What Makes Hawthorn Bancshares, Inc. (NASDAQ:HWBK) A Hard Investment?

As a small-cap finance stock with a market capitalisation of US$136m, the risk and profitability of Hawthorn Bancshares, Inc. (NASDAQ:HWBK) are largely tied to the underlying economic growth of the region it operates in US. 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. Post-GFC recovery brought about a new set of reforms, Basel III, which was created to improve regulation, supervision and risk management in the financial services industry. These reforms target banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks like Hawthorn Bancshares to vulnerabilities. Since its financial standing can unexpectedly decline in the case of an adverse macro event such as political instability, it is important to understand how prudent the bank is at managing 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 Hawthorn Bancshares’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.

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NasdaqGS:HWBK Historical Debt January 22nd 19
NasdaqGS:HWBK Historical Debt January 22nd 19

Why Does HWBK’s Leverage Matter?

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. While financial companies will always have some leverage for a sufficient capital buffer, Hawthorn Bancshares’s leverage ratio of less than the suitable maximum level of 20x, at 15.3x, 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. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.

What Is HWBK’s Level of Liquidity?

Handing Money Transparent As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up Hawthorn Bancshares’s total assets. Normally, they should not exceed 70% of total assets, however its current level of 76% means the bank has lent out 6.08% 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.

Does HWBK Have Liquidity Mismatch?

Banks profit 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, 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. Since Hawthorn Bancshares’s loan to deposit ratio of 93% is higher than the appropriate level of 90%, this level positions the bank in a risky spot given the potential to cross into negative liquidity disparity between loan and deposit levels. Basically, for $1 of deposits with the bank, it lends out over $0.9 which is imprudent.

Next Steps:

We’ve only touched on operational risks for HWBK in this article. But as a stock investment, there are other fundamentals you need to understand. Below, I’ve compiled three pertinent factors you should further research:

  1. Future Outlook: What are well-informed industry analysts predicting for HWBK’s future growth? Take a look at our free research report of analyst consensus for HWBK’s outlook.
  2. Valuation: What is HWBK 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 HWBK is currently mispriced by the market.
  3. 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.