As a small-cap finance stock with a market capitalisation of USD $197.18M, the risk and profitability of First Business Financial Services Inc (NASDAQ:FBIZ) are largely tied to the underlying economic growth of the region it operates in US. Since a bank profits from reinvesting its clients’ deposits in the form of loans, negative economic growth may lower deposit levels and demand for loan, adversely impacting its cash flow. 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. These reforms target banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks like First Business Financial Services 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 First Business Financial Services’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 First Business Financial Services
Why Does FBIZ’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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. First Business Financial Services’s leverage level of 11x is significantly below the appropriate ceiling of 20x. This means the bank has a sensibly high level of equity compared to the level of debt it has taken on to maintain operations which places it in a strong position to pay back its debt in unforeseen circumstances. 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.
How Should We Measure FBIZ’s Liquidity?
Due to its illiquid nature, loans are an important asset class we should learn more about. Usually, they should not be higher than 70% of total assets, but its current level of 81.02% means the bank has obviously lent out 11% above the sensible upper limit. This indicates that revenue is dependent on this particular asset but also the bank is more exposed to default compared to banks with less loans.
What is FBIZ’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, yet customer deposits on the liability side must be paid on-demand and in short notice. The disparity between the immediacy of deposits compared to the illiquid nature of loans puts pressure on the bank’s financial position if an adverse event requires the bank to repay its depositors. Since First Business Financial Services’s loan to deposit ratio of 101.62% is higher than the appropriate level of 90%, this level positions the bank in a risky spot given the adverse liquidity disparity between loan and deposit levels. Basically, for USD 1 of deposits with the bank, it lends out over USD 1 which is imprudent.
Now that you know to keep in mind these liquidity factors when putting together your investment thesis, I recommend you check out our latest free analysis report on First Business Financial Services to see its growth prospects and whether it could be considered an undervalued opportunity.
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The author is an independent contributor and at the time of publication had no position in the stocks mentioned.