Paragon Commercial Corporation’s (NASDAQ:PBNC) profitability and risk are largely affected by the underlying economic growth for the region it operates in US given it is a small-cap stock with a market capitalisation of USD $305.57M. 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. 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. These reforms target banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks like Paragon Commercial 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. 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 Paragon Commercial’s financial risk position by looking at three leverage and liquidity metrics. See our latest analysis for Paragon Commercial
Is PBNC’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. While financial companies will always have some leverage for a sufficient capital buffer, Paragon Commercial’s leverage ratio of less than the suitable maximum level of 20x, at 12x, 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 increase its debt levels to firm up its capital cushion, there is plenty of headroom to do so without deteriorating its financial position.
How Should We Measure PBNC’s Liquidity?As I eluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up Paragon Commercial’s total asset. Normally, they should not exceed 70% of total assets, but its current level of 79.16% means the bank has lent out 9% above the sensible upper limit. This level implies dependency on this particular asset class as a source of revenue which makes the bank more exposed to default compared to banks with less loans.
What is PBNC’s Liquidity Discrepancy?Banks profit 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 Paragon Commercial’s loan to deposit ratio of 107.18% is higher than the appropriate level of 90%, this level puts the bank in a risky position due to the negative liquidity disparity between loan and deposit levels. Basically, for USD 1 of deposits with the bank, it lends out over USD 1 which is imprudent.
Now that you know to keep in mind these liquidity factors when putting together your investment thesis, I recommend you check out our latest free analysis report on Paragon Commercial to see its growth prospects and whether it could be considered an undervalued opportunity.
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