As a small-cap bank stock with a market capitalisation of øre452m, Aurskog Sparebank’s (OB:AURG) risk and profitability are largely determined by the underlying economic growth of the NO 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. 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 banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks like Aurskogrebank 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. Strong management of leverage and liquidity could place the bank in a protected position at the face of macro headwinds. We can gauge Aurskogrebank’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now.

Check out our latest analysis for Aurskogrebank

Is AURG’s Leverage Level Appropriate?

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. While financial companies will always have some leverage for a sufficient capital buffer, Aurskogrebank’s leverage ratio of 9.12x is significantly below the appropriate ceiling of 20x. This means the bank has a sensibly high level of equity compared to the level of debt it has taken on to maintain operations which places it in a strong position to pay back its debt in unforeseen circumstances. 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 AURG’s Liquidity?

Due to its illiquid nature, loans are an important asset class we should learn more about. Usually, they should not be higher than 70% of total assets, however its current level of 85% means the bank has clearly lent out 15.17% above the sensible threshold. This indicates that revenue is dependent on this particular asset but also the bank is more exposed to default compared to banks with less loans.

What is AURG’s Liquidity Discrepancy?

Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. Loans are generally fixed term which means they 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. Compared to the appropriate industry loan to deposit level of 90%, Aurskogrebank’s ratio of over 141% is unsustainably higher, which positions the bank in a risky spot given the significantly high liquidity disparity between loan and deposit levels. Essentially, for NOK1 of deposits with the bank, it lends out more than NOK1.20 which is unsustainable.

Next Steps:

We’ve only touched on operational risks for AURG in this article. But as a stock investment, there are other fundamentals you need to understand. There are three relevant aspects you should further research:

1. Future Outlook: What are well-informed industry analysts predicting for AURG’s future growth? Take a look at our free research report of analyst consensus for AURG’s outlook.

2. Valuation: What is AURG 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 AURG is currently mispriced by the market.

3. 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 editorial-team@simplywallst.com.