Though large banks, like the €36.33b market cap Crédit Agricole SA (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. After the Financial Crisis in 2008, a set of reforms called Basel III was created with the purpose of strengthening regulation, risk management and supervision 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. Adverse macro events such as political instability could abruptly deteriorate the bank’s financial position if the bank is currently engaged in risky operational behaviour, making its stock a riskier investment. A way to measure this behaviour is to look at three leverage and liquidity metrics which I will take you through today.
Is ACA’s Leverage Level Appropriate?
Banks with high leverage are exposed to higher risks around its ability to repay debt. A bank’s leverage can be thought of as the amount of assets it holds compared to its own shareholders’ funds. While financial institutions are required to have a certain level of buffer to meet capital adequacy levels, Crédit Agricole leverage level of less than the suitable maximum level of 20x, at 25.2x, is considered to be very cautious and prudent. This means the bank exhibits very strong leverage management and is well-positioned to repay its debtors in the case of any adverse events since it has an appropriately high level of equity relative to the debt it has taken on to remain in business. 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. The bank has very little headroom to increase its debt level as it may ratchet up interest cost and further deteriorate its financial position.
What Is ACA’s Level of 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, 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?
ACA profits by lending out its customers’ deposits as loans and charge an interest on the principle. These loans may be fixed term and often cannot be readily realized, however, customer deposits are liabilities which must be repaid on-demand and in short notice. 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%, Crédit Agricole’s ratio of over 64.5% is noticeably lower, which 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.
While the bank has retained appropriate liquidity, its high debt level may impede its capacity to repay the large pool of debtors in times of adverse 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. I’ve put together three relevant 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.
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.