As a small-cap finance stock with a market capitalisation of US$4.1b, the risk and profitability of Sterling Bancorp (NYSE:STL) 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. 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. The Basel III reforms are aimed at banking regulations to improve financial institutions’ ability to absorb shocks caused by economic stress which could expose banks like Sterling Bancorp 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. Low levels of leverage coupled with sufficient liquidity may place Sterling Bancorp in a safe position in the face of adverse headwinds. We can measure this risk exposure by analysing three metrics for leverage and liquidity which I will take you through today.
Is STL’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. Though banks are required to have a certain level of buffer to meet its capital requirements, Sterling Bancorp’s leverage level of 7.09x 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 firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.
How Should We Measure STL’s 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, which is the case for Sterling Bancorp’s ratio at 61%. This is a reasonable ratio and suggests that slightly over half of the bank’s total assets are tied up in the form of illiquid loans, striking an appropriate balance between liquidity and interest income.
What is STL’s Liquidity Discrepancy?
A way banks make money is by lending out its deposits as loans. These loans may be fixed term and often cannot be readily realized, however, customer deposits are liabilities which must be repaid on-demand and in short notice. The discrepancy between loan assets and deposit liabilities threatens the bank’s financial position. If an adverse event occurs, it may not be well-placed to repay its depositors immediately. Compared to the appropriate industry loan to deposit level of 90%, Sterling Bancorp’s ratio of over 90% is higher which places the bank in a relatively dangerous territory to go into negative discrepancy in liquidity. Essentially, for $1 of deposits with the bank, it lends out more than $0.9 which is risky.
The bank’s liquidity and leverage ratios suggest it has sensible operational risk management. This means it is well-placed to meet its financial obligations in the case of any adverse and unpredictable macro events. We’ve only touched on operational risks for STL 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 further examine:
- Future Outlook: What are well-informed industry analysts predicting for STL’s future growth? Take a look at our free research report of analyst consensus for STL’s outlook.
- Valuation: What is STL 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 STL 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 firstname.lastname@example.org. 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.