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As a small-cap bank stock with a market capitalisation of US$85m, Sound Financial Bancorp, Inc.’s (NASDAQ:SFBC) risk and profitability are largely determined by the underlying economic growth of the US regions in which it operates. 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. 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. These reforms target banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks like Sound Financial 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 Sound Financial Bancorp’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
Is SFBC'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. Though banks are required to have a certain level of buffer to meet its capital requirements, Sound Financial Bancorp’s leverage level of less than the suitable maximum level of 20x, at 10.01x, is considered to be very cautious and prudent. 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 firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.
How Should We Measure SFBC's Liquidity?
Since loans are relatively illiquid, we should know how much of Sound Financial Bancorp’s total assets are comprised of these loans. Normally, they should not exceed 70% of total assets, but its current level of 86% means the bank has obviously lent out 15.63% 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 default compared to banks with less loans.
What is SFBC's Liquidity Discrepancy?
Banks profit by lending out its customers’ deposits as loans and charge an interest on the principle. Loans are generally 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. Relative to the prudent industry loan to deposit level of 90%, Sound Financial Bancorp’s ratio of over 111% 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.
We've only touched on operational risks for SFBC in this article. But as a stock investment, there are other fundamentals you need to understand. Below, I've compiled three important aspects you should look at:
- Future Outlook: What are well-informed industry analysts predicting for SFBC’s future growth? Take a look at our free research report of analyst consensus for SFBC’s outlook.
- Valuation: What is SFBC 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 SFBC 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.