Sterling Bancorp’s (NYSE:STL) 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 US$4.4b. 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. 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. 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 Sterling Bancorp’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
Is STL’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, Sterling Bancorp’s leverage ratio of 6.78x is very safe and substantially below the maximum limit of 20x. With assets 6.78 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 STL’s Level of Liquidity?Due to its illiquid nature, loans are an important asset class we should learn more about. Normally, they should not exceed 70% of total assets, which is the case for Sterling Bancorp’s ratio at 66%. 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 STL Have Liquidity Mismatch?A way banks make money is by lending out its deposits as loans. These loans may be fixed term and often cannot be readily realized, yet customer deposits on the liability side must be paid on-demand and in short notice. This mismatch between illiquid loans and liquid deposits poses a risk for the bank if unusual events occur and requires it to immediately repay its depositors. Compared to the appropriate industry loan to deposit level of 90%, Sterling Bancorp’s ratio of over 93% is higher which positions the bank in a risky spot given the potential to cross into negative liquidity disparity between loan and deposit levels. Essentially, for $1 of deposits with the bank, it lends out more than $0.9 which is risky.
Passing two of the three checks for liquidity and leverage demonstrates a relatively sensible operational risk management by the bank. This means it is well-placed to meet its financial obligations in the case of any adverse and unpredictable macro events. Today, we’ve only explored one aspect of Sterling Bancorp. However, as a potential stock investment, there are many more fundamentals you need to consider. There are three key factors you should look at:
- Future Outlook: What are well-informed industry analysts predicting for STL’s future growth? Take a look at our free research report of analyst consensus for STL’s outlook.
- Valuation: What is STL 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 STL 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.