As a small-cap bank stock with a market capitalisation of US$161m, First Financial Northwest, Inc.’s (NASDAQ:FFNW) risk and profitability are largely determined by the underlying economic growth of the US regions in which it operates. 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. Post-GFC recovery brought about a new set of reforms, Basel III, which was created to improve regulation, supervision and risk management in the financial services industry. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like First Financial Northwest 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. Strong management of leverage and liquidity could place the bank in a protected position at the face of macro headwinds. We can gauge First Financial Northwest’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
Is FFNW’s Leverage Level Appropriate?
Banks with low leverage are exposed to lower risks around their ability to repay debt. A bank’s leverage can be thought of as the amount of assets it holds compared to its own shareholders’ funds. While financial companies will always have some leverage for a sufficient capital buffer, First Financial Northwest’s leverage ratio of less than the suitable maximum level of 20x, at 7.98x, 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 firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.
What Is FFNW’s Level of Liquidity?
As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up First Financial Northwest’s total assets. Generally, they should make up less than 70% of total assets, however its current level of 81% means the bank has clearly lent out 10.62% above the sensible threshold. 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 FFNW 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, 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%, First Financial Northwest’s ratio of over 109% is higher, which puts the bank in a risky position due to the negative liquidity disparity between loan and deposit levels. Basically, for $1 of deposits with the bank, it lends out over $1 which is imprudent.
Today, we’ve only explored one aspect of First Financial Northwest. However, as a potential stock investment, there are many more fundamentals you need to consider. There are three important factors you should look at:
- Future Outlook: What are well-informed industry analysts predicting for FFNW’s future growth? Take a look at our free research report of analyst consensus for FFNW’s outlook.
- Valuation: What is FFNW 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 FFNW 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.