As a small-cap finance stock with a market capitalisation of US$292m, the risk and profitability of The First Bancorp, Inc. (NASDAQ:FNLC) are largely tied to the underlying economic growth of the region it operates in US. Given that banks operate by reinvesting deposits in the form of loans, negative economic growth may lower the level of saving deposits and demand for loans, directly affecting those banks’ levels of cash flows. 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. Its financial position may weaken in an adverse macro event such as political instability which is why it is crucial to understand how well the bank manages its risks. High liquidity and low leverage could position First 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.
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Why Does FNLC’s Leverage Matter?
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. Though banks are required to have a certain level of buffer to meet its capital requirements, First Bancorp’s leverage level of 10.73x is significantly below the appropriate ceiling of 20x. 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. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.
What Is FNLC’s Level of Liquidity?
Since loans are relatively illiquid, we should know how much of the bank’s total assets are comprised of these loans. Usually, they should not be higher than 70% of total assets, which is consistent with First Bancorp’s state given its ratio of 62%. This means slightly over half of the bank’s total assets are tied up in the form of illiquid loans, leading to a sensible balance between interest income and liquidity.
What is FNLC’s Liquidity Discrepancy?
FNLC profits by lending out its customers’ deposits as loans and charge an interest on the principle. 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 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. Relative to the prudent industry loan to deposit level of 90%, First Bancorp’s ratio of over 81%is appropriately lower, which positions the bank cautiously in terms of liquidity as it has not disproportionately lent out its deposits and has retained an apt level of deposits.
First Bancorp ticks all the boxes for operational prudency in terms of liquidity and leverage. These factors often sideline next to other fundamentals but are equally important to consider as part of the investment thesis. High liquidity and low leverage places the bank in an ideal position to repay financial liabilities in case of adverse headwinds. Today, we’ve only explored one aspect of First Bancorp. However, as a potential stock investment, there are many more fundamentals you need to consider. I’ve put together three key factors you should further research:
- Future Outlook: What are well-informed industry analysts predicting for FNLC’s future growth? Take a look at our free research report of analyst consensus for FNLC’s outlook.
- Valuation: What is FNLC 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 FNLC 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 email@example.com.