observed that throughout 2003 to 2007, recoveries/total net loans and leases have decreased from 0.04% to a minimal amount of 0.01%. The most significant change in this ratio occurred between 2005 and 2006, simultaneously accompanied with an increase in net loans and leases and an increase in net credit losses, minimizing the spread between the LN & LS allowance/total LN & LS and net loss/average total LN & LS ratios. The ratios mentioned above clearly identify and quantify credit risk for Westpac. The fact that the bank has minimized its allowances over time proves that the bank is generally less exposed to credit risk. This statement is supported by the rising figure of net losses over the specified period, and the decreasing recoveries. As of 2006 onwards, Westpac is showing a trend of reducing individual firmspecific credit risk. Liquidity Risk

Net loans & leases / Total Deposits

2003 124.33%

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2004 124.53% 2005 132.85%

2006 134.63%

2007 136.80%

Figure B

Capital Risk

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By referring to figure B, Westpac’s net loans and leases/total deposits ratio has increased over the last 5 years from 124.33% in 2003 to 136.80% in 2007. This ratio provides a comparison between the bank’s least liquid assets (loans and leases) with its most stable funding source (deposits). For Westpac, it can be seen that the amount of illiquid assets exceeds the amount of deposits. The increasing trend of this ratio shows that Westpac’s loan portfolio is mostly financed by illiquid sources of funds. The high and increasing levels throughout 2003 to 2007 depict the notion that Westpac is exposed to more liquidity risk. This means that Westpac has experienced greater difficulty in being able to meet its short term financial obligations.

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Total RBC/Risk Weighted Assets Equity Capital/Total Assets

2003 11.12% 6.32%

2004 9.65% 6.66%

2005 10.24% 6.34%

2006 9.57% 4.74%

2007 4.54% 4.76%

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Figure C

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation Figure C depicts two imperative ratios that are used to calculate capital or insolvency risk for Westpac over the last 5 years. From 2003 to 2007, there appears to be a downward trend in Westpac’s Total RBC/Risk-Weighted Assets, ranging from 11.12% through to 4.54%. This is due to the fact that Westpac’s risk-weighted assets have risen relatively higher than total risk based capital. Similarly, Westpac’s Equity Capital/Total Assets ratio has also decreased between 2003 and 2007, from 6.32% to 4.76%. The above ratios demonstrate that Westpac has been exposed to a higher degree of capital risk, making it more prone to insolvency in the future. Operational Risk
2003 $8.27 53.56% 2004 $9.14 51.24% 2005 $9.81 49.66% 2006 $11.00 46.60% 2007 $13.38 46.88%

Total Assets/No. of Employees Efficiency Ratio

Figure D

Figure D shows two essential ratios that help determine Westpac’s operational risk over the last 5 years. Between 2003 and 2007, Westpac’s total assets/number of employees has risen from $8.27 to $13.38. Whilst there has been an increase in employees over time, this has been proportionately less than the rise in total assets, and thus posing less operational risk exposure for Westpac. Furthermore, this notion is supported by the decrease in Westpac’s efficiency ratio from 53.56% to 46.88%. According to bank analysts, when the ratio is either equal to or below 55%, for large banks of the same magnitude as Westpac, such banks are able to better manage their non interest expense. Westpac’s decreasing ratio indicates a steady level of net income and overall firm value. Hence, it appears that Westpac’s operational risk exposure has been significantly reduced over the past 5 years.

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ROE

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NAB’s Bank Performance Analysis

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation Figure 1 demonstrates NAB’s trend of the Return on Equity (ROE), over the period from the year 2003 to 2007. As shown, the value of ROE dropped from 14.51% in 2003 to 12.46% in 2004, followed by a steady growth from 2004 to 2005 and an even more rapid growth thereafter from 2005 through to 2007. Overall, the trend of a stable growth in the value of ROE can be observed over this five-year period, despite the drop from 2003 to 2004. Therefore, this would suggest that NAB has performed relatively well during this period in terms the returns on their capital contributions. Similarly to the Du Pont analysis of Westpac’s ROE, another one is conducted in order to further analyze the performance of NAB. ROA

The trend of ROA (Return on Asset) for NAB over this five-year period is as illustrated in Figure 2 together with the trends of AU and ER. The value of ROA dropped from 1.06% in 2003 to 0.87% 2004 and then rose gradually from 2004 through to 2006, followed by another drop from 1.12% in 2006 to 1.07% in 2007. The overall movement of ROA for NAB can be explained by further decomposing ROA into the difference between Asset Utilization (AU) and Expense Ratio (ER).

