Bank of Commerce Holdings’s (NASDAQ:BOCH) profitability and risk are largely affected by the underlying economic growth for the region it operates in US given it is a small-cap stock with a market capitalisation of US$192m. 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. Post-GFC 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. The Basel III reforms are aimed at banking regulations to improve financial institutions’ ability to absorb shocks caused by economic stress which could expose banks like Bank of Commerce Holdings 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. Low levels of leverage coupled with sufficient liquidity may place Bank of Commerce Holdings 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.
Why Does BOCH’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. Bank of Commerce Holdings’s leverage level of 9.85x is very safe and substantially below the maximum limit of 20x. 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.
How Should We Measure BOCH’s Liquidity?
Due to its illiquid nature, loans are an important asset class we should learn more about. Normally, they should not exceed 70% of total assets, but its current level of 72% means the bank has lent out 2.27% above the sensible upper limit. 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.
Does BOCH Have Liquidity Mismatch?
BOCH profits 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. 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. Since Bank of Commerce Holdings’s loan to deposit ratio of 88% is within the sensible margin, below than the appropriate maximum of 90%, this level 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.
The bank’s prudent management of its risk levels is reflected in its sensible leverage and liquidity ratios. Its high liquidity and low leverage levels mean it is well-positioned to meet its financial obligations in the case of any adverse and unpredictable macro events. We’ve only touched on operational risks for BOCH in this article. But as a stock investment, there are other fundamentals you need to understand. There are three key aspects you should further research:
- Future Outlook: What are well-informed industry analysts predicting for BOCH’s future growth? Take a look at our free research report of analyst consensus for BOCH’s outlook.
- Valuation: What is BOCH 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 BOCH 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.