Should You Be Concerned About Bank of Zhengzhou Co Ltd’s (HKG:6196) Liquidity?

As a small-cap bank stock with a market capitalisation of HK$34b, 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. 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. 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 banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from 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. High liquidity and low leverage could position Bank of Zhengzhou 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 Bank of Zhengzhou

SEHK:6196 Historical Debt November 15th 18
SEHK:6196 Historical Debt November 15th 18

Is 6196’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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Bank of Zhengzhou’s leverage level of 11.83x is significantly below the appropriate ceiling of 20x. 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 6196’s Level of 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, which is consistent with Bank of Zhengzhou’s state given its much lower ratio of 35%. 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.

Does 6196 Have Liquidity Mismatch?

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. 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. Since Bank of Zhengzhou’s loan to deposit ratio of 55% 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. Given the large headroom for growth in loans, the bank has opportunity to grow its interest income.

Next Steps:

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. High liquidity and low leverage places the bank in an ideal position to repay financial liabilities in case of adverse headwinds. Today, we’ve only explored one aspect of Bank of Zhengzhou. However, as a potential stock investment, there are many more fundamentals you need to consider. Below, I’ve compiled three important aspects you should look at:

  1. 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.
  2. Valuation: What is 6196 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 6196 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.

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.