Understated Factors To Consider Before Investing In Huishang Bank Corporation Limited (HKG:3698)

As a small-cap bank stock with a market capitalisation of HK$41.88B, Huishang Bank Corporation Limited’s (SEHK:3698) risk and profitability are largely determined by the underlying economic growth of the HK regions in which it operates. Since banks make money by reinvesting its customers’ deposits in the form of loans, strong economic growth will drive the level of savings deposits and demand for loans, directly impacting the cash flows of those banks. Following the Financial Crisis in 2008, a set of reforms termed Basel III was enforced to bolster risk management, regulation, and supervision in the financial services industry. These reforms target bank level regulation and aims to improve the banking sector’s ability to absorb shocks arising from economic stress which could expose financial institutions to vulnerabilities. Unpredictable macro events such as political instability could weaken its financial position which is why it is important to understand how well the bank manages its risk levels. High liquidity and low leverage could position Huishang Bank favourably at the face of macro headwinds. A way to measure this risk is to look at three leverage and liquidity metrics which I will take you through today. See our latest analysis for Huishang Bank

SEHK:3698 Historical Debt Apr 14th 18
SEHK:3698 Historical Debt Apr 14th 18

Is 3698’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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Huishang Bank’s leverage level of less than the suitable maximum level of 20x, at 15x, is considered to be very cautious and prudent. This means the bank exhibits very strong leverage management and is well-positioned to repay its debtors in the case of any adverse events since it has an appropriately high level of equity relative to the debt it has taken on to remain in business. If the bank needs to firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.

How Should We Measure 3698’s Liquidity?

Handing Money Transparent Since loans are relatively illiquid, we should know how much of the bank’s total assets are comprised of these loans. Generally, they should make up less than 70% of total assets, consistent with Huishang Bank’s case with a much lower ratio of 36.50%. At this level of loan, the bank has preserved a high level of liquidity but perhaps at the cost of producing interest income from illiquid loan.

Does 3698 Have Liquidity Mismatch?

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, however, customer deposits are liabilities which must be repaid on-demand and in short notice. The disparity between the immediacy of deposits compared to the illiquid nature of loans puts pressure on the bank’s financial position if an adverse event requires the bank to repay its depositors. Compared to the appropriate industry loan to deposit level of 90%, Huishang Bank’s ratio of over 54.46%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:

Huishang Bank 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. 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. Keep in mind that a stock investment requires research on more than just its operational side. I’ve put together three key aspects you should further examine:

  1. Future Outlook: What are well-informed industry analysts predicting for 3698’s future growth? Take a look at our free research report of analyst consensus for 3698’s outlook.
  2. Valuation: What is 3698 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 3698 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.