The banking sector has been experiencing growth as a result of improving credit quality from post-GFC recovery. As a small-cap bank with a market capitalisation of US$427.97m, Farmers Capital Bank Corporation’s (NASDAQ:FFKT) profit and value are directly affected by economic growth. This is because borrowers’ demand for, and ability to repay, their loans depend on the stability of their salaries and interest rates. Risk associated with repayment is measured by bad debt which is written off as an expense, impacting Farmers Capital Bank’s bottom line. Since the level of risky assets held by the bank impacts the attractiveness of it as an investment, I will take you through three metrics that are insightful proxies for risk.
How Good Is Farmers Capital Bank At Forecasting Its Risks?
Farmers Capital Bank’s ability to forecast and provision for its bad loans relatively accurately indicates it has a good understanding of the level of risk it is taking on. If it writes off more than 100% of the bad debt it provisioned for, then it has inadequately estimated the factors that may have added to a higher bad loan level which begs the question – does Farmers Capital Bank understand its own risk? With a bad loan to bad debt ratio of 64.66%, Farmers Capital Bank has under-provisioned by -35.34% which is below the sensible margin of error, illustrating room for improvement in the bank’s forecasting methodology.
How Much Risk Is Too Much?
Farmers Capital Bank is considered to be in a good financial shape if it does not engage in overly risky lending practices. So what constitutes as overly risky? Total loans should generally be made up of less than 3% of loans that are considered unrecoverable, also known as bad debt. When these loans are not repaid, they are written off as expenses which comes directly out of the bank’s profit. A ratio of 1.45% indicates the bank faces relatively low chance of default and exhibits strong bad debt management.
Is There Enough Safe Form Of Borrowing?
Farmers Capital Bank makes money by lending out its various forms of borrowings. Deposits from customers tend to bear the lowest risk given the relatively stable amount available and interest rate. As a rule, a bank is considered less risky if it holds a higher level of deposits. Farmers Capital Bank’s total deposit level of 93.08% of its total liabilities is very high and is well-above the sensible level of 50% for financial institutions. This may mean the bank is too cautious with its level of its safer form of borrowing and has plenty of headroom to take on risker forms of liability.
FFKT’s acquisition will impact the business moving forward. Keep an eye on how this decision plays out in the future, especially on its financial health and earnings growth. I’ve bookmarked FFKT’s company page on Simply Wall St to stay informed with changes in outlook and valuation. This is also the source of data for this article. The three main sections I’d recommend you check out are:
- Future Outlook: What are well-informed industry analysts predicting for FFKT’s future growth? Take a look at our free research report of analyst consensus for FFKT’s outlook.
- Valuation: What is FFKT 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 FFKT is currently mispriced by the market.
- 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.
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