1. Introduction

The paper examines the corporate profile and the operational activities of the Commonwealth Bank Group. The paper studies and analyses the activities of the financial and the management structure of the corporation. Comparisons are also made with a bench mark firm over 2 periods and the portfolio and the 2 asset theory is concluded upon as well. The comparisons enable the understanding and analysis of the performance of the firm over a period of 2 years.

Let us first undertake the analysis of the corporate profile of the group.

2. Corporate Profile of the Common Wealth Group

Formed by the Commonwealth Bank Act 1911, the Commonwealth group commenced operations in 1912. The group has emerged providing saving as well as general banking solutions to the Australian citizens. The Commonwealth bank group has gradually expanded its operations and today constitutes over 200,000 employees and is answerable to 800,000 shareholders. The operations of the Commonwealth group are not confided to Australia the group has its operations in New Zealand, Asia Pacific, UK as well as the US. Commonwealth Bank of Australia (CBA.AX) –ASX has a market capitalization of over 81 billion dollars.

The bank was eventually privatised, the bank was restructured by the passing on the Commonwealth restructuring Act 1990, and the corporation was converted into a public company with partial government owning and conventional share capital. The Bank was privatised finally in 3 phases until its completion in 1996. With the privatization the bank has increased its focus to customer services as well as the adoption of technology in the modern day banking. Standard and poor in 2011 has given the Commonwealth Bank Australia a credit rating of AA- and labelled the organization as a stable bank corporation.

(Commonwealthbank.au, yahoo-finance, Standard and Poor 2011- accessed on 11/5/2012)

2.1 Core operating Activities

The Commonwealth bank group is the largest provider of the integrated financial services in Australia; however the group’s activities are not confined to the Australia they extend globally to the Asia pacific, Europe and America as well. The integrated banking services provided by the corporation include retail banking, premium banking, business banking, institutional banking, funds management, superannuation, insurance, investment and share broking products and services. The Commonwealth bank group is the one the largest corporation listed on the Australian stock exchange and highly rated on the Morgan Stanley index (www.commbank.com.au – accessed on 11/5/2012).

The group’s activities are represented on the following chart:

Figure 1: The commonwealth Bank group Banking operations.

The Commonwealth bank group has wide spread activities spreading across various institutional customers as well as small retail customers. The aim of the group is to provide specialised banking services to all with ease of the access to the banking system.  The Business effectively manages private and business banking relationships with SME’s, agricultural businesses and provides a wide spread range of products and services. International financial services are provided by the bank and have consolidated effectively across the Asia Pacific comprising of countries like Cambodia, China and Vietnam (commbank.au- accessed on 11/5/2012).

2.2 Current Investments

2.2.1 Current Investments in Assets

For the financial year ending 2011, the Commonwealth bank had consolidated assets of $667,899 million.

Figure 2: The Assets of Commonwealth Bank Group 2011(Annual Report Commonwealth Bank – accessed on 11/05/2012)

The group has experienced an asset growth of 22 billion, an increase of 3% over the previous year. The main component of the Assets were the loans and advances given to the financial institutions at 64% standing at a total  of $500,057 for the year ending 2011, this was followed by trading investments standing at 10% at a total of $20,049. The net loans and advancements have fixed payments and are non-derivative financial instruments. The net loans are derived through the loans given to the customers, financial institutions through the various banking activities like over drafts, credit card loans, financial leases and various term loans (Commonwealth Bank -Annual Report – 2011). The Bank has taken several steps to increase the economic efficiency of the banking operations and has spent over $1,179 million to focus on the Core Banking Modernisation (CBM) initiative. The Core Banking Modernization programme has made gradual progress in the current fiscal and therefore and resulted in the bank opening 1.2 million new accounts increasing the customer base of the bank. This has also been accompanied with the migration of 10 million retail savings account to a newer platform enabling the customers to enjoy the benefits of a modernized banking facility (Annual Report Commonwealth Bank 2011 Page- 19). The bank was facing a strain on the receivables accounts owning to the high interest rate costs caused by the financial crisis in 2008-2009, but the bank has successfully managed to reduce the loan arrears in the current period. This has been accompanied by a change in the commercial and the institutional portfolio of the bank which the bank has successfully upgraded in the current year (Annual Report Commonwealth Bank 2011- Page 20).

