As a small-cap bank stock with a market capitalisation of US$153m, 1st Constitution Bancorp’s (NASDAQ:FCCY) risk and profitability are largely determined by the underlying economic growth of the US regions in which it operates. 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. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like 1st Constitution Bancorp 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. Low levels of leverage coupled with sufficient liquidity may place 1st Constitution Bancorp in a safe position in the face of adverse headwinds. We can measure this risk exposure by analysing three metrics for leverage and liquidity which I will take you through today.
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Why Does FCCY’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. Though banks are required to have a certain level of buffer to meet its capital requirements, 1st Constitution Bancorp’s leverage level of less than the suitable maximum level of 20x, at 9.27x, is considered to be very cautious and prudent. With assets 9.27 times equity, the banks has maintained a prudent level of its own fund relative to borrowed fund which places it in a strong position to pay back its debt in times of adverse events. 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 FCCY’s Level of Liquidity?
As I eluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up 1st Constitution Bancorp’s total asset. Generally, they should make up less than 70% of total assets, but its current level of 74% means the bank has lent out 4.27% 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 FCCY’s Liquidity Discrepancy?
Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. Loans are generally fixed term which means they cannot be readily realized, yet customer deposits on the liability side must be paid on-demand and in short notice. 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 1st Constitution Bancorp’s loan to deposit ratio of 92% is higher than the appropriate level of 90%, this level places the bank in a relatively dangerous territory to go into negative discrepancy in liquidity. Essentially, for $1 of deposits with the bank, it lends out more than $0.9 which is risky.
Today, we’ve only explored one aspect of 1st Constitution Bancorp. However, as a potential stock investment, there are many more fundamentals you need to consider. Below, I’ve compiled three pertinent factors you should look at:
- Future Outlook: What are well-informed industry analysts predicting for FCCY’s future growth? Take a look at our free research report of analyst consensus for FCCY’s outlook.
- Valuation: What is FCCY 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 FCCY 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.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.