As a small-cap finance stock with a market capitalisation of US$2.9b, the risk and profitability of Old National Bancorp (NASDAQ:ONB) are largely tied to the underlying economic growth of the region it operates in US. Given that banks operate by reinvesting deposits in the form of loans, negative economic growth may lower the level of saving deposits and demand for loans, directly affecting those banks’ levels of cash flows. 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. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like Old National Bancorp 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 Old National Bancorp’s financial risk position by looking at three leverage and liquidity metrics.
Is ONB’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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Old National Bancorp’s leverage level of 7.3x is significantly below the appropriate ceiling of 20x. 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 ONB’s Level of 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, consistent with Old National Bancorp’s case with a ratio of 60%. This is a reasonable ratio and suggests that slightly over half of the bank’s total assets are tied up in the form of illiquid loans, striking an appropriate balance between liquidity and interest income.
Does ONB Have Liquidity Mismatch?ONB profits by lending out its customers’ deposits as loans and charge an interest on the principle. 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. Since Old National Bancorp’s loan to deposit ratio of 83% is within the sensible margin, below than the appropriate maximum of 90%, this level 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.
Old National Bancorp passes all of our liquidity and leverage checks, suggesting it is prudent in managing those factors. This gives us confidence in the risk management side of the business, an important aspect to consider before investing in the stock. High liquidity and low leverage places the bank in an ideal position to repay financial liabilities in case of adverse headwinds. Keep in mind that a stock investment requires research on more than just its operational side. Below, I’ve compiled three essential aspects you should further research:
- Future Outlook: What are well-informed industry analysts predicting for ONB’s future growth? Take a look at our free research report of analyst consensus for ONB’s outlook.
- Valuation: What is ONB 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 ONB 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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