As a small-cap finance stock with a market capitalisation of øre264m, the risk and profitability of Grong Sparebank (OB:GRONG-ME) are largely tied to the underlying economic growth of the region it operates in NO. A bank’s cash flow is directly impacted by economic growth as it is the main driver of deposit levels and demand for loans which it profits from. 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. These reforms target bank level regulation and aims to improve the banking sector’s ability to absorb shocks arising from economic stress which could expose financial institutions 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 Grongrebank’s financial risk position by looking at three leverage and liquidity metrics.
Is GRONG-ME’s Leverage Level Appropriate?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. Though banks are required to have a certain level of buffer to meet its capital requirements, Grongrebank’s leverage level of less than the suitable maximum level of 20x, at 10.4x, is considered to be very cautious and prudent. 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 GRONG-ME’s Liquidity?Since loans are relatively illiquid, we should know how much of Grongrebank’s total assets are comprised of these loans. Generally, they should make up less than 70% of total assets, but its current level of 85% means the bank has obviously lent out 15.5% above the sensible upper limit. This means its revenue is reliant on these specific assets which means the bank is also more exposed to defaulting relative to banks with less loans.
What is GRONG-ME’s Liquidity Discrepancy?A way banks make money is by lending out its deposits as loans. These loans tend to be fixed term which means they cannot be readily realized, conversely, on the liability side, customer deposits must be paid in very short notice and on-demand. 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%, Grongrebank’s ratio of over 124% is unsustainably higher, which positions the bank in a risky spot given the significantly high liquidity disparity between loan and deposit levels. Basically, for NOK1 of deposits with the bank, it lends out over NOK1.20 which is unjustifiable.
Today, we’ve only explored one aspect of Grongrebank. However, as a potential stock investment, there are many more fundamentals you need to consider. Below, I’ve compiled three important factors you should further research:
- Future Outlook: What are well-informed industry analysts predicting for GRONG-ME’s future growth? Take a look at our free research report of analyst consensus for GRONG-ME’s outlook.
- Valuation: What is GRONG-ME 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 GRONG-ME 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.