Canadian Western Bank’s (TSE:CWB) profitability and risk are largely affected by the underlying economic growth for the region it operates in CA given it is a small-cap stock with a market capitalisation of CA$2.5b. Since banks make money by reinvesting its customers’ deposits in the form of loans, strong economic growth will drive the level of savings deposits and demand for loans, directly impacting the cash flows of those banks. Following the Financial Crisis in 2008, a set of reforms termed Basel III was enforced to bolster risk management, regulation, and supervision in the financial services industry. 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. Strong management of leverage and liquidity could place the bank in a protected position at the face of macro headwinds. We can gauge Canadian Western Bank’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
Why Does CWB'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. While financial companies will always have some leverage for a sufficient capital buffer, Canadian Western Bank’s leverage ratio of less than the suitable maximum level of 20x, at 10.55x, 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 CWB's Level of Liquidity?
As I alluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up Canadian Western Bank’s total asset. Generally, they should make up less than 70% of total assets, but its current level of 91% means the bank has obviously lent out 21.25% above the sensible upper limit. This indicates that revenue is dependent on this particular asset but also the bank is more exposed to default compared to banks with less loans.
What is CWB's Liquidity Discrepancy?
Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. These loans may be fixed term and often 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. Relative to the prudent industry loan to deposit level of 90%, Canadian Western Bank’s ratio of over 112% is higher, which places the bank in a relatively dangerous position given the negative liquidity discrepancy. Basically, for CA$1 of deposits with the bank, it lends out over CA$1 which is imprudent.
Today, we've only explored one aspect of Canadian Western Bank. However, as a potential stock investment, there are many more fundamentals you need to consider. I've put together three relevant factors you should further examine:
- Future Outlook: What are well-informed industry analysts predicting for CWB’s future growth? Take a look at our free research report of analyst consensus for CWB’s outlook.
- Valuation: What is CWB 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 CWB 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.