As a small-cap finance stock with a market capitalisation of US$1.5b, the risk and profitability of Westamerica Bancorporation (NASDAQ:WABC) 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. Since its financial standing can unexpectedly decline in the case of an adverse macro event such as political instability, it is important to understand how prudent the bank is at managing its risk levels. 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 Westamerica Bancorporation’s financial risk position by looking at three leverage and liquidity metrics.
Why Does WABC’s Leverage Matter?
Banks with low leverage are exposed to lower risks around their 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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Westamerica Bancorporation’s leverage level of 9.33x is significantly below the appropriate ceiling of 20x. This means the bank has a sensibly high level of equity compared to the level of debt it has taken on to maintain operations which places it in a strong position to pay back its debt in unforeseen circumstances. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.
What Is WABC’s Level of Liquidity?
As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up the bank’s total assets. Normally, they should not exceed 70% of total assets, however, this should not be a concern for Westamerica Bancorporation given its substantially lower ratio of below 30%. This means less than a third of the bank’s total assets are tied up in the form of illiquid loans, leading to extremely high liquidity, imaginably at the expense of generating interest income.
What is WABC’s Liquidity Discrepancy?
WABC profits 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. 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. Since Westamerica Bancorporation’s loan to deposit ratio of 24% is extremely below than the appropriate maximum of 90%, this means the bank is lending out less than half its total deposits and places the bank in an extremely safe liquidity position given it has not lent out the majority of its deposits and has maintained a high level of deposits. There is opportunity for the bank to increase its interest income by lending out more loans.
Westamerica Bancorporation ticks all the boxes for operational prudency in terms of liquidity and leverage. These factors often sideline next to other fundamentals but are equally important to consider as part of the investment thesis. The bank’s favourable liquidity and leverage position exposes it to less risk when it comes to repaying financial obligations, in particular, in the case of an adverse macro event. Keep in mind that a stock investment requires research on more than just its operational side. Below, I’ve compiled three pertinent aspects you should further research:
- Future Outlook: What are well-informed industry analysts predicting for WABC’s future growth? Take a look at our free research report of analyst consensus for WABC’s outlook.
- Valuation: What is WABC 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 WABC 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.
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