Umpqua Holdings Corporation’s (NASDAQ:UMPQ) 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$4.58b. 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. 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 Umpqua Holdings 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 Umpqua Holdings 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.
Why Does UMPQ’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. Though banks are required to have a certain level of buffer to meet its capital requirements, Umpqua Holdings’s leverage level of less than the suitable maximum level of 20x, at 6.65x, is considered to be very cautious and prudent. With assets 6.65 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 UMPQ’s Liquidity?
Since loans are relatively illiquid, we should know how much of Umpqua Holdings’s total assets are comprised of these loans. Usually, they should not be higher than 70% of total assets, but its current level of 73.6% means the bank has lent out 3.62% 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 UMPQ 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, conversely, on the liability side, customer deposits must be paid in very short notice and on-demand. 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%, Umpqua Holdings’s ratio of over 94.0% is higher which puts the bank in a risky position as it borders 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.
Today, we’ve only explored one aspect of Umpqua Holdings. However, as a potential stock investment, there are many more fundamentals you need to consider. Below, I’ve compiled three essential factors you should further examine:
- Future Outlook: What are well-informed industry analysts predicting for UMPQ’s future growth? Take a look at our free research report of analyst consensus for UMPQ’s outlook.
- Valuation: What is UMPQ 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 UMPQ 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 email@example.com.