As a small-cap finance stock with a market capitalisation of US$1.1b, the risk and profitability of Lakeland Financial Corporation (NASDAQ:LKFN) 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. 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. 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 Lakeland Financial 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 Lakeland Financial’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
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Why Does LKFN’s Leverage Matter?
A low level of leverage subjects a bank to less risk and enhances its ability to pay back its debtors. Leverage can be thought of as the amount of assets a bank owns relative to its shareholders’ funds. While financial companies will always have some leverage for a sufficient capital buffer, Lakeland Financial’s leverage ratio of 9.34x is significantly below the appropriate ceiling of 20x. 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 LKFN’s Level of Liquidity?
Due to its illiquid nature, loans are an important asset class we should learn more about. Usually, they should not be higher than 70% of total assets, however its current level of 79% means the bank has lent out 9.3% above the sensible threshold. This indicates that revenue is dependent on this particular asset but also the bank is more exposed to defaulting relative to banks with less loans.
Does LKFN Have Liquidity Mismatch?
Banks profit 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, however, customer deposits are liabilities which must be repaid 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. Since Lakeland Financial’s loan to deposit ratio of 96% is higher than the appropriate level of 90%, this level positions the bank in a risky spot given the potential to cross into 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.
We’ve only touched on operational risks for LKFN in this article. But as a stock investment, there are other fundamentals you need to understand. Below, I’ve compiled three essential aspects you should look at:
- Future Outlook: What are well-informed industry analysts predicting for LKFN’s future growth? Take a look at our free research report of analyst consensus for LKFN’s outlook.
- Valuation: What is LKFN 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 LKFN 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.