2.2.2 Liabilities of the Group

Figure 3: Liabilities of the Commonwealth Bank (Annual Report 2011 – accessed on 11/05/2012)

The consolidated balance sheet of the commonwealth group totals the liabilities of the group at $630,612 million with the maximum liabilities being generated from the Debt issue done by the bank at 56%, though the bank claims that the debt issues have decreased in comparison to the previous year i.e. 2010. The debt issue has decreased from $13 billion to just $108 billion. The decrease in the debt issue was the result of the strengthening of the Australian dollar in the current year. On the other hand the bank has also made considerable progress in effectively decreasing the high costs on interests on their loan account, which have decreased from $4 billion to $38 billion as 8% decrease from the previous year. The bank has effectively started funding its activities from non-interest bearing derivative operations, insurance activities etc. which now account for 6% of the total liabilities a clear increase in the number from 2010(Commonwealth Bank Annual Report , Page 20).

Figure 4: Comparison of Assets vs. Liabilities 2010-2011 (Annual Report Commonwealth Bank – accessed on 11/05/2012)

Comparing the Assets and the liabilities from the previous year it is evident that the Assets have increased marginally on the other hand the liabilities have shown a sharp increase. Although the debt to asset ratio has declined from 27% in 2010 to 24% 2011 thus, clearly reflecting the organizations asset creation and investment activity. The Core Banking Modernization programme has made gradual progress in the current fiscal and therefore and resulted in the bank opening 1.2 million new accounts increasing the customer base of the bank this has also resulted in the corporations increase in the liabilities of customer deposits with the bank in comparison to 2011. Comparing the 2 numbers the number of customer deposits has increased from $368903 in 2010 to $ 397084 million in 2011 , which has also accounted for the change in the liabilities position of the organization.

The current financial structure of the firm is a clear reflection that the Commonwealth bank has effectively emerged out of the financial crisis, and therefore it is clearly reflected in the balance sheet position of the bank. The financial structure suggests that there exists a balance between the debt and equity of the organization and the firm has enough organizational efficiency and cash flows to finance its operations without taking excessive debt.

2.3 Management Structure

The Commonwealth Bank group management structure is a mixture of the wide diversity of people collectively working together to ensure a profitable and efficient organization for the entire stakeholders. The group Chairman Mr David Turner expressed his positive outlook on the Bank’s performance in the year 2011 and claimed that the bank has successfully combated the financial crisis on 2008. The risk committee headed by Harrison has been effectively been working round the clock to make all the risk assessments particularly in the current times, where global liquidity constraints have been quite clearly evident.

Figure 4: Corporate Governance Structure of Common Wealth Bank

The Commonwealth Bank group effectively accesses the independence of each of its directors from time to time to ensure free and fair corporate structure. The Directors of the Group are strictly advised to be under ethical and the legal compliance of the Corporations Act 2001.

In 2011 the remuneration framework for the CEO’s and the group’s executives was effectively evaluated. Some re-structuring of the remuneration and the management framework has been undertaken by the corporation. Barbara Chapman was appointed as Chief Executive and the Managing Director of the New Zealand subsidiary of the bank; this was accompanied by the retirement of the groups CEO Ralf in 2011 as well.

The aim of the management is provide a competitive remuneration in line with the Australian management. The corporation’s remuneration structure is a mix of three components

I.          Fixed remuneration

II.          Short term incentives

III.          Long term incentives

Based on the three criteria and the roles and the responsibilities of the several directors and the executives the remuneration is determined.  The strategy of the corporation has been to link the remuneration with the performance of the individuals in the corporation. To avoid any clash with the management a fixed criteria for the short term incentives was also determined for the management of the company. A funding cap was set up by the board to limit the short term incentives being given to the organization. The performance objectives were effectively linked to the long term strategy of the firm and were chosen on the basis of the long term drivers of the shareholder value.

The Managing Director and CEO Ralph Norris was made a base remuneration of $3,120,000, $1,638,000 accounted for the various performance incentives given while $ 4,758,000 was the total cash shelled out for the CEO payments. Performance based compensation and the alignment of compensation with the effective attainment of business goals leads to the long term profitability for the organization.

