As a small-cap bank stock with a market capitalisation of US$86m, Community West Bancshares’s (NASDAQ:CWBC) risk and profitability are largely determined by the underlying economic growth of the US 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. 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 Community West Bancshares 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. Low levels of leverage coupled with sufficient liquidity may place Community West Bancshares in a safe position in the face of adverse headwinds. We can measure this risk exposure by analysing three metrics for leverage and liquidity which I will take you through today.
Why Does CWBC’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, Community West Bancshares’s leverage level of less than the suitable maximum level of 20x, at 11.52x, is considered to be very cautious and prudent. With assets 11.52 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.
What Is CWBC’s Level of 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, but its current level of 81% means the bank has obviously lent out 11.07% above the sensible upper limit. This indicates that revenue is dependent on this particular asset but also the bank is more likely to be exposed to default compared to its competitors with less loans.
What is CWBC’s Liquidity Discrepancy?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, conversely, on the liability side, customer deposits must be paid in very short notice and on-demand. 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 Community West Bancshares’s loan to deposit ratio of 99% is higher than the appropriate level of 90%, this level positions the bank in a risky spot given the potential to cross into negative liquidity disparity between loan and deposit levels. Basically, for $1 of deposits with the bank, it lends out over $0.9 which is imprudent.
We’ve only touched on operational risks for CWBC in this article. But as a stock investment, there are other fundamentals you need to understand. There are three essential factors you should further research:
- Future Outlook: What are well-informed industry analysts predicting for CWBC’s future growth? Take a look at our free research report of analyst consensus for CWBC’s outlook.
- Valuation: What is CWBC 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 CWBC 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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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.