As a small-cap bank stock with a market capitalisation of US$560.15m, Arrow Financial Corporation’s (NASDAQ:AROW) risk and profitability are largely determined by the underlying economic growth of the US 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 banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks like Arrow Financial to vulnerabilities. Its financial position may weaken in an adverse macro event such as political instability which is why it is crucial to understand how well the bank manages its risks. 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 Arrow Financial’s financial risk position by looking at three leverage and liquidity metrics.
Check out our latest analysis for Arrow Financial
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. While financial companies will always have some leverage for a sufficient capital buffer, Arrow Financial’s leverage ratio of less than the suitable maximum level of 20x, at 10.96x, is considered to be very cautious and prudent. 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 AROW’s Liquidity?
As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up Arrow Financial’s total assets.
Normally, they should not exceed 70% of total assets,
but its current level of 71.64% means the bank has lent out 1.64% 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?
AROW profits by lending out its customers’ deposits as loans and charge an interest on the principle. Loans are generally 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. This mismatch between illiquid loans and liquid deposits poses a risk for the bank if unusual events occur and requires it to immediately repay its depositors. Compared to the appropriate industry loan to deposit level of 90%, Arrow Financial’s ratio of over 88.44% is sensibly lower and within the safe margin, which positions the bank cautiously in terms of liquidity as it has not disproportionately lent out its deposits and has retained an apt level of deposits.Next Steps:
The bank’s prudent management of its risk levels is reflected in its sensible leverage and liquidity ratios. This means it is well-placed 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. I’ve put together three relevant aspects you should further examine:
- Future Outlook: What are well-informed industry analysts predicting for AROW’s future growth? Take a look at our free research report of analyst consensus for AROW’s outlook.
- 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.
- 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 editorial-team@simplywallst.com.