Northeast Bancorp’s (NASDAQ:NBN) profitability and risk are largely affected by the underlying economic growth for the region it operates in US given it is a small-cap stock with a market capitalisation of US$176m. Since banks make money by reinvesting its customers’ deposits in the form of loans, strong economic growth will drive the level of savings deposits and demand for loans, directly impacting the cash flows of those banks. After the GFC, a set of reforms called Basel III was imposed in order to strengthen regulation, supervision and risk management 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 Northeast Bancorp 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. Strong management of leverage and liquidity could place the bank in a protected position at the face of macro headwinds. We can gauge Northeast Bancorp’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
Is NBN’s Leverage Level Appropriate?
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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Northeast Bancorp’s leverage level of less than the suitable maximum level of 20x, at 8.04x, is considered to be very cautious and prudent. With assets 8.04 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. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.
How Should We Measure NBN’s Liquidity?
Since loans are relatively illiquid, we should know how much of Northeast Bancorp’s total assets are comprised of these loans. Generally, they should make up less than 70% of total assets, however its current level of 78% means the bank has lent out 8.13% above the sensible threshold. 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 NBN Have Liquidity Mismatch?
Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. These loans tend to be 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 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%, Northeast Bancorp’s ratio of over 95% is higher, which places the bank in a relatively dangerous territory to go into negative discrepancy in liquidity. Essentially, for $1 of deposits with the bank, it lends out more than $0.9 which is risky.
Today, we’ve only explored one aspect of Northeast Bancorp. However, as a potential stock investment, there are many more fundamentals you need to consider. There are three pertinent factors you should further examine:
Future Outlook: What are well-informed industry analysts predicting for NBN’s future growth? Take a look at our free research report of analyst consensus for NBN’s outlook.
Valuation: What is NBN 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 NBN 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.