SmartFinancial Inc’s (NASDAQ:SMBK) profitability and risk are largely affected by the underlying economic growth for the region it operates in US given it is a small-cap stock with a market capitalisation of US$259.73M. 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 banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks like SmartFinancial 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. 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 SmartFinancial’s financial risk position by looking at three leverage and liquidity metrics. See our latest analysis for SmartFinancial

Is SMBK’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. SmartFinancial’s leverage level of 8x 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. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.

How Should We Measure SMBK’s Liquidity?

Since loans are relatively illiquid, we should know how much of SmartFinancial’s total assets are comprised of these loans. Generally, they should make up less than 70% of total assets, but its current level of 76.56% means the bank has lent out 7% above the sensible upper limit. This means its revenue is reliant on these specific assets which means the bank is also more likely to be exposed to default compared to its competitors with less loans.

What is SMBK’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%, SmartFinancial’s ratio of over 91.58% is higher which positions the bank in a risky spot given the potential to cross into 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.