As a small-cap finance stock with a market capitalisation of USD $68.72M, the risk and profitability of Emclaire Financial Corp (NASDAQ:EMCF) 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 Emclaire Financial 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. Low levels of leverage coupled with sufficient liquidity may place Emclaire Financial 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. Check out our latest analysis for Emclaire Financial
Is EMCF’s Leverage Level Appropriate?
Banks with low leverage are better positioned to weather adverse headwinds as they have less debt to pay off. A bank’s leverage may be thought of as the level of assets it owns compared to its own shareholders’ equity. While financial companies will always have some leverage for a sufficient capital buffer, Emclaire Financial’s leverage ratio of less than the suitable maximum level of 20x, at 13x, is considered to be very cautious and prudent. This means the bank exhibits very strong leverage management and is well-positioned to repay its debtors in the case of any adverse events since it has an appropriately high level of equity relative to the debt it has taken on to remain in business. If the bank needs to increase its debt levels to firm up its capital cushion, there is plenty of headroom to do so without deteriorating its financial position.
What Is EMCF’s Level of Liquidity?
Due to its illiquid nature, loans are an important asset class we should learn more about. Normally, they should not exceed 70% of total assets, but its current level of 74.26% means the bank has lent out 4% above the sensible upper limit. This means its revenue is reliant on these specific assets which means the bank is also more likely to be exposed to default compared to its competitors with less loans.
Does EMCF Have Liquidity Mismatch?
CBA profits 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, however, customer deposits are liabilities which must be repaid 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. Compared to the appropriate industry loan to deposit level of 90%, Emclaire Financial’s ratio of over 86.75% is sensibly lower and within the safe margin, which places the bank in a relatively safe liquidity position given it has not excessively lent out its deposits and has maintained a suitable level for compliance.
Passing two of the three checks for liquidity and leverage demonstrates a relatively sensible operational risk management by the bank. This means it is well-placed to meet its financial obligations in the case of any adverse and unpredictable macro events.
Now that you know to keep in mind these liquidity factors when putting together your investment thesis, I recommend you check out our latest free analysis report on Emclaire Financial to see its growth prospects and whether it could be considered an undervalued opportunity.
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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.