As a small-cap bank stock with a market capitalisation of US$83.0m, Wellesley Bancorp Inc’s (NASDAQ:WEBK) risk and profitability are largely determined by the underlying economic growth of the US regions in which it operates. Since banks make money by reinvesting its customers’ deposits in the form of loans, strong economic growth will drive the level of savings deposits and demand for loans, directly impacting the cash flows of those banks. 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 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. 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 Wellesley Bancorp’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
Why Does WEBK’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. Though banks are required to have a certain level of buffer to meet its capital requirements, Wellesley Bancorp’s leverage level of less than the suitable maximum level of 20x, at 13.51x, is considered to be very cautious and prudent. This means the bank has a sensibly high level of equity compared to the level of debt it has taken on to maintain operations which places it in a strong position to pay back its debt in unforeseen circumstances. 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 WEBK’s Level of Liquidity?Since loans are relatively illiquid, we should know how much of Wellesley Bancorp’s total assets are comprised of these loans. Normally, they should not exceed 70% of total assets, however its current level of 84.9% means the bank has clearly lent out 14.86% above the sensible threshold. This level implies dependency on this particular asset class as a source of revenue which makes the bank more likely to be exposed to default compared to its competitors with less loans.
What is WEBK’s Liquidity Discrepancy?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 discrepancy between loan assets and deposit liabilities threatens the bank’s financial position. If an adverse event occurs, it may not be well-placed to repay its depositors immediately. Since Wellesley Bancorp’s loan to deposit ratio of 110% is higher than the appropriate level of 90%, this level positions the bank in a risky spot given the adverse liquidity disparity between loan and deposit levels. Essentially, for $1 of deposits with the bank, it lends out more than $1 which is unsustainable.
We’ve only touched on operational risks for WEBK in this article. But as a stock investment, there are other fundamentals you need to understand. I’ve put together three essential aspects you should look at:
- Future Outlook: What are well-informed industry analysts predicting for WEBK’s future growth? Take a look at our free research report of analyst consensus for WEBK’s outlook.
- Valuation: What is WEBK 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 WEBK 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 firstname.lastname@example.org.