As a small-cap finance stock with a market capitalisation of US$557m, the risk and profitability of First Community Bankshares, Inc. (NASDAQ:FCBC) are largely tied to the underlying economic growth of the region it operates in US. A bank’s cash flow is directly impacted by economic growth as it is the main driver of deposit levels and demand for loans which it profits from. After the Financial Crisis in 2008, a set of reforms called Basel III was created with the purpose of strengthening regulation, risk management and supervision in the banking sector. These reforms target bank level regulation and aims to improve the banking sector’s ability to absorb shocks arising from economic stress which could expose financial institutions 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. Sufficient liquidity and low levels of leverage could place the bank in a safe place in case of unexpected macro headwinds. Today we will be measuring First Community Bankshares’s financial risk position by looking at three leverage and liquidity metrics.

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Why Does FCBC’s Leverage Matter?

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. First Community Bankshares’s leverage level of less than the suitable maximum level of 20x, at 6.71x, is considered to be very cautious and prudent. 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 firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.

What Is FCBC’s Level of Liquidity?

Since loans are relatively illiquid, we should know how much of First Community Bankshares’s total assets are comprised of these loans. Usually, they should not be higher than 70% of total assets, but its current level of 78% means the bank has lent out 8.1% above the sensible upper limit. 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 FCBC’s Liquidity Discrepancy?

A way banks make money is by lending out its deposits as loans. 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. Relative to the prudent industry loan to deposit level of 90%, First Community Bankshares’s ratio of over 94% is higher, which places the bank in a relatively dangerous territory to go into negative discrepancy in liquidity. Basically, for $1 of deposits with the bank, it lends out over $0.9 which is imprudent.

Next Steps:

We’ve only touched on operational risks for FCBC in this article. But as a stock investment, there are other fundamentals you need to understand. I’ve put together three pertinent aspects you should look at:

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

2. Valuation: What is FCBC 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 FCBC 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.