As a small-cap bank stock with a market capitalisation of øre238m, Sparebank 1 Nordvest’s (OB:SNOR) risk and profitability are largely determined by the underlying economic growth of the NO regions in which it operates. Since a bank profits from reinvesting its clients’ deposits in the form of loans, negative economic growth may lower deposit levels and demand for loan, adversely impacting its cash flow. 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. 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 Sparebank 1 Nordvest 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 Sparebank 1 Nordvest 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.
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Why Does SNOR’s Leverage Matter?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. While financial companies will always have some leverage for a sufficient capital buffer, Sparebank 1 Nordvest’s leverage ratio of 7.17x is very safe and substantially below the maximum limit 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 SNOR’s Liquidity?As I eluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up Sparebank 1 Nordvest’s total asset. Normally, they should not exceed 70% of total assets, however its current level of 83% means the bank has clearly lent out 13.03% above the sensible threshold. This indicates that revenue is dependent on this particular asset but also the bank is more likely to be exposed to default compared to its competitors with less loans.
Does SNOR 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. Relative to the prudent industry loan to deposit level of 90%, Sparebank 1 Nordvest’s ratio of over 144% is extremely and unsustainably higher, which puts the bank in a risky position due to the 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.
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 further research:
- Future Outlook: What are well-informed industry analysts predicting for SNOR’s future growth? Take a look at our free research report of analyst consensus for SNOR’s outlook.
- Valuation: What is SNOR 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 SNOR 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 firstname.lastname@example.org.