Bank of Commerce Holdings’s (NASDAQ:BOCH) profitability and risk are largely affected by the underlying economic growth for the region it operates in US given it is a small-cap stock with a market capitalisation of US$181m. Given that banks operate by reinvesting deposits in the form of loans, negative economic growth may lower the level of saving deposits and demand for loans, directly affecting those banks’ levels of cash flows. 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. 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. 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 Commerce Holdings’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
Why Does BOCH’s Leverage Matter?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, Bank of Commerce Holdings’s leverage level of 9.45x is very safe and substantially below the maximum limit of 20x. With assets 9.45 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. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.
How Should We Measure BOCH’s Liquidity?As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up Bank of Commerce Holdings’s total assets. Usually, they should not be higher than 70% of total assets, however its current level of 72% means the bank has lent out 1.6% above the sensible threshold. This means its revenue is reliant on these specific assets which means the bank is also more exposed to default compared to banks with less loans.
Does BOCH Have Liquidity Mismatch?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, 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 Commerce Holdings’s ratio of over 83%is appropriately lower, which 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.
The bank’s prudent management of its risk levels is reflected in its sensible leverage and liquidity ratios. This suggests it is well-positioned to meet its financial obligations in case of any unforeseen and adverse macro events. Today, we’ve only explored one aspect of Bank of Commerce Holdings. However, as a potential stock investment, there are many more fundamentals you need to consider. There are three relevant factors you should look at:
- Future Outlook: What are well-informed industry analysts predicting for BOCH’s future growth? Take a look at our free research report of analyst consensus for BOCH’s outlook.
- Valuation: What is BOCH 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 BOCH 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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.