Summit Financial Group, Inc.’s (NASDAQ:SMMF) profitability and risk are largely affected by the underlying economic growth for the region it operates in US given it is a small-cap stock with a market capitalisation of US$251m. 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 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. Low levels of leverage coupled with sufficient liquidity may place Summit Financial Group in a safe position in the face of adverse headwinds. We can measure this risk exposure by analysing three metrics for leverage and liquidity which I will take you through today.
Is SMMF’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, Summit Financial Group’s leverage ratio of less than the suitable maximum level of 20x, at 10.01x, is considered to be very cautious and prudent. 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. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.
What Is SMMF’s Level of Liquidity?
Since loans are relatively illiquid, we should know how much of Summit Financial Group’s total assets are comprised of these loans. Generally, they should make up less than 70% of total assets, but its current level of 76% means the bank has lent out 6.34% 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 SMMF Have Liquidity Mismatch?
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, 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. Since Summit Financial Group’s loan to deposit ratio of 99% is higher than the appropriate level of 90%, this level positions the bank in a risky spot given the potential to cross into negative liquidity disparity between loan and deposit levels. Basically, for $1 of deposits with the bank, it lends out over $0.9 which is imprudent.
We’ve only touched on operational risks for SMMF in this article. But as a stock investment, there are other fundamentals you need to understand. There are three relevant aspects you should further research:
- Future Outlook: What are well-informed industry analysts predicting for SMMF’s future growth? Take a look at our free research report of analyst consensus for SMMF’s outlook.
- Valuation: What is SMMF 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 SMMF 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 email@example.com.