Should You Be Concerned About Melrose Bancorp, Inc.’s (NASDAQ:MELR) Liquidity?
As a small-cap finance stock with a market capitalisation of US$45m, the risk and profitability of Melrose Bancorp, Inc. (NASDAQ:MELR) are largely tied to the underlying economic growth of the region it operates in US. 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. 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. High liquidity and low leverage could position Melrose 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 Melrose Bancorp
Why Does MELR’s Leverage Matter?
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. Melrose Bancorp’s leverage level of 7.16x 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 firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.
How Should We Measure MELR’s Liquidity?
Due to its illiquid nature, loans are an important asset class we should learn more about. Generally, they should make up less than 70% of total assets, but its current level of 83% means the bank has obviously lent out 12.82% above the sensible upper limit. This means its revenue is reliant on these specific assets which means the bank is also more exposed to defaulting relative to banks with less loans.
Does MELR Have Liquidity Mismatch?
Banks profit by lending out its customers’ deposits as loans and charge an interest on the principle. These loans tend to be 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 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. Since Melrose Bancorp’s loan to deposit ratio of 110% is higher than the appropriate level of 90%, this level places the bank in a relatively dangerous position given the negative liquidity discrepancy. Essentially, for $1 of deposits with the bank, it lends out more than $1 which is unsustainable.
Next Steps:
Today, we’ve only explored one aspect of Melrose Bancorp. However, as a potential stock investment, there are many more fundamentals you need to consider. There are three relevant aspects you should look at:
Future Outlook: What are well-informed industry analysts predicting for MELR’s future growth? Take a look at our free research report of analyst consensus for MELR’s outlook.
Valuation: What is MELR 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 MELR 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 editorial-team@simplywallst.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.
