Why These Fundamentals Make PacWest Bancorp’s (NASDAQ:PACW) More Attractive
As a small-cap finance stock with a market capitalisation of US$6.71B, the risk and profitability of PacWest Bancorp (NASDAQ:PACW) are largely tied to the underlying economic growth of the region it operates in US. A bank’s cash flow is directly impacted by economic growth as it is the main driver of deposit levels and demand for loans which it profits from. After the GFC, a set of reforms called Basel III was imposed in order to strengthen regulation, supervision and risk management 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. 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. High liquidity and low leverage could position PacWest Bancorp favourably at the face of macro headwinds. A way to measure this risk is to look at three leverage and liquidity metrics which I will take you through today. See our latest analysis for PacWest Bancorp
Is PACW’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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. PacWest Bancorp’s leverage level of less than the suitable maximum limit of 20x, at less than 5x, is exceptionally low. At this ratio, PacWest Bancorp’s assets are only less than 5 times bigger than its equity which is extremely safe. This means it is not currently reliant on a high level of debt to run its operations. If the bank needs to firm up its capital cushion, it can significantly increase its debt level without deteriorating its financial position.
How Should We Measure PACW’s Liquidity?
As I eluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up the bank’s total asset. Generally, they should make up less than 70% of total assets, which is the case for PacWest Bancorp’s ratio at 67.58%. This is a reasonable ratio and suggests that slightly over half of the bank’s total assets are tied up in the form of illiquid loans, striking an appropriate balance between liquidity and interest income.
Does PACW Have Liquidity Mismatch?
A way banks make money is by lending out its deposits as loans. 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. The disparity between the immediacy of deposits compared to the illiquid nature of loans puts pressure on the bank’s financial position if an adverse event requires the bank to repay its depositors. Relative to the prudent industry loan to deposit level of 90%, PacWest Bancorp’s ratio of over 90.28% is higher, which positions the bank in a risky spot given the potential to cross into negative liquidity disparity between loan and deposit levels. Essentially, for $1 of deposits with the bank, it lends out more than $ 0.9 which is risky.
Next Steps:
Passing two of the three checks for liquidity and leverage demonstrates a relatively sensible operational risk management by the bank. This means it is well-placed to meet its financial obligations in the case of any adverse and unpredictable macro events. We’ve only touched on operational risks for PACW in this article. But as a stock investment, there are other fundamentals you need to understand. I’ve put together three pertinent factors you should look at:
Future Outlook: What are well-informed industry analysts predicting for PACW’s future growth? Take a look at our free research report of analyst consensus for PACW’s outlook.
Valuation: What is PACW 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 PACW 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 pass 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.
