As a small-cap finance stock with a market capitalisation of HK$49.04b, the risk and profitability of Guangzhou Rural Commercial Bank Co Ltd (HKG:1551) are largely tied to the underlying economic growth of the region it operates in HK. 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. These reforms target banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks like Guangzhou Rural Commercial Bank to vulnerabilities. Its financial position may weaken in an adverse macro event such as political instability which is why it is crucial to understand how well the bank manages its risks. Low levels of leverage coupled with sufficient liquidity may place Guangzhou Rural Commercial Bank in a safe position in the face of adverse headwinds. We can measure this risk exposure by analysing three metrics for leverage and liquidity which I will take you through today.
Is 1551’s Leverage Level Appropriate?Banks with low leverage are exposed to lower risks around their ability to repay debt. A bank’s leverage can be thought of as the amount of assets it holds compared to its own shareholders’ funds. Though banks are required to have a certain level of buffer to meet its capital requirements, Guangzhou Rural Commercial Bank’s leverage level of 15.18x is very safe and substantially below the maximum limit of 20x. With assets 15.18 times equity, the banks has maintained a prudent level of its own fund relative to borrowed fund which places it in a strong position to pay back its debt in times of adverse events. 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.
How Should We Measure 1551’s 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. Usually, they should not be higher than 70% of total assets, which is the case for Guangzhou Rural Commercial Bank, with a ratio well-below the maximum level at 38.8%. This ratio suggests that less than half of the bank’s total assets are made up of loans, but the bank’s strong liquidity management may be at the price of generating higher interest income.
What is 1551’s Liquidity Discrepancy?1551 profits by lending out its customers’ deposits as loans and charge an interest on the principle. Loans are generally fixed term which means they cannot be readily realized, yet customer deposits on the liability side must be paid on-demand and in short notice. The discrepancy between loan assets and deposit liabilities threatens the bank’s financial position. If an adverse event occurs, it may not be well-placed to repay its depositors immediately. Since Guangzhou Rural Commercial Bank’s loan to deposit ratio of 53.7% is well-below than the appropriate maximum of 90%, this means the bank is lending out less than its total level of deposits and 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. There is opportunity for the bank to increase its interest income by lending out more loans.
Guangzhou Rural Commercial Bank passes all of our liquidity and leverage checks which shows it is prudent in managing those factors. This gives us confidence in the operational side of the business, an important aspect to consider before investing in the stock. The bank’s favourable liquidity and leverage position exposes it to less risk when it comes to repaying financial obligations, in particular, in the case of an adverse macro event. Today, we’ve only explored one aspect of Guangzhou Rural Commercial Bank. However, as a potential stock investment, there are many more fundamentals you need to consider. Below, I’ve compiled three important factors you should further examine:
- Future Outlook: What are well-informed industry analysts predicting for 1551’s future growth? Take a look at our free research report of analyst consensus for 1551’s outlook.
- Valuation: What is 1551 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 1551 is currently mispriced by the market.
- 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 firstname.lastname@example.org.