As a HK$584.85B market capitalisation company operating in the financial services sector, Bank of Communications Co Ltd (SEHK:3328) has benefited from strong economic growth and improved credit quality as a result of post-GFC recovery. Growth stimulates demand for loans and impacts a borrower’s ability to repay which directly affects the level of risk Bank of Communications takes on. With stricter regulations as a consequence of the recession, banks are more conservative in their lending practices, leading to more prudent levels of risky assets on the balance sheet. Since the level of risky assets held by a bank impacts its cash flow and therefore the attractiveness of its stock as an investment, I will take you through three metrics that are insightful proxies for risk. See our latest analysis for Bank of Communications
How Much Risk Is Too Much?
Bank of Communications is engaging in risking lending practices if it is over-exposed to bad debt. 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 out directly from Bank of Communications’s profit. Since bad loans only make up 1.51% of total assets for the bank, it exhibits prudent bad debt management and faces an industry-average risk of default.
How Good Is Bank of Communications At Forecasting Its Risks?
Bank of Communications’s ability to forecast and provision for its bad loans indicates it has a good understanding of the level of risk it is taking on. If the bank provisions for more than 100% of the bad debt it actually writes off, then it is considered to be relatively prudent and accurate in its bad debt provisioning. With a bad loan to bad debt ratio of 151.06%, the bank has cautiously over-provisioned by 51.06%, which illustrates a safe and prudent forecasting methodology, and its ability to anticipate the factors contributing to its bad loan levels.
How Big Is Bank of Communications’s Safety Net?
Bank of Communications 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. The general rule is the higher level of deposits a bank holds, the less risky it is considered to be. Bank of Communications’s total deposit level of 64.69% of its total liabilities is within the sensible margin for for financial institutions which generally has a ratio of 50%. This indicates a prudent level of the bank’s safer form of borrowing and a prudent level of risk.
Bank of Communications exhibits prudent management of risky assets and lending behaviour with sensible levels for all three ratios. It seems to have a clear understanding of how much it needs to provision each year for lower quality borrowers and it has maintained a safe level of deposits against its liabilities. Bank of Communications is deemed a less risky investment given its sound and sensible lending strategy which gives us more confidence in its operational risk management. We’ve only touched on operational risks for 3328 in this article. But as a stock investment, there are other fundamentals you need to understand. I’ve put together three essential aspects you should look at:
- 1. Future Outlook: What are well-informed industry analysts predicting for 3328’s future growth? Take a look at our free research report of analyst consensus for 3328’s outlook.
- 2. Valuation: What is 3328 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 3328 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 pass 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.