Arrow Financial Corporation’s (NASDAQ:AROW) 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$452m. 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 GFC, a set of reforms called Basel III was imposed in order to strengthen regulation, supervision and risk management 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. 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 Arrow Financial 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 AROW’s Leverage Level Appropriate?Banks with low leverage are exposed to lower risks around their ability to repay debt. A bank’s leverage can be thought of as the amount of assets it holds compared to its own shareholders’ funds. Though banks are required to have a certain level of buffer to meet its capital requirements, Arrow Financial’s leverage level of less than the suitable maximum level of 20x, at 11.15x, is considered to be very cautious and prudent. With assets 11.15 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 increase its debt levels to firm up its capital cushion, there is plenty of headroom to do so without deteriorating its financial position.
What Is AROW’s Level of Liquidity?As I eluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up Arrow Financial’s total asset. Usually, they should not be higher than 70% of total assets, but its current level of 71% means the bank has lent out 1.31% above the sensible upper limit. This means its revenue is reliant on these specific assets which means the bank is also more exposed to default compared to banks with less loans.
Does AROW 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, 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. Compared to the appropriate industry loan to deposit level of 90%, Arrow Financial’s ratio of over 87% is sensibly lower and within the safe margin, which places the bank in a relatively safe liquidity position given it has not excessively lent out its deposits and has maintained a suitable level for compliance.
The bank’s liquidity and leverage ratios suggest its sensible operational risk management. Its high liquidity and low leverage levels mean it is well-positioned to meet its financial obligations in the case of any adverse and unpredictable macro events. Keep in mind that a stock investment requires research on more than just its operational side. Below, I’ve compiled three relevant factors you should look at:
- Valuation: What is AROW 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 AROW is currently mispriced by the market.
- Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on Arrow Financial’s board and the CEO’s back ground.
- 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.