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As a large-cap stock with market capitalization of US$19b, Credicorp Ltd. (NYSE:BAP) falls into the category of a major bank. As these large financial institutions revert back to health after the 2008 Financial Crisis, we are seeing an increase in market confidence in these “too-big-to-fail” banking stocks. The 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. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like banks to vulnerabilities. Operating in USD, BAP is held to strict regulation which focus investor attention to the type and level of risk it takes on. Investors should be more cautious when it comes to financial stocks given the different type of risk to which they are exposed. Today we will analyse some bank-specific metrics and take a closer look at leverage and liquidity.
Is BAP's Leverage Level Appropriate?
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. While financial companies will always have some leverage for a sufficient capital buffer, Credicorp’s leverage ratio of 7.3x 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 increase its debt levels to firm up its capital cushion, there is plenty of headroom to do so without deteriorating its financial position.
How Should We Measure BAP's Liquidity?
As above-mentioned, loans are quite illiquid so it is important to understand how much of these loans make up the bank’s total assets. Generally, they should make up less than 70% of total assets, consistent with Credicorp’s case with a ratio of 59%. At this level of loan, the bank has preserved a sensible level between maintaining liquidity and generating interest income from the loan.
Does BAP Have Liquidity Mismatch?
Banks profit by lending out its customers’ deposits as loans and charge an interest on the principle. Loans are generally 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. Since Credicorp’s loan to deposit ratio of 101% is higher than the appropriate level of 90%, this level puts the bank in a risky position due to the negative liquidity disparity between loan and deposit levels. Basically, for $1 of deposits with the bank, it lends out over $1 which is imprudent.
The bank’s prudent management of its risk levels is reflected in its sensible leverage and liquidity ratios. This means it is well-placed to meet its financial obligations in the case of any adverse and unpredictable macro events. Keep in mind that a stock investment requires research on more than just its operational side. Below, I've compiled three relevant factors you should further research:
- Future Outlook: What are well-informed industry analysts predicting for BAP’s future growth? Take a look at our free research report of analyst consensus for BAP’s outlook.
- Valuation: What is BAP 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 BAP 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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.