As a small-cap bank stock with a market capitalisation of US$162m, First Financial Northwest, Inc.’s (NASDAQ:FFNW) 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 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. Strong management of leverage and liquidity could place the bank in a protected position at the face of macro headwinds. We can gauge First Financial Northwest’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
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Is FFNW’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, First Financial Northwest’s leverage ratio of less than the suitable maximum level of 20x, at 7.98x, 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 FFNW’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,
however its current level of 81% means the bank has clearly lent out 10.62% above the sensible threshold.
This means its revenue is reliant on these specific assets which means the bank is also
more exposed to defaulting relative to banks with less loans.
What is FFNW’s Liquidity Discrepancy?
A way banks make money is by lending out its deposits as loans. These loans may be fixed term and often cannot be readily realized, however, customer deposits are liabilities which must be repaid 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%, First Financial Northwest’s ratio of over 109% is higher, which puts the bank in a risky position due to the negative liquidity disparity between loan and deposit levels. Basically, for $1 of deposits with the bank, it lends out over $1 which is imprudent.Next Steps:
We’ve only touched on operational risks for FFNW in this article. But as a stock investment, there are other fundamentals you need to understand. There are three relevant aspects you should look at:
- Future Outlook: What are well-informed industry analysts predicting for FFNW’s future growth? Take a look at our free research report of analyst consensus for FFNW’s outlook.
- Valuation: What is FFNW 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 FFNW 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.