As a small-cap finance stock with a market capitalisation of US$692m, the risk and profitability of Preferred Bank ( NASDAQ:PFBC ) are largely tied to the underlying economic growth of the region it operates in US. 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. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like Preferred Bank 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. Low levels of leverage coupled with sufficient liquidity may place Preferred Bank in a safe position in the face of adverse headwinds. We can measure this risk exposure by analysing three metrics for leverage and liquidity which I will take you through today.
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Why Does PFBC’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, Preferred Bank’s leverage level of 10.19x is significantly below the appropriate ceiling of 20x. With assets 10.19 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 PFBC’s Liquidity?
Since loans are relatively illiquid, we should know how much of Preferred Bank’s total assets are comprised of these loans. Usually, they should not be higher than 70% of total assets, but its current level of 80% means the bank has lent out 9.51% above the sensible upper limit. This means its revenue is reliant on these specific assets which means the bank is also more exposed to defaulting relative to banks with less loans.
Does PFBC Have Liquidity Mismatch?
Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. 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 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%, Preferred Bank’s ratio of over 92% is higher which 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.
Keep in mind that a stock investment requires research on more than just its operational side. There are three essential aspects you should further research:
- Future Outlook : What are well-informed industry analysts predicting for PFBC’s future growth? Take a look at our free research report of analyst consensus for PFBC’s outlook.
- Valuation : What is PFBC 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 PFBC 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 .