As a small-cap finance stock with a market capitalisation of US$6.5b, the risk and profitability of Cullen/Frost Bankers Inc (NYSE:CFR) are largely tied to the underlying economic growth of the region it operates in US. 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 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 Cullen/Frost Bankers to vulnerabilities. Unpredictable macro events such as political instability could weaken its financial position which is why it is important to understand how well the bank manages its risk levels. Low levels of leverage coupled with sufficient liquidity may place Cullen/Frost Bankers 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 CFR’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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Cullen/Frost Bankers’s leverage level of less than the suitable maximum level of 20x, at 9.44x, 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 CFR’s Liquidity?
Since loans are relatively illiquid, we should know how much of the bank’s total assets are comprised of these loans. Generally, they should make up less than 70% of total assets, which is the case for Cullen/Frost Bankers, with a ratio well-below the maximum level at 44%. At this level of loan, the bank has preserved a high level of liquidity but perhaps at the cost of producing interest income from illiquid loan.
Does CFR Have Liquidity Mismatch?
CFR profits 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, yet customer deposits on the liability side must be paid on-demand and in short notice. 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%, Cullen/Frost Bankers’s ratio of over 52% is markedly lower, which means the bank is lending out less than its total level of deposits and 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. Given the large headroom for growth in loans, the bank has opportunity to grow its interest income.
Cullen/Frost Bankers 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. Today, we’ve only explored one aspect of Cullen/Frost Bankers. However, as a potential stock investment, there are many more fundamentals you need to consider. There are three essential aspects you should further examine:
- Future Outlook: What are well-informed industry analysts predicting for CFR’s future growth? Take a look at our free research report of analyst consensus for CFR’s outlook.
- Valuation: What is CFR 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 CFR 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.