As a small-cap finance stock with a market capitalisation of US$85m, the risk and profitability of Emclaire Financial Corp. (NASDAQ:EMCF) are largely tied to the underlying economic growth of the region it operates in US. Since banks make money by reinvesting its customers’ deposits in the form of loans, strong economic growth will drive the level of savings deposits and demand for loans, directly impacting the cash flows of those banks. 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. These reforms target bank level regulation and aims to improve the banking sector’s ability to absorb shocks arising from economic stress which could expose financial institutions to vulnerabilities. Since its financial standing can unexpectedly decline in the case of an adverse macro event such as political instability, it is important to understand how prudent the bank is at managing its risk levels. High liquidity and low leverage could position Emclaire 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.
Why Does EMCF’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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Emclaire Financial’s leverage level of less than the suitable maximum level of 20x, at 11.25x, is considered to be very cautious and prudent. With assets 11.25 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 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 EMCF’s Liquidity?
As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up Emclaire Financial’s total assets. Generally, they should make up less than 70% of total assets, but its current level of 79% means the bank has lent out 8.85% 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 defaulting relative to banks with less loans.
What is EMCF’s Liquidity Discrepancy?
Banks profit 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, 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. Relative to the prudent industry loan to deposit level of 90%, Emclaire Financial’s ratio of over 93% is higher, which places the bank in a relatively dangerous territory to go into negative discrepancy in liquidity. 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 key factors you should further research:
Future Outlook: What are well-informed industry analysts predicting for EMCF’s future growth? Take a look at our free research report of analyst consensus for EMCF’s outlook.
Valuation: What is EMCF 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 EMCF 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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