As a small-cap bank stock with a market capitalisation of øre766m, Totens Sparebank’s (OB:TOTG) risk and profitability are largely determined by the underlying economic growth of the NO regions in which it operates. 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. 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. High liquidity and low leverage could position Totensrebank favourably at the face of macro headwinds. A way to measure this risk is to look at three leverage and liquidity metrics which I will take you through today.
Why Does TOTG’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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Totensrebank’s leverage level of 8.91x 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 increase its debt levels to firm up its capital cushion, there is plenty of headroom to do so without deteriorating its financial position.
How Should We Measure TOTG’s Liquidity?As I eluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up Totensrebank’s total asset. Normally, they should not exceed 70% of total assets, but its current level of 85% means the bank has obviously lent out 14.86% above the sensible upper limit. This level implies dependency on this particular asset class as a source of revenue which makes the bank more likely to be exposed to default compared to its competitors with less loans.
Does TOTG Have Liquidity Mismatch?Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. 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 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%, Totensrebank’s ratio of over 150% is unsustainable higher which places the bank in a dangerous position given the exceedingly high liquidity discrepancy. Essentially, for NOK1 of deposits with the bank, it lends out more than NOK1.5 which is unsustainable.
Today, we’ve only explored one aspect of Totensrebank. However, as a potential stock investment, there are many more fundamentals you need to consider. There are three key aspects you should further research:
- Future Outlook: What are well-informed industry analysts predicting for TOTG’s future growth? Take a look at our free research report of analyst consensus for TOTG’s outlook.
- Valuation: What is TOTG 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 TOTG 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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