As a small-cap finance stock with a market capitalisation of US$1.3b, the risk and profitability of Sandy Spring Bancorp Inc (NASDAQ:SASR) 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. 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 Sandy Spring Bancorp to vulnerabilities. Its financial position may weaken in an adverse macro event such as political instability which is why it is crucial to understand how well the bank manages its risks. High liquidity and low leverage could position Sandy Spring Bancorp favourably at the face of macro headwinds. A way to measure this risk is to look at three leverage and liquidity metrics which I will take you through today.
Is SASR’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. While financial companies will always have some leverage for a sufficient capital buffer, Sandy Spring Bancorp’s leverage ratio of 7.71x 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. 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 SASR’s Liquidity?
As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up Sandy Spring Bancorp’s total assets. Generally, they should make up less than 70% of total assets, however its current level of 79% means the bank has lent out 8.89% above the sensible threshold. This means its revenue is reliant on these specific assets which means the bank is also more exposed to default compared to banks with less loans.
What is SASR’s Liquidity Discrepancy?
A way banks make money is by lending out its deposits as loans. Loans are generally fixed term which means they cannot be readily realized, however, customer deposits are liabilities which must be repaid 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. Compared to the appropriate industry loan to deposit level of 90%, Sandy Spring Bancorp’s ratio of over 107% is higher, which places the bank in a relatively dangerous position given the negative liquidity discrepancy. Basically, for $1 of deposits with the bank, it lends out over $1 which is imprudent.
Keep in mind that a stock investment requires research on more than just its operational side. Below, I’ve compiled three relevant aspects you should look at:
- Future Outlook: What are well-informed industry analysts predicting for SASR’s future growth? Take a look at our free research report of analyst consensus for SASR’s outlook.
- Valuation: What is SASR 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 SASR 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 email@example.com.