Yahoo Finance Why These Fundamentals Make Industrial and Commercial Bank of China Limited’s (HKG:1398) More Attractive
As a large-cap stock with market capitalization of HK$2.1t, Industrial and Commercial Bank of China Limited (HKG:1398) falls into the category of a major bank. As these large financial institutions revert back to health after the 2008 Financial Crisis, we are seeing an increase in market confidence in these “too-big-to-fail” banking stocks. 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 banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks to vulnerabilities. 1398 operates predominantly in and is held to stringent regulation around the type and level of risk it can take on, exposing it to higher scrutiny on its risk-taking behaviour. We should we cautious when it comes to investing in financial stocks due to the various risks large banks tend to face. Today we will analyse some bank-specific metrics and take a closer look at leverage and liquidity.
Check out our latest analysis for Industrial and Commercial Bank of China
Why Does 1398’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, Industrial and Commercial Bank of China’s leverage level of less than the suitable maximum level of 20x, at 12.36x, is considered to be very cautious and prudent. 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 firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.
What Is 1398’s Level of 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. Usually, they should not be higher than 70% of total assets, consistent with Industrial and Commercial Bank of China’s case with a ratio of 53%. This is a reasonable ratio and suggests that slightly over half of the bank’s total assets are tied up in the form of illiquid loans, striking an appropriate balance between liquidity and interest income.
Does 1398 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. 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. Relative to the prudent industry loan to deposit level of 90%, Industrial and Commercial Bank of China’s ratio of over 63% is markedly lower, which 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. There is opportunity for the bank to increase its interest income by lending out more loans.
Next Steps:
Industrial and Commercial Bank of China 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. The bank’s favourable liquidity and leverage position exposes it to less risk when it comes to repaying financial obligations, in particular, in the case of an adverse macro event. Keep in mind that a stock investment requires research on more than just its operational side. There are three essential aspects you should further research:
Future Outlook: What are well-informed industry analysts predicting for 1398’s future growth? Take a look at our free research report of analyst consensus for 1398’s outlook.
Valuation: What is 1398 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 1398 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.
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.
