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As a small-cap finance stock with a market capitalisation of US$1.4b, the risk and profitability of First Commonwealth Financial Corporation (NYSE:FCF) are largely tied to the underlying economic growth of the region it operates in US. Given that banks operate by reinvesting deposits in the form of loans, negative economic growth may lower the level of saving deposits and demand for loans, directly affecting those banks’ levels of cash flows. Following the Financial Crisis in 2008, a set of reforms termed Basel III was enforced to bolster risk management, regulation, and supervision 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 First Commonwealth Financial 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. High liquidity and low leverage could position First Commonwealth Financial 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.
Is FCF’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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. First Commonwealth Financial’s leverage level of 8.03x is significantly below the appropriate ceiling of 20x. 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. 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 FCF’s Liquidity?
Since loans are relatively illiquid, we should know how much of First Commonwealth Financial’s total assets are comprised of these loans. Generally, they should make up less than 70% of total assets, but its current level of 73% means the bank has lent out 3.15% 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.
Does FCF Have Liquidity Mismatch?
A way banks make money is by lending out its deposits as loans. 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. 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%, First Commonwealth Financial’s ratio of over 97% is higher which positions the bank in a risky spot given the potential to cross into negative liquidity disparity between loan and deposit levels. Essentially, for $1 of deposits with the bank, it lends out more than $0.9 which is risky.
Keep in mind that a stock investment requires research on more than just its operational side. I’ve put together three pertinent factors you should further examine:
- Future Outlook: What are well-informed industry analysts predicting for FCF’s future growth? Take a look at our free research report of analyst consensus for FCF’s outlook.
- Valuation: What is FCF 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 FCF 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.