As a small-cap finance stock with a market capitalisation of US$404m, the risk and profitability of Bar Harbor Bankshares (NYSEMKT:BHB) are largely tied to the underlying economic growth of the region it operates in US. 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. After the GFC, a set of reforms called Basel III was imposed in order to strengthen regulation, supervision and risk management in the banking sector. The Basel III reforms are aimed at banking regulations to improve financial institutions’ ability to absorb shocks caused by economic stress which could expose banks like Bar Harbor Bankshares 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 Bar Harbor Bankshares’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
Is BHB’s Leverage Level Appropriate?Banks with low leverage are exposed to lower risks around their ability to repay debt. A bank’s leverage can be thought of as the amount of assets it holds compared to its own shareholders’ funds. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Bar Harbor Bankshares’s leverage level of 9.74x is very safe and substantially below the maximum limit of 20x. With assets 9.74 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 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 BHB’s Liquidity?Due to its illiquid nature, loans are an important asset class we should learn more about. Generally, they should make up less than 70% of total assets, which is consistent with Bar Harbor Bankshares’s state given its ratio of 69%. This means slightly over half of the bank’s total assets are tied up in the form of illiquid loans, leading to a sensible balance between interest income and liquidity.
Does BHB Have Liquidity Mismatch?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, yet customer deposits on the liability side must be paid 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. Relative to the prudent industry loan to deposit level of 90%, Bar Harbor Bankshares’s ratio of over 100% is higher, which puts the bank in a risky position as it borders 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.
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 suggest 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 Bar Harbor Bankshares. However, as a potential stock investment, there are many more fundamentals you need to consider. Below, I’ve compiled three important aspects you should look at:
- Future Outlook: What are well-informed industry analysts predicting for BHB’s future growth? Take a look at our free research report of analyst consensus for BHB’s outlook.
- Valuation: What is BHB 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 BHB 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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