Old National Bancorp’s (NASDAQ:ONB) 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$2.5b. 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 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. 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 Old National Bancorp 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. Sufficient liquidity and low levels of leverage could place the bank in a safe place in case of unexpected macro headwinds. Today we will be measuring Old National Bancorp’s financial risk position by looking at three leverage and liquidity metrics.
Why Does ONB’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. While financial companies will always have some leverage for a sufficient capital buffer, Old National Bancorp’s leverage ratio of less than the suitable maximum level of 20x, at 7.91x, is considered to be very cautious and prudent. With assets 7.91 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 firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.
How Should We Measure ONB’s Liquidity?
As I eluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up the bank’s total asset. Usually, they should not be higher than 70% of total assets, which is the case for Old National Bancorp’s ratio at 64%. This is a reasonable ratio and suggests that slightly over half of the bank’s total assets are tied up in the form of illiquid loans, striking an appropriate balance between liquidity and interest income.
What is ONB’s Liquidity Discrepancy?
Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. 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 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. Since Old National Bancorp’s loan to deposit ratio of 89% is within the sensible margin, below than the appropriate maximum of 90%, this level places the bank in a relatively safe liquidity position given it has not excessively lent out its deposits and has maintained a suitable level for compliance.
Old National Bancorp meets all of our liquidity and leverage criteria, exhibiting operational prudency. The operational risk side of a bank is an important fundamental often overlooked by investors. The bank’s favourable liquidity and leverage position exposes it to less risk when it comes to repaying financial obligations, in particular, in the case of an adverse macro event. Keep in mind that a stock investment requires research on more than just its operational side. I’ve put together three important factors you should further research:
- Future Outlook: What are well-informed industry analysts predicting for ONB’s future growth? Take a look at our free research report of analyst consensus for ONB’s outlook.
- Valuation: What is ONB 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 ONB 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.