Bank of the James Financial Group, Inc.’s (NASDAQ:BOTJ) profitability and risk are largely affected by the underlying economic growth for the region it operates in US given it is a small-cap stock with a market capitalisation of US$65m. 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. 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 Bank of the James Financial Group 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. Strong management of leverage and liquidity could place the bank in a protected position at the face of macro headwinds. We can gauge Bank of the James Financial Group’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
Why Does BOTJ’s Leverage Matter?
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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Bank of the James Financial Group’s leverage level of 12.24x is significantly below the appropriate ceiling of 20x. This means the bank exhibits very strong leverage management and is well-positioned to repay its debtors in the case of any adverse events since it has an appropriately high level of equity relative to the debt it has taken on to remain in business. 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 BOTJ’s Liquidity?
As I eluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up Bank of the James Financial Group’s total asset. Normally, they should not exceed 70% of total assets, but its current level of 79% means the bank has lent out 8.53% above the sensible upper limit. This indicates that revenue is dependent on this particular asset but also the bank is more exposed to defaulting relative to banks with less loans.
Does BOTJ Have Liquidity Mismatch?
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. 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. Compared to the appropriate industry loan to deposit level of 90%, Bank of the James Financial Group’s ratio of over 87% is sensibly lower and within the safe margin, which positions the bank cautiously in terms of liquidity as it has not disproportionately lent out its deposits and has retained an apt level of deposits.
The bank’s prudent management of its risk levels is reflected in its sensible leverage and liquidity ratios. This suggests it is well-positioned to meet its financial obligations in case of any unforeseen and adverse macro events. Today, we’ve only explored one aspect of Bank of the James Financial Group. However, as a potential stock investment, there are many more fundamentals you need to consider. I’ve put together three relevant aspects you should look at:
Future Outlook: What are well-informed industry analysts predicting for BOTJ’s future growth? Take a look at our free research report of analyst consensus for BOTJ’s outlook.
Valuation: What is BOTJ 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 BOTJ 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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