As a small cap company operating in a heavily regulated financial services sector, an investment in BPER Banca S.p.A. (BIT:BPE) has many factors to consider. One of the biggest risk it faces as a bank is bad loans, also known as credit risk. The ability for borrowers to repay their loans depends on the stability of their salary and interest rate levels which is impacted by macroeconomic events and in turn impacts the profitability of small banks. This is because bad debt is written off as an expense and impacts BPER Banca’s bottom line and shareholders’ value. I will take you through some useful measures of bad debt and liabilities in order to properly analyse BPER Banca’s risk level before you invest in the stock.
How Good Is BPER Banca At Forecasting Its Risks?
The ability for BPER Banca to forecast and provision for its bad loans accurately serves as an indication for the bank's understanding of its own level of risk. 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 BPER Banca understand its own risk? BPER Banca’s low non-performing loan allowance to non-performing loan ratio of 58.54% means the bank has under-provisioned by -41.46%, indicating either an unexpected one-off occurrence with defaults or poor bad debt provisioning. We do note though, that many banks don't require 100% coverage of their non-performing loans, as banks often can seize collateral to cover their losses on bad loans.
What Is An Appropriate Level Of Risk?
BPER Banca may have been lending imprudently if bad loans make up more than 3% of its total loans. The bank's profit is impacted by bad loans as these cannot be recovered by the bank and are expensed directly from its bottom line. BPER Banca's bad debt ratio is greater than 10% which is unsustainably high and extremely risky, considering most banks exhibit ratios lower than the appropriate threshold of 3%. This suggests the company may have poor risk management it could be exposed to a higher chance of loan default.
Is There Enough Safe Form Of Borrowing?
BPER Banca profits from lending out its various forms of borrowings and charging interest rates. Deposits from customers tend to carry the lowest risk due to 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. BPER Banca’s total deposit level of 61% 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.
While BPER Banca 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. This possibility of an undesirable impact on cash flow lowers our conviction in BPER Banca as an investment. Keep in mind that a stock investment requires research on more than just its operational side. Below, I've compiled three essential aspects you should further research:
- Future Outlook: What are well-informed industry analysts predicting for BPE’s future growth? Take a look at our free research report of analyst consensus for BPE’s outlook.
- Valuation: What is BPE 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 BPE 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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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.