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Should You Be Concerned About First Merchants Corporation’s (NASDAQ:FRME) Risks?

Cameron Brookes

Post-GFC recovery has led to improving credit quality and a strong growth environment for the banking sector. As a small-cap bank with a market capitalisation of US$2.38b, First Merchants Corporation’s (NASDAQ:FRME) 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 First Merchants’s bottom line. Today I will take you through some bad debt and liability measures to analyse the level of risky assets held by the bank. Looking through a risk-lens is a useful way to assess the attractiveness of First Merchants’s a stock investment.

View our latest analysis for First Merchants

NasdaqGS:FRME Historical Debt August 17th 18

Does First Merchants Understand Its Own Risks?

First Merchants’s forecasting and provisioning accuracy for its bad loans indicates it has a strong understanding of its own risk levels. If the level of provisioning covers 100% or more of the actual bad debt expense the bank writes off, then it is relatively accurate and prudent in its bad debt provisioning. With a bad loan to bad debt ratio of 374.84%, the bank has extremely over-provisioned by 274.84% compared to the industry-average, which illustrates perhaps a too cautious approach to forecasting bad debt.

How Much Risk Is Too Much?

First Merchants 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? Loans that cannot be recovered by the bank are known as bad loans and typically should make up less than 3% of its total loans. Bad debt is written off as expenses when loans are not repaid which directly impacts First Merchants’s bottom line. Since bad loans only make up a very insignificant 0.29% of its total assets, the bank exhibits very strict bad loan management and is exposed to a relatively insignificant level of risk in terms of default.

Is There Enough Safe Form Of Borrowing?

Handing Money Transparent

First Merchants operates by lending out its various forms of borrowings. Customers’ deposits tend to carry the smallest risk given the relatively stable interest rate and amount available. Generally, the higher level of deposits a bank retains, the less risky it is deemed to be. First Merchants’s total deposit level of 89.39% 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.

Next Steps:

FRME’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. Below, I’ve listed three fundamental areas on Simply Wall St’s dashboard for a quick visualization on current trends for FRME. I’ve also used this site as a source of data for my article.

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