As a large-cap stock with market capitalization of HK$308b, BOC Hong Kong (Holdings) Limited (HKG:2388) falls into the category of a major bank. As these large financial institutions revert back to health after the 2008 Financial Crisis, we are seeing an increase in market confidence in these “too-big-to-fail” banking stocks. A set of reforms called Basel III was imposed in order to strengthen regulation, supervision and risk management 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 to vulnerabilities. 2388 operates predominantly in 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.
Check out our latest analysis for BOC Hong Kong (Holdings)
Is 2388’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, BOC Hong Kong (Holdings)’s leverage level of less than the suitable maximum level of 20x, at 11x, is considered to be very cautious and prudent. With assets 11 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.What Is 2388’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.
Generally, they should make up less than 70% of total assets,
which is consistent with BOC Hong Kong (Holdings)’s state given its much lower ratio of 46%.
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 2388’s Liquidity Discrepancy?
Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. 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. 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. Compared to the appropriate industry loan to deposit level of 90%, BOC Hong Kong (Holdings)’s ratio of over 61% is noticeably lower, which means the bank is lending out less than its total level of deposits and positions the bank cautiously in terms of liquidity as it has not disproportionately lent out its deposits and has retained an apt level of deposits. There is opportunity for the bank to increase its interest income by lending out more loans.Next Steps:
BOC Hong Kong (Holdings) ticks all the boxes for operational prudency in terms of liquidity and leverage. These factors often sideline next to other fundamentals but are equally important to consider as part of the investment thesis. 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. Today, we’ve only explored one aspect of BOC Hong Kong (Holdings). However, as a potential stock investment, there are many more fundamentals you need to consider. Below, I’ve compiled three pertinent aspects you should look at:
- Future Outlook: What are well-informed industry analysts predicting for 2388’s future growth? Take a look at our free research report of analyst consensus for 2388’s outlook.
- Valuation: What is 2388 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 2388 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 editorial-team@simplywallst.com.