As a small-cap finance stock with a market capitalisation of US$98.2m, the risk and profitability of Community West Bancshares (NASDAQ:CWBC) are largely tied to the underlying economic growth of the region it operates in US. Given that banks operate by reinvesting deposits in the form of loans, negative economic growth may lower the level of saving deposits and demand for loans, directly affecting those banks’ levels of cash flows. 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. Its financial position may weaken in an adverse macro event such as political instability which is why it is crucial to understand how well the bank manages its risks. Sufficient liquidity and low levels of leverage could place the bank in a safe place in case of unexpected macro headwinds. Today we will be measuring Community West Bancshares’s financial risk position by looking at three leverage and liquidity metrics.
Why Does CWBC’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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Community West Bancshares’s leverage level of less than the suitable maximum level of 20x, at 11.78x, 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 firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.
What Is CWBC’s Level of Liquidity?
Since loans are relatively illiquid, we should know how much of Community West Bancshares’s total assets are comprised of these loans. Generally, they should make up less than 70% of total assets, however its current level of 80.7% means the bank has clearly lent out 10.73% above the sensible threshold. This means its revenue is reliant on these specific assets which means the bank is also more exposed to defaulting relative to banks with less loans.
Does CWBC Have Liquidity Mismatch?
Banks profit by lending out its customers’ deposits as loans and charge an interest on the principle. These loans tend to be 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. Compared to the appropriate industry loan to deposit level of 90%, Community West Bancshares’s ratio of over 99.4% is higher which puts the bank in a risky position as it borders negative liquidity disparity between loan and deposit levels. Essentially, for $1 of deposits with the bank, it lends out more than $0.9 which is risky.
We’ve only touched on operational risks for CWBC in this article. But as a stock investment, there are other fundamentals you need to understand. There are three key factors you should further examine:
- Future Outlook: What are well-informed industry analysts predicting for CWBC’s future growth? Take a look at our free research report of analyst consensus for CWBC’s outlook.
- Valuation: What is CWBC 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 CWBC 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 email@example.com.