As a small-cap bank stock with a market capitalisation of USD $182.27M, The Community Financial Corporation’s (NASDAQ:TCFC) 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. 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. 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. High liquidity and low leverage could position Community Financial 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. See our latest analysis for Community Financial
Is TCFC’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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Community Financial’s leverage level of 13x is significantly below the appropriate ceiling of 20x. With assets 13 times equity, the banks has maintained a prudent level of its own fund relative to borrowed fund which places it in a strong position to pay back its debt in times of adverse events. 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 TCFC’s Level of Liquidity?
Since loans are relatively illiquid, we should know how much of Community Financial’s total assets are comprised of these loans. Usually, they should not be higher than 70% of total assets, but its current level of 81.02% means the bank has obviously lent out 11% above the sensible upper limit. This level implies dependency on this particular asset class as a source of revenue which makes the bank more exposed to defaulting relative to banks with less loans.
Does TCFC Have Liquidity Mismatch?
Banks profit 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, yet customer deposits on the liability side must be paid 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. Compared to the appropriate industry loan to deposit level of 90%, Community Financial’s ratio of over 103.46% is higher, which positions the bank in a risky spot given the adverse liquidity disparity between loan and deposit levels. Essentially, for USD 1 of deposits with the bank, it lends out more than USD 1 which is unsustainable.
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 Community Financial to see its growth prospects and whether it could be considered an undervalued opportunity.
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The author is an independent contributor and at the time of publication had no position in the stocks mentioned.