As a small-cap bank stock with a market capitalisation of CN¥22.41b, Bank of Zhengzhou Co Ltd’s (HKG:6196) risk and profitability are largely determined by the underlying economic growth of the HK regions in which it operates. A bank’s cash flow is directly impacted by economic growth as it is the main driver of deposit levels and demand for loans which it profits from. After the GFC, a set of reforms called Basel III was imposed in order to strengthen regulation, supervision and risk management 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 Bank of Zhengzhou 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 Bank of Zhengzhou’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
Is 6196’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. While financial companies will always have some leverage for a sufficient capital buffer, Bank of Zhengzhou’s leverage ratio of 12.83x is very safe and substantially below the maximum limit of 20x. With assets 12.83 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 6196’s Liquidity?Due to its illiquid nature, loans are an important asset class we should learn more about. Normally, they should not exceed 70% of total assets, which is consistent with Bank of Zhengzhou’s state given its much lower ratio of 32.44%. 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 6196’s Liquidity Discrepancy?6196 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. 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%, Bank of Zhengzhou’s ratio of over 50.44% is markedly 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.
Bank of Zhengzhou 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. Keep in mind that a stock investment requires research on more than just its operational side. There are three pertinent factors you should look at:
- Future Outlook: What are well-informed industry analysts predicting for 6196’s future growth? Take a look at our free research report of analyst consensus for 6196’s outlook.
- Historical Performance: What has 6196’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- 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.
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