As a small-cap bank stock with a market capitalisation of US$191.3m, First Community Corporation’s (NASDAQ:FCCO) risk and profitability are largely determined by the underlying economic growth of the US regions in which it operates. Given that banks operate by reinvesting deposits in the form of loans, negative economic growth may lower the level of saving deposits and demand for loans, directly affecting those banks’ levels of cash flows. Post-GFC recovery brought about a new set of reforms, Basel III, which was created to improve regulation, supervision and risk management in the financial services industry. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like First Community 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 Community’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
Why Does FCCO’s Leverage Matter?
A low level of leverage subjects a bank to less risk and enhances its ability to pay back its debtors. Leverage can be thought of as the amount of assets a bank owns relative to its shareholders’ funds. While financial companies will always have some leverage for a sufficient capital buffer, First Community’s leverage ratio of 10.21x is very safe and substantially below the maximum limit of 20x. With assets 10.21 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.
What Is FCCO’s Level of Liquidity?
As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up the bank’s total assets. Usually, they should not be higher than 70% of total assets, which is consistent with First Community’s state given its ratio of 62.1%. This means slightly over half of the bank’s total assets are tied up in the form of illiquid loans, leading to a sensible balance between interest income and liquidity.
What is FCCO’s Liquidity Discrepancy?
FCCO profits by lending out its customers’ deposits as loans and charge an interest on the principle. 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. 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%, First Community’s ratio of over 72.7%is appropriately lower, 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.
First Community 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 FCCO in this article. But as a stock investment, there are other fundamentals you need to understand. Below, I’ve compiled three important aspects you should look at:
- Future Outlook: What are well-informed industry analysts predicting for FCCO’s future growth? Take a look at our free research report of analyst consensus for FCCO’s outlook.
- Valuation: What is FCCO 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 FCCO 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.