Bank of Zhengzhou Co., Ltd.’s (HKG:6196) profitability and risk are largely affected by the underlying economic growth for the region it operates in HK given it is a small-cap stock with a market capitalisation of HK$35b. 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. Post-GFC recovery brought about a new set of reforms, Basel III, which was created to improve regulation, supervision and risk management in the financial services industry. 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. 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. 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.
Is 6196’s Leverage Level Appropriate?A low level of leverage subjects a bank to less risk and enhances its ability to pay back its debtors. Leverage can be thought of as the amount of assets a bank owns relative to its shareholders’ funds. Though banks are required to have a certain level of buffer to meet its capital requirements, Bank of Zhengzhou’s leverage level of 11.83x is significantly below the appropriate ceiling of 20x. 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 6196’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. 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 means less than half of the bank’s total assets are tied up in the form of illiquid loans, leading to high liquidity, perhaps at the expense of generating interest income.
What is 6196’s Liquidity Discrepancy?Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. Loans are generally fixed term which means they 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. 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.
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. We’ve only touched on operational risks for 6196 in this article. But as a stock investment, there are other fundamentals you need to understand. Below, I’ve compiled three pertinent aspects 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.
- 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.
- 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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