UmweltBank AG (XTRA:UBK) is a small-cap bank with a market capitalisation of €276.57M. The risk associated with investing in a small cap, accentuated by financial industry regulations, make UBK a complex investment. Given that banks operate by reinvesting deposits in the form of loans, negative economic growth may lower the level of saving deposits and demand for loans, directly affecting these banks level of cash flows. 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 UmweltBank to vulnerabilities. Since a bank’s financial standing can quickly decline in the case of an adverse macro event such as political instability, it is important to understand how prudent it is at managing its risk levels. Poor liquidity and high leverage could place UmweltBank in a precarious position at the face of macro headwinds. We can gauge the bank’s risk-taking behaviour by analysing three metrics for leverage and liquidity which I will take you through now. See our latest analysis for UmweltBank

Is UBK’s Leverage Level Appropriate?

Banks with high leverage are exposed to higher risks around its 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. Though banks are required to have a certain level of buffer to meet its capital requirements, UmweltBank leverage level of 33x is very safe and substantially below the maximum limit of 20x. 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. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so. The bank has very little headroom to increase its debt level as it may ratchet up interest cost and further deteriorate its financial position.

How Should We Measure UBK’s Liquidity?

As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up the bank’s total assets. Usually, they should not be higher than 70% of total assets, which is consistent with UmweltBank’s state given its ratio of 69.55%. At this level of loan, the bank has preserved a sensible level between maintaining liquidity and generating interest income from the loan.