As a small-cap bank stock with a market capitalisation of US$2.0b, TowneBank’s (NASDAQ:TOWN) risk and profitability are largely determined by the underlying economic growth of the US regions in which it operates. 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. The Basel III reforms are aimed at banking regulations to improve financial institutions’ ability to absorb shocks caused by economic stress which could expose banks like TowneBank 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. Strong management of leverage and liquidity could place the bank in a protected position at the face of macro headwinds. We can gauge TowneBank’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
Is TOWN’s Leverage Level Appropriate?
A low level of leverage subjects a bank to less risk and enhances its ability to pay back its debtors. Leverage can be thought of as the amount of assets a bank owns relative to its shareholders’ funds. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. TowneBank’s leverage level of less than the suitable maximum level of 20x, at 7.42x, is considered to be very cautious and prudent. 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. If the bank needs to increase its debt levels to firm up its capital cushion, there is plenty of headroom to do so without deteriorating its financial position.
How Should We Measure TOWN’s Liquidity?
Since loans are relatively illiquid, we should know how much of TowneBank’s total assets are comprised of these loans. Usually, they should not be higher than 70% of total assets, however its current level of 70% means the bank has lent out 0.42% above the sensible threshold. 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.
What is TOWN’s Liquidity Discrepancy?
A way banks make money is by lending out its deposits as loans. Loans are generally fixed term which means they cannot be readily realized, yet customer deposits on the liability side must be paid on-demand and in short notice. The discrepancy between loan assets and deposit liabilities threatens the bank’s financial position. If an adverse event occurs, it may not be well-placed to repay its depositors immediately. Relative to the prudent industry loan to deposit level of 90%, TowneBank’s ratio of over 94% is higher, which puts the bank in a risky position as it borders 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. Below, I’ve compiled three key factors you should further examine:
- Future Outlook: What are well-informed industry analysts predicting for TOWN’s future growth? Take a look at our free research report of analyst consensus for TOWN’s outlook.
- Valuation: What is TOWN 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 TOWN 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.
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