(Annual Report Commonwealth Bank 2011 Page 84 – accessed on 11/5/2012).

2.4 Agency Problem

In economics the agency theory is defined as a nexus of contracts between different stakeholders parties .As the interests of the agents are not the interests of the principal organization, they impose certain agency costs upon the organization. These agency costs are compensation, budget restrictions etc. The Agency theory suggests that the incentive the primary means by which the shareholders are given incentives they have to compensate the top management and the CEO’s of the company. The corporations believe that it is their primary duty to compensate their CEO’s and the management to ensure corporate performance (Proffitt,2000 and Senbet ,2011).

The existence of the agency problem is relatively less in the Commonwealth bank group because the remuneration is based on three clear principles

The corporation’s remuneration structure is a mix of three components

I.          Fixed remuneration

II.         Short term incentives

III.       Long term incentives

There is a clear definition of the principles and the remunerations. The Plans are flexible and are often linked to the performance of the executives. The corporation has in line flexible and reward structures linked to the group’s business strategy. The corporation has effectively set up a long term incentive plan, to motivate the management and the employees of the corporation.

There also exists a Group leadership Reward Plan (GLRP) this plan has been effectively formulated for the groups CEO’s and the executives. The aim of the plan is to reward the groups CEO’s and executives and is linked with the levels of customer satisfaction and the total shareholder return.  The agency problem is not likely to arise if the compensation is linked to the performance of the executives in the key management positions. A clearly defined management structure and the definition of the management goals and principles are essential to achieve fair organization where there is no conflict of interests between different stakeholder groups. The Agency problem is effectively minimised where a clear cut compensation strategy is established and the compensation is linked to performance and the attainment of goals.

(Commonwealth Bank Annual Report – Page 84-87 accessed on 11/05/2012)

3. Comparison of Commonwealth Bank and S&X in Different Time Periods

3.1 Comparison of the Return of the Periods 1 and Period 2

Figure 4: Weekly Share Price Comparison between Commonwealth Bank and S&X in Time Period 1 31/12/2007 -31/10/2009 (yahoo finance- accessed on 11/05/2012)

Figure 5: Weekly Share Price Comparison between S&X and Common Wealth Bank in time Period 29/12/2009 – 26/12/2011(yahoo finance – accessed on 11/5/2012)

Comparing the return graphs for both the time periods for Commonwealth Bank and S&X there is a clear indication of uncertainty in Period 1 i.e. is in between (December 2007- December 2009) in comparison to period 2 i.e. is between (December 2009-December 2011). There is an indication higher degree of fluctuation in period 1 with the shares of the Commonwealth Bank plunging downward in Jan- Feb 2008. This plunge has been caused by the financial instability evident in the global financial markets. Incidentally this period can be characterised with the onset of the global financial crisis which led to the worldwide financial market collapse in 2008(Hinton 2009). The collapse of the US residential market has resulted in creation of a global balance sheet problem. A$900 billion (out of a $9 trillion in mortgage debt) is in the sub-prime paper in global balance sheets of banks, investment houses, hedge funds and mutual funds (Adair et al, 2009).

Period 2 is considered to be relatively less volatile and the market appears to be relatively consolidating after the effects of the GFC. There have been no widespread movements in the weekly share prices and the movement of the commonwealth bank share have been around in between $50-$55, the same consolidating signs are evident in the overall financial markets with the banks shares moving in line with the financial market index. Despite the on-going weakness in the financial markets and the liquidity constrains in the banking sector, the outlook for the Australian economy and the Australian banking industry has been quite positive. The Commonwealth Bank has also identified that it has successfully overcome the weaknesses cause by the GFC (Commbank.au, Annual Report Common Wealth Bank Annual Report 2010- accessed 11/05/2012).

