As a small-cap finance stock with a market capitalisation of US$1.2b, the risk and profitability of Sandy Spring Bancorp, Inc. (NASDAQ:SASR) 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. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like Sandy Spring 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. Strong management of leverage and liquidity could place the bank in a protected position at the face of macro headwinds. We can gauge Sandy Spring Bancorp’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
Why Does SASR’s Leverage Matter?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, Sandy Spring Bancorp’s leverage ratio of less than the suitable maximum level of 20x, at 7.72x, is considered to be very cautious and prudent. With assets 7.72 times equity, the banks has maintained a prudent level of its own fund relative to borrowed fund which places it in a strong position to pay back its debt in times of adverse events. If the bank needs to firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.
What Is SASR’s Level of Liquidity?Since loans are relatively illiquid, we should know how much of Sandy Spring Bancorp’s total assets are comprised of these loans. Generally, they should make up less than 70% of total assets, however its current level of 79% means the bank has lent out 9.07% 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 SASR Have Liquidity Mismatch?Banks profit by lending out its customers’ deposits as loans and charge an interest on the principle. These loans tend to be fixed term which means they cannot be readily realized, conversely, on the liability side, customer deposits must be paid in very short notice and on-demand. 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%, Sandy Spring Bancorp’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.
Today, we’ve only explored one aspect of Sandy Spring Bancorp. However, as a potential stock investment, there are many more fundamentals you need to consider. Below, I’ve compiled three pertinent factors you should further research:
- Future Outlook: What are well-informed industry analysts predicting for SASR’s future growth? Take a look at our free research report of analyst consensus for SASR’s outlook.
- Valuation: What is SASR 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 SASR 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.