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One of the biggest risk Arbuthnot Banking Group PLC (LON:ARBB) faces as a bank is bad loans, also known as credit risk. As a small cap stock in the heavily regulated financial services sector, its stock has many factors to consider. Small banks are directly affected by macroeconomic events as the ability for borrowers to repay their loan depends on the stability of their salary and level of interest rates. Since bad debt is written off as an expense, it impacts Arbuthnot Banking Group’s bottom line and shareholders’ value. Today we will analyse Arbuthnot Banking Group’s level of bad debt and liabilities in order to understand the risk involved with investing in Arbuthnot Banking Group
How Good Is Arbuthnot Banking Group At Forecasting Its Risks?
Arbuthnot Banking Group’s understanding of its risk level can be estimated by its ability to forecast and provision for its bad loans. If it writes off more than 100% of the bad debt it provisioned for, then it may have underestimated the risks that may have led to a higher bad loan level which begs the question – does Arbuthnot Banking Group understand its own risk? Given Arbuthnot Banking Group’s non-performing loan allowance to non-performing loan ratio is 17.58%, the bank has under-provisioned by -82.42% which is fairly low. This may be due to a one-off bad debt occurrence or an underestimation of the factors contributing to its bad loan levels.
What Is An Appropriate Level Of Risk?
If bad loans comprise of more than 3% of Arbuthnot Banking Group's total loans, it has likely been taking on more risky loans. Bad loans are those that cannot be recovered and are directly expensed from the bank’s bottom line. Since bad loans make up 3.01% of its total assets, which is above the prudent level of 3%, it faces a higher chance of default. Given that most banks tend to be well below this threshold, Arbuthnot Banking Group faces a higher risk level and shows below-average bad debt management.
Is There Enough Safe Form Of Borrowing?
Arbuthnot Banking Group 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. The general rule is the higher level of deposits a bank holds, the less risky it is considered to be. Since Arbuthnot Banking Group’s total deposit to total liabilities is very high at 98% which is well-above the prudent level of 50% for banks, Arbuthnot Banking Group may be too cautious with its level of deposits and has plenty of headroom to take on risker forms of liability.
While Arbuthnot Banking Group has maintained a safe level of deposits against its liabilities, it has taken on excess levels of bad debt and poorly provisioned for these bad debt payments. This could lead to lower profits than may have been expected by the company. The potential for an adverse effect on Arbuthnot Banking Group’s cash flow diminishes our confidence in Arbuthnot Banking Group as a stock investment. Keep in mind that a stock investment requires research on more than just its operational side. There are three relevant aspects you should look at:
- Future Outlook: What are well-informed industry analysts predicting for ARBB’s future growth? Take a look at our free research report of analyst consensus for ARBB’s outlook.
- Valuation: What is ARBB 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 ARBB 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.