As a small-cap bank stock with a market capitalisation of US$48m, Village Bank and Trust Financial Corp.’s (NASDAQ:VBFC) 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. 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. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like Village Bank and Trust Financial to vulnerabilities. Since its financial standing can unexpectedly decline in the case of an adverse macro event such as political instability, it is important to understand how prudent the bank is at managing its risk levels. Sufficient liquidity and low levels of leverage could place the bank in a safe place in case of unexpected macro headwinds. Today we will be measuring Village Bank and Trust Financial’s financial risk position by looking at three leverage and liquidity metrics.
Is VBFC'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. Village Bank and Trust Financial’s leverage level of less than the suitable maximum level of 20x, at 13.87x, is considered to be very cautious and prudent. With assets 13.87 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.
How Should We Measure VBFC's Liquidity?
As above-mentioned, loans are quite illiquid so it is important to understand how much of these loans make up Village Bank and Trust Financial’s total assets. Generally, they should make up less than 70% of total assets, but its current level of 80% means the bank has obviously lent out 10.04% above the sensible upper limit. This indicates that revenue is dependent on this particular asset but also the bank is more likely to be exposed to default compared to its competitors with less loans.
Does VBFC Have Liquidity Mismatch?
Banks profit 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%, Village Bank and Trust Financial’s ratio of over 94% is higher, which positions the bank in a risky spot given the potential to cross into negative liquidity disparity between loan and deposit levels. Basically, for $1 of deposits with the bank, it lends out over $0.9 which is imprudent.
We've only touched on operational risks for VBFC in this article. But as a stock investment, there are other fundamentals you need to understand. I've put together three essential factors you should look at:
- Future Outlook: What are well-informed industry analysts predicting for VBFC’s future growth? Take a look at our free research report of analyst consensus for VBFC’s outlook.
- Valuation: What is VBFC 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 VBFC 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.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.