As a small-cap finance stock with a market capitalisation of US$100.2m, the risk and profitability of Sound Financial Bancorp Inc (NASDAQ:SFBC) are largely tied to the underlying economic growth of the region it operates in US. A bank’s cash flow is directly impacted by economic growth as it is the main driver of deposit levels and demand for loans which it profits from. 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 Sound Financial Bancorp to vulnerabilities. Unpredictable macro events such as political instability could weaken its financial position which is why it is important to understand how well the bank manages its risk levels. Sufficient liquidity and low levels of leverage could place the bank in a safe place in case of unexpected macro headwinds. Today we will be measuring Sound Financial Bancorp’s financial risk position by looking at three leverage and liquidity metrics.
Why Does SFBC’s Leverage Matter?
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. While financial companies will always have some leverage for a sufficient capital buffer, Sound Financial Bancorp’s leverage ratio of less than the suitable maximum level of 20x, at 10.02x, 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.
How Should We Measure SFBC’s Liquidity?
Due to its illiquid nature, loans are an important asset class we should learn more about. Generally, they should make up less than 70% of total assets, but its current level of 85.3% means the bank has obviously lent out 15.29% above the sensible upper limit. 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 SFBC 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 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. Compared to the appropriate industry loan to deposit level of 90%, Sound Financial Bancorp’s ratio of over 108% is higher, which positions the bank in a risky spot given the adverse liquidity disparity between loan and deposit levels. Basically, for $1 of deposits with the bank, it lends out over $1 which is imprudent.
Keep in mind that a stock investment requires research on more than just its operational side. Below, I’ve compiled three key 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.
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.