As a small-cap finance stock with a market capitalisation of øre72m, the risk and profitability of Høland og Setskog Sparebank (OB:HSPG) 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. 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. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like Høland og Setskogrebank to vulnerabilities. Unpredictable macro events such as political instability could weaken its financial position which is why it is important to understand how well the bank manages its risk levels. Low levels of leverage coupled with sufficient liquidity may place Høland og Setskogrebank 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 HSPG’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, Høland og Setskogrebank’s leverage ratio of 9.43x is significantly below the appropriate ceiling of 20x. With assets 9.43 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 firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.
What Is HSPG’s Level of Liquidity?As above-mentioned, loans are quite illiquid so it is important to understand how much of these loans make up Høland og Setskogrebank’s total assets. Normally, they should not exceed 70% of total assets, but its current level of 86% means the bank has obviously lent out 15.6% above the sensible upper limit. This level implies dependency on this particular asset class as a source of revenue which makes the bank more exposed to defaulting relative to banks with less loans.
Does HSPG Have Liquidity Mismatch?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, yet customer deposits on the liability side must be paid 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. Since Høland og Setskogrebank’s loan to deposit ratio of 125% is unsustainably higher than the appropriate level of 90%, this level places the bank in a very dangerous position given the high liquidity discrepancy. Essentially, for NOK1 of deposits with the bank, it lends out more than NOK1.20 which is unsustainable.
Keep in mind that a stock investment requires research on more than just its operational side. I’ve put together three pertinent aspects you should look at:
- Future Outlook: What are well-informed industry analysts predicting for HSPG’s future growth? Take a look at our free research report of analyst consensus for HSPG’s outlook.
- Valuation: What is HSPG 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 HSPG 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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