As a small-cap finance stock with a market capitalisation of US$324m, the risk and profitability of Citizens & Northern Corporation (NASDAQ:CZNC) 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 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. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like Citizens & Northern to vulnerabilities. Its financial position may weaken in an adverse macro event such as political instability which is why it is crucial to understand how well the bank manages its risks. High liquidity and low leverage could position Citizens & Northern 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.
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Why Does CZNC’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, Citizens & Northern’s leverage ratio of less than the suitable maximum level of 20x, at 6.77x, is considered to be very cautious and prudent. This means the bank exhibits very strong leverage management and is well-positioned to repay its debtors in the case of any adverse events since it has an appropriately high level of equity relative to the debt it has taken on to remain in business. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.
How Should We Measure CZNC’s Liquidity?
Since loans are relatively illiquid, we should know how much of the bank’s total assets are comprised of these loans. Usually, they should not be higher than 70% of total assets, consistent with Citizens & Northern’s case with a ratio of 63%. 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 CZNC’s Liquidity Discrepancy?
Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. These loans may be fixed term and often cannot be readily realized, conversely, on the liability side, customer deposits must be paid in very short notice and on-demand. This mismatch between illiquid loans and liquid deposits poses a risk for the bank if unusual events occur and requires it to immediately repay its depositors. Relative to the prudent industry loan to deposit level of 90%, Citizens & Northern’s ratio of over 78%is appropriately lower, which positions the bank cautiously in terms of liquidity as it has not disproportionately lent out its deposits and has retained an apt level of deposits.
Citizens & Northern ticks all the boxes for operational prudency in terms of liquidity and leverage. These factors often sideline next to other fundamentals but are equally important to consider as part of the investment thesis. Its high liquidity and low leverage levels mean the bank is well-positioned to meet its financial obligations in the case of any adverse and unpredictable macro events. We’ve only touched on operational risks for CZNC in this article. But as a stock investment, there are other fundamentals you need to understand. Below, I’ve compiled three relevant aspects you should further examine:
- Future Outlook: What are well-informed industry analysts predicting for CZNC’s future growth? Take a look at our free research report of analyst consensus for CZNC’s outlook.
- Valuation: What is CZNC 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 CZNC 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 firstname.lastname@example.org.