Though large banks, like the €32b market cap Crédit Agricole S.A. (EPA:ACA), may have a “too big to fail” aura, we have recently observed international banks defaulting and undergoing debt restructuring, putting investors on edge wondering when the next domino will fall. Following the Financial Crisis in 2008, a set of reforms termed Basel III was enforced to bolster risk management, regulation, and supervision in the financial services industry. 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. If Crédit Agricole is relatively illiquid and highly levered, adverse macro events could suddenly worsen its financial position, making its stock a riskier investment. Today we will be measuring ACA’s risk-taking behaviour by looking at three leverage and liquidity metrics.
Why Does ACA’s Leverage Matter?
A high level of leverage may subject the bank to higher risk and lowers its ability to pay back its debtors. Leverage can be thought of as the amount of assets the bank owns relative to its shareholders’ funds. Though banks are required to have a certain level of buffer to meet its capital requirements, Crédit Agricole leverage level of 24.79x is very safe and substantially below the maximum limit of 20x. With assets 24.79 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. If the bank increases its debt level, it can ratchet up interest cost and further deteriorate its financial position.
What Is ACA’s Level of Liquidity?
Since loans are relatively illiquid, we should know how much of the bank’s total assets are comprised of these loans. Normally, they should not exceed 70% of total assets, although this should not be a worry for Crédit Agricole due to its significantly lower ratio of below 30%. At this level of loan, the bank has preserved a significantly high level of liquidity but possibly at the cost of producing interest income from illiquid loan.
What is ACA’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, conversely, on the liability side, customer deposits must be paid in very short notice and on-demand. 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. Compared to the appropriate industry loan to deposit level of 90%, Crédit Agricole’s ratio of over 65% is noticeably 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. Given the large headroom for growth in loans, the bank has opportunity to grow its interest income.
Although the bank has maintained a high level of liquidity, its above-average level of debt relative to its equity may hinder its ability to repay its large pool of debtors in unforeseen circumstances. Poor leverage management may make ACA a risky investment for both debt-and shareholders. Today, we’ve only explored one aspect of Crédit Agricole. However, as a potential stock investment, there are many more fundamentals you need to consider. Below, I’ve compiled three pertinent aspects you should further research:
- Future Outlook: What are well-informed industry analysts predicting for ACA’s future growth? Take a look at our free research report of analyst consensus for ACA’s outlook.
- Valuation: What is ACA 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 ACA 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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.