Figure 6: Weekly Return Period 1 (Appendix)

Figure 7 : Weekly Returns Period 1 (Appendix)

Figure 9: Weekly Return S&P (Appendix 2 )

Figure 10 : Weekly Return Common Wealth Bank in Period 2 (Appendix)

There is an indication higher degree of fluctuation in period 1 with the shares of the Commonwealth Bank plunging downward in Jan- Feb 2008. This plunge has been caused by the financial instability evident in the global financial markets. Incidentally this period can be characterised with the onset of the global financial crisis which led to the worldwide financial market collapse in 2008(Hinton 2009). The collapse of the US residential market has resulted in creation of a global balance sheet problem. A$900 billion (out of a $9 trillion in mortgage debt) is in the sub-prime paper in global balance sheets of banks, investment houses, hedge funds and mutual funds (Adair et al, 2009).

Period 2 is considered to be relatively less volatile and the market appears to be relatively consolidating after the effects of the GFC. There have been no widespread movements in the weekly share prices and the movement of the commonwealth bank share have been around in between $50-$55, the same consolidating signs are evident in the overall financial markets with the banks shares moving in line with the financial market index. Despite the on-going weakness in the financial markets and the liquidity constrains in the banking sector, the outlook for the Australian economy and the Australian banking industry has been quite positive. The Commonwealth Bank has also identified that it has successfully overcome the weaknesses cause by the GFC (Commbank.au, Annual Report Common Wealth Bank Annual Report 2010- accessed 11/05/2012).

3.2 Systematic Risks

In view of the Global financial Crisis which struck in 2008, there has been a presence of volatility in the returns; this volatility is a result of the large scale volatility of the global financial markets. This presents difficulty for the organization to raise capital both through debt and equity. Raising capital through debt has been difficult owning too the rise in the interest costs of the firm. The Collapse of the Lehmann brothers in 2008 posed a huge financial risk for the global financial markets.

The risk has further increased with the Euro debt crisis that has occurred in 2009. The economists globally have argued that the fiscal situation in Europe has worsened over the past 5 years. The fiscal pressure on the Euro zone has been mounting with the subsequent bailout given to Ireland and Troika and the worsening situation of the Greek economy. The Euro zone continues to have debt/GDP ratios over 60%, and this trend has also been seen in the economies like France as well Germany. The Euro situation has been worsened with the rising cost of borrowings experienced across most Eurozone economies, like Italy, Greece, Spain as well as Portugal. The rising cost of borrowings has also weakened the growth outlook for the region with recent data’s reporting the contraction of the economies over the past 3 year’s period. The worst crisis has been experienced by the Greek economy which has left the world financial markets and economies in jeopardy. The Greek economy has worsened, as a result of the economic crisis, with the crisis intensifying further in the current year 2012. The Greek economy has faced continuous contraction from 2008 onwards with the strike of the Subprime crisis. The crisis has intensified as a result of excessive government spending the current Greek Debt is €300 billion ($413.6 billion) with a rising fiscal deficit of 12.7%. This has resulted in the low credit rating for the Greek economy and has been downgraded to the lowest in the Eurozone. This has left the entire Eurozone in jeopardy as well as loss of policy options to the Greek government. The impact of the Greek debt crisis has also impacted global markets which have registered consequent falls with declaration of the crisis in 2011(cnn.com – accessed on 9/5/2011, Kganyago, 2012)

The Euro zone crisis have placed many global banks and economic firms in jeopardy ,but despite the inherent risks evident in the global business environment the outlook for common wealth bank has been fairly positive.

3.3 Comparison of the 2 Periods

3.3.1 Period 1

3.3.2 Period 2

The Performance of the group has been better in Period 1with the average return generation of 47% and the increased volatility is evident in the organization in Period where the returns have been reduced over 15 % and stand at 31%. . The returns of the Common wealth Bank have been affected because of the volatility introduced in the market by the global financial crisis and further worsened by the Eurozone crisis. Despite some consolidation achieved in Period 2 the bank is still recovering from the impact of the global financial crisis.

There is an increased volatility experienced by the Commonwealth Bank in Period 1 of about 7% this is because the year marked world economies slipping into crisis, and the volatility and the panic was also evident in the Australian economy. On the other hand with slight recovery the degree of volatility has considerably reduced in Period 2 (Appendix 1 and 2)

The S&X index and the Commonwealth Bank shares represent a high degree of Co- relation in both the period. This is a clear reflection of the impact of the changes in the index a representative of the financial market on the performance of the individual bank. The performance is co-related as the bank performs as well as the index.