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation ROA-Asset Utilization (AU)

ROA-Expense Ratio (ER)

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As shown in Figure 3, it can be observed that the value of AU has increased dramatically from 2003 to 2005 and then increased at a slowing rate from 2005 to 2007. The large increase observed of AU from 2003 to 2005 can be attributed to the increase in both of its components during this period with non-interest income increasing at a faster rate, while the relatively slower growth thereafter, are attributed to the large increase in the interest income component that outweighs the decrease in the non-interest component.

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation As shown in Figure 4, the value of ER has increased rapidly from 2003 to 2005, followed by a slight decline from 2005 to 2006 and then an increase from 2006 to 2007. The increasing trend from 2003 to 2005 is attributed to the simultaneous growth of both interest and non-interest components, despite the minor decline in this period for provision for LLL. The value of ER dropped from 2005 to 2006 due to the faster decline rate of the non-interest expense component relative to the increase in the interest expense component. Whilst the increase from 2006 to 2007 was primarily due to the faster increasing rate of interest expense component relative to the decline rate in the non-interest expense component. The linkage between the components of AU and ER to the overall changes in ROA The value of ROA dropped from 2003 to 2004 primarily due to the fact that ER increased at a faster rate than AU did although they both increased, and there was a relatively large increase in the noninterest expense component of ER (from 1.68% to 2.17%). This primarily drove this trend, with other components increasing at a steady rate in this period. The growth in ROA from 2004 to 2006 was driven by AU increasing steadily in these two years whilst ER increased at a slower rate from 2004 to 2005 and then decreased from 2005 to 2006, with the non-interest income component being the driving factor from 2004 to 2005 (from 1.7% to 2.03%) and the non-interest expense component was the determining factor from 2005 to 2006 (from 2.15% to 1.63%). The observed decline in ROA from 2006 to 2007 was due to the increase in both AU and ER, with ER increasing more than AU. The major force that drove this trend was the rapid increase in the interest expense component of ER (from 3.64% to 4.08%). Equity Multiplier (EM) 2003 14.61% 1.00% 14.51% 2004 14.19% 0.87% 12.46%

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Earnings Base (EB)

Figure 6 shows that EB has had an upward trend from 2003 to 2005 whilst a downward trend from 2005 to 2007. The EB proves to be quite stable over time, except 2005, showing that NAB has consistently been able to generate interest income from their average total assets. This notion is reflected in the overall increase in ROE mentioned in previous sections.

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EB Burden Ratio

2003 81.54% 0.29%

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As shown in Figure 5, the decline in ROE from 2003 to 2004 was caused by the decline in both ROA and EM, with EM declining at a faster rate. The rise of ROE from 2004 to 2005 was driven by a larger effect of the rise in ROA. The dramatic rise in ROE from 2005 to 2006, specifically 1.77%, was driven by the corresponding rises in both EM and ROA in this period. From 2006 to 2007, the rise in ROE was primarily driven by the increase in EM that outweighed the drop in ROA. 2004 83.00% 0.47%

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EM ROA ROE

2005 13.60% 0.94% 13.25%

2006 15.25% 1.12% 17.49%

2007 18.14% 1.07% 19.26%

Figure 5

2005 85.05% 0.12%

2006 83.01% 0.16%

2007 81.04% 0.22%

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Figure 6

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation Burden/Average Total Assets (Burden Ratio) As observed in Figure 6, the trend of the burden ratio had increased dramatically in 2004 but had been relatively low thereafter and generally fluctuated over the past years. However, there has been a recent improvement in this ratio which suggests a better profitability position for NAB. NAB’s Risk Exposure Evaluation Accounting data over the past 5 years have been used to examine the potential sources of assumed risks present in order to achieving the returns outlined by the ROE model. Namely, NAB has faced credit risk, liquidity risk, capital risk and operational risk. Credit Risk
Figure I- Credit Risk
1.20% 1.00% 0.80% % 0.60% 0.40% 0.20% 0.00% Net loss/Avg. Tot LN&LS Recoveries /Avg. Tot LN&LS LN&LS Allowance to totalLN&LS

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2003

2004 0.21% 0.07% 1.00%

2005 0.12% 0.06% 0.75% Year

2006 0.15% 0.06% 0.70%

2007 0.14% 0.05% 0.65%

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Net loss to average total LN & LS ratio have also seen a gradual decrease since 2003, although slight increases are evident from the 2006 to 2007 period. This ratio has been generally dropping, and the reason can be linked to the decreasing LN & LS allowance/ total LN & LS ratio. It seems that the net

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The LN & LS allowance/ total LN & LS ratio seems to be continually decreasing at a steady rate of 0.05% since 2005, reflected from the fact that although the total amount of LN & LS have increased steadily, the allowance loss had been kept fairly the same amount since 2005.

