As a small-cap finance stock with a market capitalisation of USD $333.20M, the risk and profitability of Summit Financial Group Inc (NASDAQ:SMMF) 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. 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. The Basel III reforms are aimed at banking regulations to improve financial institutions’ ability to absorb shocks caused by economic stress which could expose banks like Summit Financial Group 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 Summit Financial Group 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. View our latest analysis for Summit Financial Group
Is SMMF’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. Summit Financial Group’s leverage level of 11x is significantly below the appropriate ceiling 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.
What Is SMMF’s Level of 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, however its current level of 74.21% means the bank has lent out 4% above the sensible threshold. This indicates that revenue is dependent on this particular asset but also the bank is more exposed to defaulting relative to banks with less loans.
Does SMMF Have Liquidity Mismatch?
A way banks make money is by lending out its deposits as loans. 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 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 Summit Financial Group’s loan to deposit ratio of 96.45% is higher than the appropriate level of 90%, this level positions the bank in a risky spot given the potential to cross into negative liquidity disparity between loan and deposit levels. Basically, for USD 1 of deposits with the bank, it lends out over USD 0.9 which is imprudent.
We’ve only touched on operational risks for SMMF in this article. But as a stock investment, there are other fundamentals you need to understand. Below, I’ve compiled three key aspects you should further examine:
- 1. Future Outlook: What are well-informed industry analysts predicting for SMMF’s future growth? Take a look at our free research report of analyst consensus for SMMF’s outlook.
- 2. Valuation: What is SMMF 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 SMMF is currently mispriced by the market.
- 3. 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.