As a small-cap finance stock with a market capitalisation of US$49m, the risk and profitability of Village Bank and Trust Financial Corp (NASDAQ:VBFC) are largely tied to the underlying economic growth of the region it operates in US. Since banks make money by reinvesting its customers’ deposits in the form of loans, strong economic growth will drive the level of savings deposits and demand for loans, directly impacting the cash flows of those banks. 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. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like Village Bank and Trust Financial 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. Sufficient liquidity and low levels of leverage could place the bank in a safe place in case of unexpected macro headwinds. Today we will be measuring Village Bank and Trust Financial’s financial risk position by looking at three leverage and liquidity metrics.
Is VBFC’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. While financial companies will always have some leverage for a sufficient capital buffer, Village Bank and Trust Financial’s leverage ratio of 14.55x 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. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.
What Is VBFC’s Level of Liquidity?
As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up Village Bank and Trust Financial’s total assets. Usually, they should not be higher than 70% of total assets, but its current level of 79% means the bank has lent out 9.18% 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 VBFC Have Liquidity Mismatch?
A way banks make money is by lending out its deposits as loans. These loans may be fixed term and often cannot be readily realized, however, customer deposits are liabilities which must be repaid on-demand and in short notice. 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 Village Bank and Trust Financial’s loan to deposit ratio of 93% 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. Basically, for $1 of deposits with the bank, it lends out over $0.9 which is imprudent.
We’ve only touched on operational risks for VBFC in this article. But as a stock investment, there are other fundamentals you need to understand. There are three relevant aspects you should look at:
- Future Outlook: What are well-informed industry analysts predicting for VBFC’s future growth? Take a look at our free research report of analyst consensus for VBFC’s outlook.
- Valuation: What is VBFC 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 VBFC 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.
To help readers see past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.