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Relating to Figure I, it is seen that the LN & LS allowance to total LN & LS ratio had increased slightly in 2004 and then decreased substantially thereafter. The difference between the general drop within 5 years had been 0.32%. This had been a result of NAB’s accumulative increasing net loans and leases, which have been increasing at an average rate of above 9%.

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0.29% 0.08% 0.97%

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation losses have been managed well as NAB has not lifted the allowance for LN&LS losses even when total LN&LS are rising. By further examining the recoveries to total NL&NL ratio for the 2003 to 2007 period, it is seen that there has been a small yet decreasing trend of recoveries. This could be the reason for the slight increase in the net loss to average total LN & LS for 2006 to 2007, despite a decrease in the LN & LS allowance to total LN & LS ratio These ratios examined as a whole provides a better understanding of the credit risks for NAB. The general trend shows that the net loss to LN&LS had been substantially lower since 2003, which is reflected through lowering of the allowance ratio, providing NAB with less exposure to credit risk. However, some attention should be noted for the 2006 to 2007 period as the slowdown of recoveries has made small impacts and could possibly affect the future of NAB’s credit risk exposure. Generally however, NAB is showing a trend of reducing individual firm-specific credit risk. Liquidity Risk
2,003 124.33% 2,004 124.53% 2,005 132.85% 2,006 134.63% 2,007 136.80%

Net loans & leases / Total Deposits

Figure II

Figure II shows that NAB’s Net Loans and Leases/Total Deposits ratio have increased from 2003 to 2005 and are decreasing thereafter. This ratio provides a comparison between the bank’s least liquid assets (loans) with its most stable funding source (deposits). The reason for an increase in the ratio from 2003 to 2005 is reflected through an increase in net loans and leases offsetting a relatively stable total deposits base, especially core deposits. However, the decreasing trend in the ratio from 2006 onwards indicates that NAB’s loan portfolio is financed proportionately more by stable funds and thus less by volatile funds. This is reflected through the increase in total deposits, especially core deposits, which has provided a much more stable source of funding. However, it should still be noted that although the net loans and leases to total deposits ratio is decreasing since 2006, it is still above levels of that achieved in 2003, mostly due to the continually increasing net loans and leases, thus continual actions should be taken to further reduce these levels.

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Total RBC/Risk Weighted Assets Equity Capital/Total Assets

2,003 11.12% 6.32%

2,004 9.65% 6.66%

2,005 10.24% 6.34%

2,006 9.57% 4.74%

2,007 4.54% 4.76%

Figure III

NAB’s Total RBC to Risk-Weighted Assets ratio has been generally steady and rising from 2003 to 2006. In 2003, the ratio began to rise where the 2004 to 2006 period has seen a generally steady and rising trend, making NAB to be considered well capitalised (above 10%). This is reflected from the 12

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Figure III highlights the two important ratios used to calculate capital or insolvency risk for NAB over the past 5 years. The Total RBC to Risk-Weighted Assets ratio must be at least 8% to meet regulatory requirements and at least 10% to be considered well capitalised.

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation fact that the risk-weighted assets have risen relatively higher than total risk based capital. The ratio in 2007 had dropped down just below 10% for the first time in 3 years, thus this should be further looked upon. Also, NAB’s Equity Capital to Total Assets ratio had increased from 2003 to 2005, yet decreased thereafter. This similar trend of a rise and fall in the last 5 years with the risk-based capital, clearly make NAB’s capital risk appear higher in the last 2 years. Overall, NAB is exposed to a higher degree of capital risk, and potentially prone to insolvency in the future. Operational Risk
2003 $8.27 53.56% 2004 $9.14 51.24% 2005 $9.81 49.66% 2006 $11.00 46.60% 2007 $13.38 46.88%

Total Assets/No. of Employees Efficiency Ratio

Figure IV

Figure IV contains two relevant ratios that have been examined to determine NAB’s operational risk over the past 5 years. For the period 2003 to 2007, NAB’s total assets/no. of employees has risen substantially, especially in the period 2005 to 2007. This is reflected from the fact that the increases in employees over the years have been offset by a higher rise in its asset base. This could mean a higher productivity level, which would pose less operational risk exposure for NAB. Further, the NAB’s efficiency ratio rose in 2004 but has been decreasing since, most notably in 2006 to 2007. This is indicative of the fact that the bank is able to manage its operational risk since 2004, as the bank is better able to control noninterest expense relative to operating income. Thus, NAB’s operational risk exposures have been well reduced over the past 5 years.

