As a small-cap finance stock with a market capitalisation of US$154.53M, the risk and profitability of DNB Financial Corporation (NASDAQ:DNBF) are largely tied to the underlying economic growth of the region it operates in US. A bank’s cash flow is directly impacted by economic growth as it is the main driver of deposit levels and demand for loans which it profits from. 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 DNB 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 DNB 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 DNB Financial
Is DNBF’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, DNB Financial’s leverage ratio of less than the suitable maximum level of 20x, at 11x, is considered to be very cautious and prudent. 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 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 DNBF’s Level of Liquidity?
As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up DNB Financial’s total assets. Generally, they should make up less than 70% of total assets, but its current level of 77.65% means the bank has lent out 8% 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 DNBF Have Liquidity Mismatch?
Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. These loans may be fixed term and often 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 DNB Financial’s loan to deposit ratio of 97.54% is higher than the appropriate level of 90%, this level puts the bank in a risky position as it borders negative liquidity disparity between loan and deposit levels. Basically, for $1 of deposits with the bank, it lends out over $ 0.9 which is imprudent.
Keep in mind that a stock investment requires research on more than just its operational side. I’ve put together three important factors you should further examine:
- Future Outlook: What are well-informed industry analysts predicting for DNBF’s future growth? Take a look at our free research report of analyst consensus for DNBF’s outlook.
- Valuation: What is DNBF 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 DNBF 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 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.