Period 1 represents a higher degree of risk with the maximum returns has been 53 whereas the lowest has been 23, this clear indication of the existence of the volatility in the financial market. On the other hand after some recovery made in the Period 2 there is less volatility with a maximum of 57 and the minimum being 47. There was a little recovery made by the global market as well as positive outlook of the Australian economy has reduced the existing volatility in the market.

Comparing the performance of the Commonwealth Bank group and S&X, There is a high degree of volatility evident in the Period 1 with a co relation of 7.9% in comparison to 9% in Period 2 ; therefore it is advisable to invest in the Commonwealth group because of the diversified portfolio risk in the business. A diversified portfolio reduces the inherent risk in the organization. The S&X index and the Commonwealth Bank shares represent a high degree of Co- relation in both the period. This is a clear reflection of the impact of the changes in the index a representative of the financial market on the performance of the individual bank. The performance is co-related as the bank performs as well as the index.

Period 1

Period 2

4. Portfolio Diversification

Diversification is simply the implication of the minimization of risk. The diversification simply reduces the risk on investment and enables the asset to generate a steady rate of interest and the earning on the asset.

An investor would to choose to diversify in the various shares owning to the factor of the minimization of the risk owning to the large-scale volatility in the market. Diversification implies the spreading of the risk cover over more than 2 investments to generate maximum gains out of the investments.

In light of the global financial crisis and Euro zone crisis which have led to the presence of the high volatility in the financial markets, and several liquidity pressures on the market. The investor has chosen to diversify their current investment. The Australian financial markets have been relatively insulated from the impact of the global financial crisis, but however now the effects of the crisis are beginning to be seen .For this purpose diversification of the portfolio is important.

For this purpose the investor is considering investment into BHP Bilton a mining corporation in Australia. BHP Bilton is the world’s largest mining and natural resource company. BHP Bilton is a global corporation with operations in over 100 locations globally.BHP Bilton is over 150 year old company founded in the 1860’s in Indonesia , and Bilton emerged as a global leader in the mining and the natural resources operations in the area . It was then in the 1886 BHP began the discovery of metals like zinc and silver. Both the Corporations flourished individually until the merger of the corporations in 2001. With the merger Bilton became the world’s largest natural resource organization with having mining operations all metals of nickel, iron ore, zinc as well as silver. As the scale of operations expanded Bilton also ventured into other metals like and natural resources like diamonds, oil and natural gas. The preliminary results for the corporation in 2011 indicated an increase in the profits by over 74% and the cash flows by 78%. This is a clear indicator of the inherent ptofit creating capacity of the organization. Therefore; indicating that BHP Bilton is a stable organization and which is suitable for investments and consideration for portfolio diversification.

Figure 11: Standard and Poor Sector Breakdown (standardandpoors.com- accessed on 11/05/2012)

The standard and poor sector breakdown indicates that the materials sector constitutes the largest after the financial sector according to the 2012 estimates. The financial sector constitutes nearly 39% of the total sector contribution while the energy sector constitutes 23% of the total. Therefore the natural resources sector is the 2nd largest contributor in the Australia economy, therefore it is advisable to expand and diversify in this sector. The projected growth on the sector is also high on the sector which makes it wise to consider investment in the sector.

4.1 Returns BHP in Both the Periods

Figure 12: weekly returns on BHP in Period 1(Appendix 1)

Figure 12:Weekly Returns BHP Period 2

Period 1

Period 2

4.2 Comparison of Commonwealth Bank and BHP

Analysing the performance of the Commonwealth Bank and Bilton BHP we can conclude that the average weekly returns for Commonwealth Bank are better than BHP. While on the other hand the BHP has performed slightly better in period 2. This is because that the organization has been battling the impact of the global financial crisis in period 1.While in period 2 the performances of both the corporations have been better owning to the consolidation after the impact of the global financial crisis.

The average weekly return for the corporation continues to be positive in both the periods continues to be positive with a minor decline to 0.33% in period 2 from 41% in the first period. This is a clear indicator of the impact of the GFC.

