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MidWestOne Financial Group, Inc.’s (NASDAQ:MOFG) 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$370m. 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. 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 MidWestOne Financial Group 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 MidWestOne Financial Group 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 MOFG’s Leverage Matter?
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, MidWestOne Financial Group’s leverage ratio of 9.22x is very safe and substantially below the maximum limit of 20x. 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. 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.
What Is MOFG’s Level of Liquidity?
As I eluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up MidWestOne Financial Group’s total asset. Usually, they should not be higher than 70% of total assets, but its current level of 72% means the bank has lent out 1.99% above the sensible upper limit. This indicates that revenue is dependent on this particular asset but also the bank is more exposed to default compared to banks with less loans.
What is MOFG’s Liquidity Discrepancy?
Banks profit by lending out its customers’ deposits as loans and charge an interest on the principle. Loans are generally 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. Since MidWestOne Financial Group’s loan to deposit ratio of 91% is higher than the appropriate level of 90%, this level 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.
We’ve only touched on operational risks for MOFG in this article. But as a stock investment, there are other fundamentals you need to understand. There are three essential aspects you should further research:
- Future Outlook: What are well-informed industry analysts predicting for MOFG’s future growth? Take a look at our free research report of analyst consensus for MOFG’s outlook.
- Valuation: What is MOFG 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 MOFG 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 firstname.lastname@example.org. 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.