Oversea-Chinese Banking Corp Limited (SGX: O39) is one of Southeast Asia’s largest banks with total assets of nearly S$400 billion at the moment. It is also one of the largest stocks in Singapore’s market with its market capitalisation of S$35.9 billion. Given these traits, it’s likely that OCBC is a well-known bank and company amongst investors. But, just how risky might the bank be? An analysis of banking stocks is a hairy operation and there are many (emphasis on the word) variables to look at. But, some big picture ratios can still give us a rough gauge of how much…
Oversea-Chinese Banking Corp Limited (SGX: O39) is one of Southeast Asia’s largest banks with total assets of nearly S$400 billion at the moment. It is also one of the largest stocks in Singapore’s market with its market capitalisation of S$35.9 billion.
Given these traits, it’s likely that OCBC is a well-known bank and company amongst investors. But, just how risky might the bank be?
An analysis of banking stocks is a hairy operation and there are many (emphasis on the word) variables to look at. But, some big picture ratios can still give us a rough gauge of how much risk investors might be taking with a bank stock. These ratios are the leverage ratio, the loans-to-deposits ratio, the efficiency ratio, and the price-to-book ratio.
The leverage ratio
The leverage ratio is simply a bank’s total assets divided by its shareholders’ equity. In this area, the lower it is, the better. Here’s how the math works. A bank with a leverage ratio of 20 would see its equity wiped out if its assets decline in value by 5%. But, a bank with a leverage ratio of just 10 can see its assets fall by up to 10% before it becomes insolvent (or bankrupt).
In OCBC’s case, its current financials (for the second-quarter of 2016) show that it has S$395.7 billion of assets and shareholder’s equity of S$35.78 billion. This gives rise to a leverage ratio of 11. Here’s how the bank’s leverage ratio has changed since 2007:
Source: S&P Global Market Intelligence
A starting point of 2007 was chosen because that was the year before the Great Financial Crisis really blew up (in 2008). OCBC had performed admirably during the crisis. Its net profit in 2009 was only 8% lower than in 2007. As the crisis erupted, many Western banks collapsed or were teetering on the edge of failure.
So, a look at how OCBC’s leverage ratio had evolved over time can give me clues on whether the bank’s risk profile has changed – if the ratio has not changed much since the days of the financial crisis, I would think that the bank’s riskiness has not been greatly altered since those terrifying times for the global economy. This applies to the loan-to-deposit ratio and efficiency ratio too.
As the table above shows, OCBC’s leverage ratio has not changed much from 2007 to day.
The loans-to-deposits ratio
Whereas the leverage ratio gives us an idea of the solvency risks for a bank, the loans-to-deposits ratio paints a picture of the liquidity risks sitting in a bank. Again, the lower the ratio is, the better it could be.
A bank’s basic business model is this: It borrows money (mainly by taking in deposits) and lends that capital out to businesses or individuals. But, this gives rise to liquidity risks. Here’s how professors Charles Calomiris and Stephen Haber describe it in their book, Fragile By Design:
“[It] is extraordinarily difficult, if not impossible, for bankers to exactly match the durations of their contracts with depositors and debtors. Bank deposits can typically be withdrawn on very short notice, but the loans financed by those deposits may extend for months, years, or even decades.
In fact, bankers face the risk that, even if their banks are not insolvent, worried depositors might show up en masse to withdraw their money, and there might not be enough cash in the till to satisfy all those withdrawal demands.”
As of the second-quarter of 2016, OCBC’s loans-to-deposits ratio is at 82.2%. The following table illustrates how the ratio has looked like since 2007:
Source: OCBC’s earnings releases
We can see that OCBC’s loans-to-deposits ratio has not changed much in the past few years and from the financial crisis era.
The efficiency ratio
This ratio measures a bank’s non-interest expenses as a percentage of its revenue. In OCBC’s financial statements, it is reported as the cost to income ratio. As with the previous two ratios, what we’re looking for is a low efficiency ratio.
The importance of the efficiency ratio is the insight it can give investors on how much risk a bank is more or less forced to take. Banking is a very competitive business. A bank with looser cost controls would find it hard to compete with more efficient peers. To make up for this deficiency, less-efficient banks would have to engage in riskier banking activity to make money.
OCBC reported a cost to income ratio of 45.5% in the second-quarter of 2016. You can see in the table below how this ratio has increased since 2007:
Source: OCBC’s annual reports
The bank has appeared to be a little less efficient than before and investors might want to keep a close watch on OCBC’s cost controls.
The price-to-book ratio
Lastly, we have the price-to-book ratio. This ratio tells us nothing much about a bank’s business performance, unlike the previous three ratios. Instead, it’s a valuation metric that tells investors how much they are paying per dollar of a bank’s net assets (where net assets equals to assets minus liabilities). In here, it’s again the lower, the better.
If an investor buys a bank with a high price-to-book ratio, he would lower his odds of success. At OCBC’s current share price of S$8.60, it has a price-to-book ratio of 1.05 with its latest book value per share of S$8.19.
You can see how the bank’s valuation has changed over the past five years:
Source: S&P Global Market Intelligence
The key takeaway with this metric is that OCBC’s current valuation is actually near a five-year low and this helps lower the risks for investors.
A Foolish summary
So, to wrap it all up, OCBC’s risk profile in terms of its business has not changed much since 2007. Meanwhile, the bank’s valuation is currently near the lowest it has been in the past five years.
Given all these, I would think that OCBC is not a particularly risky stock for investors. But, this does not mean that OCBC would go on to be a great investment. Besides, as I had already mentioned, there are plenty of other factors to investigate when it comes to a bank.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing does not own shares in any companies mentioned.