In the first period the BHP has a negative co-relation of indicator of the existence of volatility in the both the sector. However this co-relation is positive in the 2^nd period indicating the recovery of return and the profitability of the organization. Therefore in the terms of co-variance there is a positive trade-off between the risk and return.

5. Conclusion

The impact of the financial crisis and the on-going Euro crisis is in evident on the performance of the Common wealth Bank. The independent nature and the policy of the Australian RBA have ensured a positive performance of the Australian economic policy. The independent monitory policy adoption has resulted in the somewhat insulation of the Australian economy. The Australian government has maintained a steady level of consumption as evident from the World Bank data which has ensured efficient economic performance of the Australian economy. In October 2009 the RBA increased the interest rate by 25 base points to 3.25%. Now after successfully emerging from the financial strain from 2008-2011 and the growth expectations of the economy the Australian market and industry are waiting for a rate cut by the RBA in 2012.

(qfinance.com – accessed on 8/5/2012)

While in such a scenario portfolio diversification is highly important as it enables the equal distribution of risk over different asset classes and different company’s .Diversification enable the customer to realise returns from different sectors of the financial market that are performing in the current business scenario. The crisis have certainly affected the profitability and returns but however with the limited impact on the Australian economy the storm has been withered and Commonwealth Bank is consolidating its position in the market.

6. References

• “About Us – our Company – History – Privatisation – Commonwealth Bank Group.” Commonwealth Bank – Personal Banking, Business Banking and  Corporate Banking – Commonwealth Bank Group. N.p., n.d. Web. 10 May 2012. <http://www.commbank.com.au/about-us/our-company/history/privatisation.aspx>.

• ” Issuer Credit Profiles For The Top 100 Banks Globally.” www.standardandpoors.com. N.p., n.d. Web. 11 May 2012. <http://www.standardandpoors.com/ratings/articles/en/us/?articleType=HTML&assetID=1245332401015>.
• “CBA.AX: Summary for CWLTH BANK FPO- Yahoo! Finance.” Yahoo! Finance – Business Finance, Stock Market, Quotes, News. N.p., n.d. Web. 10 May 2012. <http://finance.yahoo.com/q?s=CBA.AX>.
• Fraser, Ian, Anthony Harrington, January 11, and 11 2011. “Australia – Economy and Trade of Australia – QFINANCE.” Financial resources, articles, concepts and opinions from QFINANCE – QFINANCE. N.p., n.d. Web. 23 Apr. 2012. <http://www.qfinance.com/country-profiles/australia>.
• Proffitt, Dennis. “Agency Theory as a Basis for Business Ethics.” Christian Business Faculty Association 1.1 (2000): 1-20. Print.
• W. Senbet, Lemma. “The Rise of Equity-Based Compensation: The Bright and The Dark.” Perspectives on executive Compensation 1.1 (2011): 1-3. Print
• “BHP.AX Historical Prices | BHP BLT FPO Stock – Yahoo!7 Finance.” Business, Investments, Stocks & Quotes – Yahoo!7 Finance. N.p., n.d. Web. 11 May 2012. <http://au.finance.yahoo.com/q/hp?s=BHP.AX&a=11&b=29&c=2010&d=11
• “^AXFJ Historical Prices | S&P/ASX 200 Financials Stock – Yahoo!7 Finance.” Business, Investments, Stocks & Quotes – Yahoo!7 Finance. N.p., n.d. Web. 11 May 2012. <http://au.finance.yahoo.com/q/hp?s=%5EAXFJ&a=11&b=31&c=2007&d=1
• ” S&P/ASX 300.” www.standardandpoors.com. N.p., n.d. Web. 11 May 2012. <http://www.standardandpoors.com/indices/sp-asx-300/en/us/?indexId=spausta300audff–p-au—->.
• “CBA Balance Sheet – Commonwealth Bank of Australia – Bloomberg.” Bloomberg – Business, Financial & Economic News, Stock Quotes. N.p., n.d. Web. 11 May 2012. <http://www.bloomberg.com/quote/CBA:AU/balance-sheet>.

7. Appendix

7.1 Period 2

7.3 Period 1

L081

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