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As a small-cap bank stock with a market capitalisation of US$161m, First Financial Northwest, Inc.’s (NASDAQ:FFNW) 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. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like First Financial Northwest 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 First Financial Northwest’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.
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Is FFNW’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. While financial companies will always have some leverage for a sufficient capital buffer, First Financial Northwest’s leverage ratio of less than the suitable maximum level of 20x, at 7.98x, 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. 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 FFNW’s Level of Liquidity?
As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up First Financial Northwest’s total assets. Generally, they should make up less than 70% of total assets, however its current level of 81% means the bank has clearly lent out 10.62% above the sensible threshold. 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.