The risk in investing in a small-cap business, accentuated by financial industry regulations, makes small-cap financial stocks like comdirect bank Aktiengesellschaft (ETR:COM) a complicated investment. COM operates in the financial services industry in DE with a market capitalisation of €1.4b. Since banks make money by reinvesting its customers’ deposits in the form of loans, poor economic growth will reduce the level of savings deposits and demand for loans, directly impacting the cash flows of these 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. 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 comdirect bank to vulnerabilities. Since a bank’s financial standing can quickly decline in the case of an adverse macro event such as political instability, it is important to understand how prudent it is at managing its risk levels. Poor liquidity and high leverage could place comdirect bank in a precarious position at the face of macro headwinds. We can gauge the bank’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
Why Does COM's Leverage Matter?
A high level of leverage may subject the bank to higher risk and lowers its ability to pay back its debtors. Leverage can be thought of as the amount of assets the bank owns relative to its shareholders’ funds. While financial institutions are required to have a certain level of buffer to meet capital adequacy levels, comdirect bank leverage level of 42.44x is very safe and substantially below the maximum limit of 20x. With assets 42.44 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. If the bank increases its debt level, it can ratchet up interest cost and further deteriorate its financial position.
What Is COM's Level of Liquidity?
Since loans are relatively illiquid, we should know how much of the bank’s total assets are comprised of these loans. Normally, they should not exceed 70% of total assets, however, this should not be a concern for comdirect bank given its substantially lower ratio of below 30%. This means less than a third of the bank’s total assets are tied up in the form of illiquid loans, leading to extremely high liquidity, imaginably at the expense of generating interest income.
Does COM Have Liquidity Mismatch?
COM profits by lending out its customers’ deposits as loans and charge an interest on the principle. These loans tend to be 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. Relative to the prudent industry loan to deposit level of 90%, comdirect bank’s ratio of over below 20% is outstandingly lower, which means the bank is lending out less than a third of its total deposits, implying the bank may be too restraint with its lending and liquidity practice. There is ample opportunity for the bank to maximize its interest income by lending out more loans.
Even though the bank has upheld a high level of liquidity, its elevated level of debt compared to its equity may impact its ability to pay back its large group of debtors in times of adverse conditions. Weak leverage risk management increases the risk of comdirect bank as an investment for shareholders. We've only touched on operational risks for COM in this article. But as a stock investment, there are other fundamentals you need to understand. Below, I've compiled three key factors you should further research:
- Future Outlook: What are well-informed industry analysts predicting for COM’s future growth? Take a look at our free research report of analyst consensus for COM’s outlook.
- Valuation: What is COM 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 COM 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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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.