As a small-cap bank stock with a market capitalisation of US$3.4b, Bank of Hawaii Corporation’s (NYSE:BOH) risk and profitability are largely determined by the underlying economic growth of the US regions in which it operates. Since a bank profits from reinvesting its clients’ deposits in the form of loans, negative economic growth may lower deposit levels and demand for loan, adversely impacting its cash flow. 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. Unpredictable macro events such as political instability could weaken its financial position which is why it is important to understand how well the bank manages its risk levels. Low levels of leverage coupled with sufficient liquidity may place Bank of Hawaii 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.
Is BOH’s Leverage Level Appropriate?
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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Bank of Hawaii’s leverage level of 13.52x is significantly below the appropriate ceiling of 20x. With assets 13.52 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. 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 BOH’s Liquidity?
As I eluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up the bank’s total asset. Generally, they should make up less than 70% of total assets, which is consistent with Bank of Hawaii’s state given its ratio of 60%. At this level of loan, the bank has preserved a sensible level between maintaining liquidity and generating interest income from the loan.
What is BOH’s Liquidity Discrepancy?
BOH profits 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, 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. Since Bank of Hawaii’s loan to deposit ratio of 69% is well-below than the appropriate maximum of 90%, this means the bank is lending out less than its total level of deposits and 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. There is opportunity for the bank to increase its interest income by lending out more loans.
Bank of Hawaii 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. High liquidity and low leverage places the bank in an ideal position to repay financial liabilities in case of adverse headwinds. Keep in mind that a stock investment requires research on more than just its operational side. Below, I’ve compiled three pertinent aspects you should further research:
- Future Outlook: What are well-informed industry analysts predicting for BOH’s future growth? Take a look at our free research report of analyst consensus for BOH’s outlook.
- Valuation: What is BOH 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 BOH 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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