ANZ Bank's Financial Analysis: Capital Structure, WACC, Performance (essay).

Describe the estimate the future cash flows, other capital budgeting approach can be sensitivity analysis. It is well-known technique that is useful in evaluating how independent variables respond to out of dependant variables. Generally, based on single variable like rate of interest that is discounted sensitivity analysis technique calculates the time value of money. Output as NPV and ERR which takes only one variable is highly influenced by independent variables such as tax rate, discount rate, growth rate and cash flow. As a result, deviation in each variable analysed will affect the independent variable. Eventually, there will be involvement of risk in the projects will be excess from different independent variable. In base case, those independent variables have higher contribution to increase the riskiness in the future cash flows rather than in best and worst case.

Capital Structure Analysis

The report presented here deals with the financial analysis of ANZ Bank. The ANZ Bank is one of the top most banks operating in Australia and New Zealand. The report presents an analysis of the capital structure and cost of capital of the bank. Further, the report also puts light on the financial performance of the bank.

The capital structure of a firm shows the composition of its capital funds. A firm may arrange funds from various sources which mainly fall in two primary categories such as equity and debt. Different sources of funds have incurs different costs and have different risk characteristics. Therefore, it becomes essential for a firm to analyze its capital structure and optimize the cost of capital and risk.

The capital structure of ANZ Bank for the year 2017 has been analyzed as under:

The equity capital has been taken at market value weights. It could be observed that 86% of the capital of the bank comprises of debt funds and remaining 14% is arranged through equity. So, quite clearly, the weight age of debt funds is higher than equity. Among the debt funds, the major portion is covered by deposit and other borrowings. The main business of the firm is to borrowing and lending money so this is the reason of high debt ratio.

The weighted average cost of capital (WACC) of ANZ bank has been calculated as follows: 

The cost of equity has been computed applying the CAPM model. The cost of equity is 10.51% which is higher than the cost of debt of 1.35%. The weight of debt in the total capital of the bank is 86%. So, the bank is using low cost funds more than the equity which incurs high cost. Due to this composition, the weighted average cost of capital of the bank is 2.65% which can be said to be quite low.

The CAPM return provides an approximation to the minimum required rate of return for the equity investors. The equity investors can analyze that whether the firm is able to provide them adequate return by comparing the CAPM return with the actual return on equity (ROE) of the firm (Hou & Van Dijk, 2018). In the case of ANZ Bank, the CAPM return is 10.51% while the return on equity is 11.90% (ANZ Bank, 2017), which indicates that the bank has been able to provide adequate return to its equity investors.

Weighted Average Cost of Capital (WACC) Analysis

The comparison of ANZ’s capital structure with the capital structure of Common Wealth Bank is presented below:

The Common Wealth Bank is one of the core competitors of ANZ Bank. The comparison of capital structure of ANZ Bank with the capital structure of Common Wealth Bank shows that ANZ uses more debt. The Common Wealth Bank uses 82% debt while ANZ uses 86%. Use of more debt signifies that Bank is relies more on debt than equity funds. However, it may be noted that keeping financing structure this way may help the company to keep the cost of capital low but at the same time it also gives rise to risk of solvency.

Ratio analysis provides an insight into the financial performance of a firm and forms a strong basis to compare and analyze the trend. In the case of ANZ Bank, five key financial ratios such as return on equity, cost to income, common equity tier-1, earning per share, and liquidity coverage ratio have been analyzed.

The return on equity depicts the percentage return earned by the firm relative to the equity investment. The higher the return on equity better will be the financial performance of the firm (Valverde, Solas, & Fernández, 2016). The return on equity helps in analyzing the profitability of the firm and this is main reason that this ratio is considered one of crucial ratios in the financial analysis. In respect of ANZ, it was observed that the firm earned a return on equity of 10.30% in the year 2016 which increased to 11.90% in the current year (Appendix). The increase in return on equity clearly indicates that the profitability of the bank has improved in the current year. Further, the earning per share (EPS) ratio also indicates the same trend in profitability. The EPS of the bank increased to 237.10 cents in 2017 from 202.60 cents in 2016 (Appendix).

The improvement in the profitability seems to be majorly driven by the reduction in the cost. The cost to income ratio is used to analyze the trend in costs incurred by a firm. In respect of ANZ, the cost to income ratio was 50.70% in 2016 which declined to 46.10% in the year 2017 (Appendix). The decline in the cost to income ratio indicates that the bank has been efficient in terms of utilization of the resources. The efficiency in utilization of the resources has caused improvement in the profitability as shown by the increase in return on equity.

