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As a small-cap bank stock with a market capitalisation of AU$4.0b, Bank of Queensland Limited’s (ASX:BOQ) risk and profitability are largely determined by the underlying economic growth of the AU regions in which it operates. 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. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like Bank of Queensland to vulnerabilities. Unpredictable macro events such as political instability could weaken its financial position which is why it is important to understand how well the bank manages its risk levels. Low levels of leverage coupled with sufficient liquidity may place Bank of Queensland 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.
Is BOQ’s Leverage Level Appropriate?
A low level of leverage subjects a bank to less risk and enhances its ability to pay back its debtors. Leverage can be thought of as the amount of assets a bank owns relative to its shareholders’ funds. While financial companies will always have some leverage for a sufficient capital buffer, Bank of Queensland’s leverage ratio of less than the suitable maximum level of 20x, at 13.74x, is considered to be very cautious and prudent. With assets 13.74 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. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.
How Should We Measure BOQ’s Liquidity?
As I eluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up Bank of Queensland’s total asset. Usually, they should not be higher than 70% of total assets, but its current level of 85% means the bank has obviously lent out 15.08% above the sensible upper limit. This level implies dependency on this particular asset class as a source of revenue which makes the bank more exposed to default compared to banks with less loans.
What is BOQ’s Liquidity Discrepancy?
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, 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%, Bank of Queensland’s ratio of over 119% is higher, which positions the bank in a risky spot given the adverse liquidity disparity between loan and deposit levels. Essentially, for A$1 of deposits with the bank, it lends out more than A$1 which is unsustainable.
Today, we’ve only explored one aspect of Bank of Queensland. However, as a potential stock investment, there are many more fundamentals you need to consider. I’ve put together three pertinent aspects you should further research:
- Future Outlook: What are well-informed industry analysts predicting for BOQ’s future growth? Take a look at our free research report of analyst consensus for BOQ’s outlook.
- Valuation: What is BOQ 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 BOQ 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.