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As a large-cap stock with market capitalization of HK$319b, China CITIC Bank Corporation Limited (HKG:998) 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 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. As a large bank in HKD, 998 is exposed to strict regulation which has focused investor attention on the type and level of risks it is subjected to, and 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.
See our latest analysis for China CITIC Bank
Why Does 998'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, China CITIC Bank’s leverage ratio of 13.42x is significantly below the appropriate ceiling of 20x. With assets 13.42 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 firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.
How Should We Measure 998'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. Normally, they should not exceed 70% of total assets, consistent with China CITIC Bank’s case with a ratio of 62%. 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.
What is 998's Liquidity Discrepancy?
Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. These loans tend to be fixed term which means they cannot be readily realized, however, customer deposits are liabilities which must be repaid 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. Since China CITIC Bank’s loan to deposit ratio of 83% is within the sensible margin, below than the appropriate maximum of 90%, this level 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.