Why These Fundamentals Make Canadian Western Bank’s (TSE:CWB) More Attractive

As a small-cap finance stock with a market capitalisation of CA$2.3b, the risk and profitability of Canadian Western Bank (TSE:CWB) are largely tied to the underlying economic growth of the region it operates in CA. Since a bank profits from reinvesting its clients’ deposits in the form of loans, negative economic growth may lower deposit levels and demand for loan, adversely impacting its cash flow. After the Financial Crisis in 2008, a set of reforms called Basel III was created with the purpose of strengthening regulation, risk management and supervision in the banking sector. The Basel III reforms are aimed at banking regulations to improve financial institutions’ ability to absorb shocks caused by economic stress which could expose banks like Canadian Western Bank to vulnerabilities. Since its financial standing can unexpectedly decline in the case of an adverse macro event such as political instability, it is important to understand how prudent the bank is at managing its risk levels. Strong management of leverage and liquidity could place the bank in a protected position at the face of macro headwinds. We can gauge Canadian Western Bank’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.

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Why Does CWB's Leverage Matter?

Banks with low leverage are better positioned to weather adverse headwinds as they have less debt to pay off. A bank’s leverage may be thought of as the level of assets it owns compared to its own shareholders’ equity. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Canadian Western Bank’s leverage level of 11.21x is significantly below the appropriate ceiling of 20x. This means the bank has a sensibly high level of equity compared to the level of debt it has taken on to maintain operations which places it in a strong position to pay back its debt in unforeseen circumstances. If the bank needs to increase its debt levels to firm up its capital cushion, there is plenty of headroom to do so without deteriorating its financial position.

What Is CWB's Level of Liquidity?

As I eluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up Canadian Western Bank’s total asset. Generally, they should make up less than 70% of total assets, but its current level of 90% means the bank has obviously lent out 20.29% above the sensible upper limit. This means its revenue is reliant on these specific assets which means the bank is also more exposed to default compared to banks with less loans.

What is CWB's Liquidity Discrepancy?

Banks profit by lending out its customers’ deposits as loans and charge an interest on the principle. These loans may be fixed term and often cannot be readily realized, conversely, on the liability side, customer deposits must be paid in very short notice and on-demand. This mismatch between illiquid loans and liquid deposits poses a risk for the bank if unusual events occur and requires it to immediately repay its depositors. Since Canadian Western Bank’s loan to deposit ratio of 111% is higher than the appropriate level of 90%, this level positions the bank in a risky spot given the adverse liquidity disparity between loan and deposit levels. Basically, for CA$1 of deposits with the bank, it lends out over CA$1 which is imprudent.

Next Steps:

We've only touched on operational risks for CWB in this article. But as a stock investment, there are other fundamentals you need to understand. I've put together three key aspects you should further research:

1. Future Outlook: What are well-informed industry analysts predicting for CWB’s future growth? Take a look at our free research report of analyst consensus for CWB’s outlook.
2. Valuation: What is CWB worth today? Has the future growth potential already been factored into the price? The intrinsic value infographic in our free research report helps visualize whether CWB is currently mispriced by the market.
3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.