As a small-cap finance stock with a market capitalisation of HK$13b, the risk and profitability of Chong Hing Bank Limited (HKG:1111) are largely tied to the underlying economic growth of the region it operates in HK. Since a bank profits from reinvesting its clients’ deposits in the form of loans, negative economic growth may lower deposit levels and demand for loan, adversely impacting its cash flow. 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. Its financial position may weaken in an adverse macro event such as political instability which is why it is crucial to understand how well the bank manages its risks. Strong management of leverage and liquidity could place the bank in a protected position at the face of macro headwinds. We can gauge Chong Hing Bank’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.

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Is 1111’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. Though banks are required to have a certain level of buffer to meet its capital requirements, Chong Hing Bank’s leverage level of 8.93x is very safe and substantially below the maximum limit 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. 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.

What Is 1111’s Level of Liquidity?

Since loans are relatively illiquid, we should know how much of the bank’s total assets are comprised of these loans. Generally, they should make up less than 70% of total assets, which is consistent with Chong Hing Bank’s state given its ratio of 64%. At this level of loan, the bank has preserved a sensible level between maintaining liquidity and generating interest income from the loan.

Does 1111 Have Liquidity Mismatch?

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, 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 Chong Hing Bank’s loan to deposit ratio of 81% is within the sensible margin, below than the appropriate maximum of 90%, this level places the bank in a relatively safe liquidity position given it has not excessively lent out its deposits and has maintained a suitable level for compliance.