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Figure 1.1 - ROE for NAB and Westpac

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Bank Performance Comparison between NAB and Westpac

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21.98% 20.11% 17.02% 12.46% 17.97% 17.49% 13.25% 19.26%

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15.65% 14.51%

N AB W estpac

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2003

2004

2005 Year

2006

2007

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation Figure 1 above depicts the ROE for both NAB and Westpac in the last 5 years. It is visible that both banks have had a general upward trend in their ROE between 2003 and 2007, highlighting an improvement in profitability. Despite this general upward trend for both banks, Westpac’s ROE has been higher than NAB’s every year in the specified period, highlighting more return on shareholder’s funds. Furthermore, the above figure portrays the volatile nature of NAB’s ROE in contrast to the stability and consistency of Westpac’s. This is evident by the fact that Westpac has had a 1.58% average increase per year over the last 5 years, with no drops in ROE from year to year. On the other hand, NAB has had a rapid drop between 2003 and 2004 by 2.05%, followed by an immense jump of 4.24% between 2005 and 2006.
Figure 1.2 ROA for NAB and W estpac
1.40 1.20 , 1.00 0.80 0.60 0.40 0.20 0.00 2003 2004 2005 Y ear 2006 2007 1.04 R A (% O ) 1.00 1.09 0.87 1.17 0.94 NAB (ROA) Westpac (ROA) 1.22 1.12 1.07

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Figure 1.2 shows the ROA for NAB and Westpac in the last 5 years. Westpac’s ROA has been generally higher than NAB’s, showing more proportional return in terms of assets, which is an imperative measure of profitability. This can be shown by the ROA spreads between the two banks, ranging from -0.04% in 2003, 0.22% in 2004, 0.23% in 2005, 0.10% in 2006 and 0.00% in 2007. We can see that throughout the last 5 years, the difference in ROA has increased in the first 2 years, and converged to the same value by 2007. Whilst Westpac’s ROA has not been completely consistent in the specified period, it has still been less volatile than NAB’s. Between 2003 and 2006, Westpac’s ROA consistently increased at an average rate of 0.073% per year whereas NAB dropped between 2003 and 2004 by 0.17% and rose substantially between 2004 and 2006 by 0.25%.

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation

Figure 1.3 EM for NAB and Westpac
25.00 20.00 15.81 15.00 14.61 10.00 5.00 0.00 2003 2004 2005 Year 2006 2007 14.19 13.60 15.39 15.40 , EM (x) 18.21 15.25 21.06 18.14 NAB (EM) Westpac (EM)

It is evident from figure 1.3 above, that the EM for both banks has followed a similar pattern or trend in the last 5 years, being very stable and flat between 2003 and 2005, followed by a substantial increase between 2005 and 2007. Alternatively, Westpac’s EM has been consistently higher than NAB’s, with an average spread of 2.02 units. We would now look at the relationship between ROE, ROA and EM and compare it in both banks Westpac’s ROE has been on average, greater than NAB’s because both its ROA and EM were generally higher over the specified period. In addition, NAB’s ROE has been a lot more volatile than Westpac’s. These fluctuations have been created by the fact that NAB’s ROA has been more volatile, and not the EM, because it was generally more stable for both banks. In conclusion, Westpac has performed better than NAB in terms of profitability. This has been evidenced by a higher ROE, which means shareholders return on their investment is greater. This has also stemmed from the fact that ROA and the EM have been relatively higher for Westpac.
Figure 1.4 - Comparison of Credit Risk
1.20% 1.00% 0.80% % 0.60% 0.40% 0.20% 0.00%

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Net loss / Av Tot LN&LS g. (Westpac) Recov eries / Av Tot LN&LS g. (Westpac) LN&LS allowance to Tot LN&LS (Westpac) Net loss / Av Tot LN&LS g. (NAB) Recov eries / Av Tot LN&LS g. (NAB)

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FINS3630 Group Project: Bank Performance and Risk Exposure Evaluation A comparison between the credit risks of NAB and Westpac has shown the banks’ similarities to credit risk exposures before 2005, but NAB has demonstrated a much better risk position thereafter. Westpac’s net loss/avg. tot LN&LS has increased dramatically since 2005 whereas the ratio for NAB has been quite stable. This has been the main reason contributing to the different levels of credit risks for both banks. Similarly, LN&LS allowance has been much lower for Westpac after 2005, and NAB are in a slightly better position for recoveries. The net loans and leases/total deposits ratio shows that both NAB and Westpac are exposed to similar levels of liquidity risk, however NAB seems to be in a slightly better position as of 2007, as their ratio has decreased. NAB is exposed to less capital risk as Westpac’s risk based capital ratio has generally decreased over time, whereas NAB’s has increased and is generally above 10%. Both banks show a decreasing trend of the efficiency ratio, however, Westpac’s ratio has shown more stability. This shows that while both banks are alleviating operational risk, Westpac is doing it in a more consistent fashion. In conclusion, NAB has a lower risk exposure compared to Westpac even though it is not as profitable in terms of ROE. Word count is 4268. If graph and tables weren’t included it would be equal to 8 and a ¼ pages.

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