In This Article:
East West Bancorp, Inc.’s (NASDAQ:EWBC) 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$6.2b. 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. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like East West Bancorp 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. Sufficient liquidity and low levels of leverage could place the bank in a safe place in case of unexpected macro headwinds. Today we will be measuring East West Bancorp’s financial risk position by looking at three leverage and liquidity metrics.
See our latest analysis for East West Bancorp
Why Does EWBC’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. While financial companies will always have some leverage for a sufficient capital buffer, East West Bancorp’s leverage ratio of less than the suitable maximum level of 20x, at 9.2x, 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. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.
What Is EWBC’s Level of Liquidity?
Since loans are relatively illiquid, we should know how much of East West Bancorp’s total assets are comprised of these loans. Normally, they should not exceed 70% of total assets, however its current level of 79% means the bank has lent out 9.08% above the sensible threshold. This level implies dependency on this particular asset class as a source of revenue which makes the bank more exposed to defaulting relative to banks with less loans.
What is EWBC’s Liquidity Discrepancy?
Banks profit 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, 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. Compared to the appropriate industry loan to deposit level of 90%, East West Bancorp’s ratio of over 92% is higher which 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.