As a small-cap bank stock with a market capitalisation of US$184m, First Business Financial Services, Inc.’s (NASDAQ:FBIZ) 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. 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 First Business Financial Services 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 First Business Financial Services 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 FBIZ’s Leverage Level Appropriate?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. First Business Financial Services’s leverage level of less than the suitable maximum level of 20x, at 10.88x, is considered to be very cautious and prudent. 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. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.
How Should We Measure FBIZ’s Liquidity?Due to its illiquid nature, loans are an important asset class we should learn more about. Generally, they should make up less than 70% of total assets, however its current level of 81% means the bank has clearly lent out 11.22% 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.
What is FBIZ’s Liquidity Discrepancy?Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. 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. Relative to the prudent industry loan to deposit level of 90%, First Business Financial Services’s ratio of over 110% is higher, which places the bank in a relatively dangerous position given the negative liquidity discrepancy. Essentially, for $1 of deposits with the bank, it lends out more than $1 which is unsustainable.
We’ve only touched on operational risks for FBIZ in this article. But as a stock investment, there are other fundamentals you need to understand. There are three relevant aspects you should further examine:
- Future Outlook: What are well-informed industry analysts predicting for FBIZ’s future growth? Take a look at our free research report of analyst consensus for FBIZ’s outlook.
- Valuation: What is FBIZ 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 FBIZ 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 firstname.lastname@example.org. 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.