As a small-cap bank stock with a market capitalisation of US$216m, The Bank of Princeton’s (NASDAQ:BPRN) risk and profitability are largely determined by the underlying economic growth of the US 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. Following the Financial Crisis in 2008, a set of reforms termed Basel III was enforced to bolster risk management, regulation, and supervision in the financial services industry. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like Bank of Princeton 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 Bank of Princeton 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 BPRN’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. Though banks are required to have a certain level of buffer to meet its capital requirements, Bank of Princeton’s leverage level of 6.79x is very safe and substantially below the maximum limit of 20x. This means the bank has a sensibly high level of equity compared to the level of debt it has taken on to maintain operations which places it in a strong position to pay back its debt in unforeseen circumstances. 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 BPRN’s Liquidity?Due to its illiquid nature, loans are an important asset class we should learn more about. Normally, they should not exceed 70% of total assets, but its current level of 85% means the bank has obviously lent out 15.43% above the sensible upper limit. This means its revenue is reliant on these specific assets which means the bank is also more likely to be exposed to default compared to its competitors with less loans.
What is BPRN’s Liquidity Discrepancy?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. Relative to the prudent industry loan to deposit level of 90%, Bank of Princeton’s ratio of over 106% is higher, which positions the bank in a risky spot given the adverse liquidity disparity between loan and deposit levels. Basically, for $1 of deposits with the bank, it lends out over $1 which is imprudent.
We’ve only touched on operational risks for BPRN in this article. But as a stock investment, there are other fundamentals you need to understand. There are three essential aspects you should further research:
- Future Outlook: What are well-informed industry analysts predicting for BPRN’s future growth? Take a look at our free research report of analyst consensus for BPRN’s outlook.
- Valuation: What is BPRN 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 BPRN 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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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.