As a small-cap finance stock with a market capitalisation of US$482.61m, the risk and profitability of Enterprise Bancorp Inc (NASDAQ:EBTC) 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. 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. These reforms target bank level regulation and aims to improve the banking sector’s ability to absorb shocks arising from economic stress which could expose financial institutions 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. Strong management of leverage and liquidity could place the bank in a protected position at the face of macro headwinds. We can gauge Enterprise Bancorp’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now. Check out our latest analysis for Enterprise Bancorp
Is EBTC’s Leverage Level Appropriate?
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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Enterprise Bancorp’s leverage level of 12.24x is significantly below the appropriate ceiling of 20x. 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.
What Is EBTC’s Level of Liquidity?
Due to its illiquid nature, loans are an important asset class we should learn more about. Normally, they should not exceed 70% of total assets, but its current level of 79.57% means the bank has lent out 9.57% above the sensible upper limit. This means its revenue is reliant on these specific assets which means the bank is also more likely to be exposed to default compared to its competitors with less loans.
Does EBTC Have Liquidity Mismatch?
Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. These loans tend to be 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. 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. Compared to the appropriate industry loan to deposit level of 90%, Enterprise Bancorp’s ratio of over 87.72% is sensibly lower and within the safe margin, which 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.
The bank’s prudent management of its risk levels is reflected in its sensible leverage and liquidity ratios. Its high liquidity and low leverage levels mean it is well-positioned to meet its financial obligations in the case of any adverse and unpredictable macro events. Today, we’ve only explored one aspect of Enterprise Bancorp. However, as a potential stock investment, there are many more fundamentals you need to consider. There are three essential aspects you should look at:
- Future Outlook: What are well-informed industry analysts predicting for EBTC’s future growth? Take a look at our free research report of analyst consensus for EBTC’s outlook.
- Historical Performance: What has EBTC’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- 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 pass 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.