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Post-GFC recovery has driven major financial institutions’ return to health, increasing market confidence in these “too-big-to-fail” banks. As a large-cap stock with market capitalization of AU$85b, Westpac Banking Corporation (ASX:WBC) falls into this category. The 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 banks to vulnerabilities. Operating in AUD, WBC is held to strict regulation which focus investor attention to the type and level of risk it takes on. 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.
Why Does WBC’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, Westpac Banking’s leverage ratio of 13.62x is very safe and substantially below the maximum limit of 20x. 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 increase its debt levels to firm up its capital cushion, there is plenty of headroom to do so without deteriorating its financial position.
How Should We Measure WBC’s Liquidity?
Since loans are relatively illiquid, we should know how much of Westpac Banking’s total assets are comprised of these loans. Usually, they should not be higher than 70% of total assets, however its current level of 81% means the bank has clearly lent out 10.85% above the sensible threshold. This means its revenue is reliant on these specific assets which means the bank is also more exposed to default compared to banks with less loans.
What is WBC’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. Relative to the prudent industry loan to deposit level of 90%, Westpac Banking’s ratio of over 126% is extremely and unsustainably higher, which puts the bank in a risky position due to the high liquidity disparity between loan and deposit levels. Basically, for A$1 of deposits with the bank, it lends out over A$1.20 which is unjustifiable.
Today, we’ve only explored one aspect of Westpac Banking. However, as a potential stock investment, there are many more fundamentals you need to consider. There are three pertinent factors you should further examine:
- Future Outlook: What are well-informed industry analysts predicting for WBC’s future growth? Take a look at our free research report of analyst consensus for WBC’s outlook.
- Valuation: What is WBC 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 WBC 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 firstname.lastname@example.org.