As a small-cap finance stock with a market capitalisation of US$1.6b, the risk and profitability of Heartland Financial USA, Inc. (NASDAQ:HTLF) 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. 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 Heartland Financial USA 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 Heartland Financial USA’s financial risk position by looking at three leverage and liquidity metrics.
Is HTLF's Leverage Level Appropriate?
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, Heartland Financial USA’s leverage ratio of 8.61x is significantly below the appropriate ceiling 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 HTLF's Level of Liquidity?
As I alluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up the bank’s total asset. Normally, they should not exceed 70% of total assets, consistent with Heartland Financial USA’s case with a ratio of 64%. This is a reasonable ratio and suggests that slightly over half of the bank’s total assets are tied up in the form of illiquid loans, striking an appropriate balance between liquidity and interest income.
Does HTLF 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. 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%, Heartland Financial USA’s ratio of over 78%is appropriately lower, which positions the bank cautiously in terms of liquidity as it has not disproportionately lent out its deposits and has retained an apt level of deposits.
Heartland Financial USA ticks all the boxes for operational prudency in terms of liquidity and leverage. Investors often sideline these factors compared to other fundamentals, but they are equally important to consider as part of the investment thesis. High liquidity and low leverage places the bank in an ideal position to repay financial liabilities in case of adverse headwinds. We've only touched on operational risks for HTLF in this article. But as a stock investment, there are other fundamentals you need to understand. I've put together three essential aspects you should further examine:
- Future Outlook: What are well-informed industry analysts predicting for HTLF’s future growth? Take a look at our free research report of analyst consensus for HTLF’s outlook.
- Valuation: What is HTLF 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 HTLF 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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