As a small-cap bank stock with a market capitalisation of US$3.8b, Sterling Bancorp’s (NYSE:STL) risk and profitability are largely determined by the underlying economic growth of the US regions in which it operates. Since a bank profits from reinvesting its clients’ deposits in the form of loans, negative economic growth may lower deposit levels and demand for loan, adversely impacting its cash flow. 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. These reforms target banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks like Sterling Bancorp 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. High liquidity and low leverage could position Sterling Bancorp favourably at the face of macro headwinds. A way to measure this risk is to look at three leverage and liquidity metrics which I will take you through today.
Why Does STL’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, Sterling Bancorp’s leverage ratio of less than the suitable maximum level of 20x, at 7.04x, 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. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.
How Should We Measure STL’s Liquidity?As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up the bank’s total assets. Normally, they should not exceed 70% of total assets, which is consistent with Sterling Bancorp’s state given its ratio of 65%. At this level of loan, the bank has preserved a sensible level between maintaining liquidity and generating interest income from the loan.
What is STL’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 Sterling Bancorp’s loan to deposit ratio of 95% is higher than the appropriate level of 90%, this level puts the bank in a risky position as it borders negative liquidity disparity between loan and deposit levels. Basically, for $1 of deposits with the bank, it lends out over $0.9 which is imprudent.
The bank’s prudent management of its risk levels is reflected in its sensible leverage and liquidity ratios. Its high liquidity and low leverage levels mean it is well-positioned 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. I’ve put together three key aspects you should further examine:
- 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.
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 email@example.com.