What Makes National Bank of Canada (TSE:NA) A Complex Investment?

As a large-cap stock with market capitalization of CAD CA$21.63B, National Bank of Canada (TSX:NA) is classified as a major bank. As these large financial institutions revert back to health after the Global Financial Crisis, we are seeing an increase in market confidence, and understanding of, these “too-big-to-fail” banking stocks. The recovery brought about a new set of reforms, Basel III, which was created to improve regulation, supervision and risk management in the financial services industry. These reforms target banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks to vulnerabilities. NA operates predominantly in CAD and is held to stringent regulation around the type and level of risk it can take on, exposing it to higher scrutiny on its risk-taking behaviour. Investors should be more cautious when it comes to financial stocks given the different type of risk to which they are exposed. Today we will analyse some bank-specific metrics and take a closer look at leverage and liquidity. See our latest analysis for National Bank of Canada

Is NA's Leverage Level Appropriate?

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. Though banks are required to have a certain level of buffer to meet its capital requirements, National Bank of Canada’s leverage level of less than the suitable maximum level of 20x, at 18x, is considered to be very cautious and prudent. 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 NA's Level of Liquidity?

As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up the bank’s total assets. Normally, they should not exceed 70% of total assets, which is consistent with National Bank of Canada’s state given its ratio of 52.25%. This means slightly over half of the bank’s total assets are tied up in the form of illiquid loans, leading to a sensible balance between interest income and liquidity.

Does NA Have Liquidity Mismatch?

CBA profits 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, however, customer deposits are liabilities which must be repaid on-demand and in short notice. 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. Relative to the prudent industry loan to deposit level of 90%, National Bank of Canada’s ratio of over 81.99%is appropriately lower, which places the bank in a relatively safe liquidity position given it has not excessively lent out its deposits and has maintained a suitable level for compliance.

Final words

National Bank of Canada meets all of our liquidity and leverage criteria, exhibiting operational prudency. The operational risk side of a bank is an important fundamental often overlooked by investors. Its high liquidity and low leverage levels mean the bank is well-positioned to meet its financial obligations in the case of any adverse and unpredictable macro events.

Now that you know to keep in mind these liquidity factors when putting together your investment thesis, I recommend you check out our latest free analysis report on National Bank of Canada to see its growth prospects and whether it could be considered an undervalued opportunity.

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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.