As a small-cap finance stock with a market capitalisation of US$806m, the risk and profitability of Community Trust Bancorp Inc (NASDAQ:CTBI) 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. After the Financial Crisis in 2008, a set of reforms called Basel III was created with the purpose of strengthening regulation, risk management and supervision 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 Community Trust Bancorp 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. Low levels of leverage coupled with sufficient liquidity may place Community Trust Bancorp in a safe position in the face of adverse headwinds. We can measure this risk exposure by analysing three metrics for leverage and liquidity which I will take you through today.
Why Does CTBI’s Leverage Matter?
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, Community Trust Bancorp’s leverage level of 7.76x is very safe and substantially below the maximum limit 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 firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.
What Is CTBI’s Level of Liquidity?
Since loans are relatively illiquid, we should know how much of Community Trust Bancorp’s total assets are comprised of these loans. Generally, they should make up less than 70% of total assets, but its current level of 75% means the bank has lent out 4.51% 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 CTBI’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, 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 Community Trust Bancorp’s loan to deposit ratio of 95% 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.
Keep in mind that a stock investment requires research on more than just its operational side. There are three important aspects you should further examine:
- Future Outlook: What are well-informed industry analysts predicting for CTBI’s future growth? Take a look at our free research report of analyst consensus for CTBI’s outlook.
- Valuation: What is CTBI 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 CTBI 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.
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