Comparison between ANZ Bank and Commonwealth Bank

The common equity tier-1 ratio is important in analyzing liquidity risk in case of a banking firm. This ratio indicates percentage of core equity capital of the bank to the total risk weighted assets (Valverde, Solas, & Fernández, 2016). In case of ANZ, the ratio was found to be 9.60% in 2016 which increased slightly to reach 10.60% in 2017 (Appendix). The increase in the ratio indicates that the core equity capital relative to total risk weighted assets has increased which implies reduction in the liquidity risk.

Further, analysis of liquidity could be done by applying liquidity coverage ratio. The liquidity coverage ratio shows percentage of high quality liquid assets to total net cash outflows (Valverde, Solas, & Fernández, 2016). The higher the ratio better would be the liquidity position of the firm. It has been found that ANZ Bank had liquidity coverage ratio of 126% in 2016 which increased to 135% in 2017 (Appendix). The increase in ratio depicts improvements in the liquidity position of the bank.    

Significant Changes to the ANZ's Capital Structure in Past Three Years

A firm may change its components of capital over the period of time. In respect of ANZ, the changes in capital structure over the period of 3 years have been analyzed as under:

The data presented above shows that there has not been any significant change in the components of the capital used by the bank over the period of three years. In the year 2015, the bank was running its business with 87% debt and 13% equity. This changed slightly in the year 2016 showing increase in debt to 88% and reduction in equity to 12%. In the year 2017, the bank again lowered the debt portion to keep to 86%. 

It is the primary duty of the directors to act with integrity and assume accountability to improve financial performance of the business and ensure that business runs in the best of its stakeholder’s interest. The board of directors of a firm sits at the top the governance system. The success of the business lies in strengthening the governance mechanism within the firm and ensuring adequate transparency. Transparency implies bringing all facts to the knowledge of relevant stakeholder. So, the board of director being the supreme governing body of the firm should ensure that all the stakeholders of the business are informed adequately on the matters of their concern. For this purpose, the board should ensure that the adequate and appropriate disclosures are made in the annual report of the company.

Financial Performance Analysis

The findings of Banking Royal Commission reveal that ANZ bank has been found to be involved in conducting misleading business. The ANZ Bank has misled its customers as well as its investors. ANZ’s Chief Shyane Elliott agreed to the misconducts of the bank and assured to regain the lost faith of its customers and investors. The results of enquiry show that the bank was offering fraudulent products to its customers. The bank brought in a new investment scheme which purposefully framed in such a manner that ultimately was to put the customer at losing end. ANZ bank is at the verge of losing its licence because of introducing fraudulent products for sale to its customers.

The findings of Banking Royal Commission clearly indicate that all was not going well in the bank and there were many things which should have been brought to the notice of the stakeholders. However, the board of directors of the company failed in making adequate and appropriate disclosures. The board of directors concealed the facts of misconduct which were brought to the light by the Banking Royal Commission. Thus, it could be said that the bank has not been able to manage its reputational risk adequately. The faith of its investors and customers has lost which is causing decline in the share price of the bank.

In order to restore the faith of the investors, the board of directors of the bank should come up in front of the stakeholders and address their grievances. The bank should also think of devising a policy to compensate to the loss of investors and customers. However, the board of directors of ANZ has failed in doing so.           

Conclusion

It could be concluded from the discussion done in this report that the analysis of capital structure and WACC is essential for a firm. ANZ Bank’s WACC has been found to be 2.65% with debt and equity being in the ratio of 86% and 14%. The financial performance of the bank being analyzed by applying ratio analysis shows that the bank has shown improvements. 

References

ANZ Bank. (2017). Annual report of ANZ Bank for the year 2017. Retrieved from https://shareholder.anz.com/sites/default/files/2017_anz_annual_report.pdf

Hou, K., & Van Dijk, M. A. (2018). Resurrecting the size effect: Firm size, profitability shocks, and expected stock returns. Charles A. Dice Center Working Paper, (2010-1).

Rodrigues, S., Torabikalaki, R., Faria, F., Cafôfo, N., Chen, X., Ivaki, A. R., ... & Morgado-Dias, F. J. S. E. (2016). Economic feasibility analysis of small scale PV systems in different countries. Solar Energy, 131, 81-95.

Valverde, S. C., Solas, P. J. C., & Fernández, F. R. (Eds.). (2016). Liquidity Risk, Efficiency and New Bank Business Models. Springer.