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As a small-cap bank stock with a market capitalisation of US$192m, Orrstown Financial Services Inc’s (NASDAQ:ORRF) risk and profitability are largely determined by the underlying economic growth of the US regions in which it operates. 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 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. These reforms target banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks like Orrstown Financial Services 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 Orrstown Financial Services’s financial risk position by looking at three leverage and liquidity metrics.
Is ORRF’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. While financial companies will always have some leverage for a sufficient capital buffer, Orrstown Financial Services’s leverage ratio of 11.82x is significantly below the appropriate ceiling of 20x. With assets 11.82 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. 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 ORRF’s Level of Liquidity?
Since loans are relatively illiquid, we should know how much of the bank’s total assets are comprised of these loans. Usually, they should not be higher than 70% of total assets, consistent with Orrstown Financial Services’s case with a ratio of 62%. This means slightly over half of the bank’s total assets are tied up in the form of illiquid loans, leading to a sensible balance between interest income and liquidity.
Does ORRF Have Liquidity Mismatch?
ORRF profits by lending out its customers’ deposits as loans and charge an interest on the principle. These loans may be fixed term and often cannot be readily realized, conversely, on the liability side, customer deposits must be paid in very short notice and on-demand. 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. Relative to the prudent industry loan to deposit level of 90%, Orrstown Financial Services’s ratio of over 75%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.
Orrstown Financial Services passes all of our liquidity and leverage checks which shows it is prudent in managing those factors. This gives us confidence in the operational side of the business, an important aspect to consider before investing in the stock. High liquidity and low leverage places the bank in an ideal position to repay financial liabilities in case of adverse headwinds. Keep in mind that a stock investment requires research on more than just its operational side. I’ve put together three essential aspects you should further research:
Future Outlook: What are well-informed industry analysts predicting for ORRF’s future growth? Take a look at our free research report of analyst consensus for ORRF’s outlook.
Valuation: What is ORRF 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 ORRF 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.