Post-GFC recovery has led to improving credit quality and a strong growth environment for the banking sector. Central Pacific Financial Corp. (NYSE:CPF) is a small-cap bank with a market capitalisation of US$698m. Its profit and value are directly impacted by its borrowers’ ability to pay which is driven by the level of economic growth. This is because growth determines the stability of a borrower’s salary as well as the level of interest rates. Risk associated with repayment is measured by bad debt which is written off as an expense, impacting Central Pacific Financial’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.
Does Central Pacific Financial Understand Its Own Risks?
Central Pacific Financial’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. Given its large bad loan to bad debt ratio of over 500%, Central Pacific Financial has excessively over-provisioned above the appropriate minimum of 100%, indicating the bank is extremely cautious with their expectation of bad debt and should adjust their forecast moving forward.
What Is An Appropriate Level Of Risk?
If Central Pacific Financial does not engage in overly risky lending practices, it is considered to be in good financial shape. Generally, loans that are “bad” and cannot be recovered by the bank should make up less than 3% of its total loans. Bad debt is written off when loans are not repaid. This is classified as an expense which directly impacts Central Pacific Financial’s bottom line. The bank’s bad debt only makes up a very small 0.066% to total debt which means means the bank has very strict bad debt management and faces insignificant levels of default.
How Big Is Central Pacific Financial’s Safety Net?
Central Pacific Financial 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 Central Pacific Financial’s total deposit to total liabilities is very high at 95% which is well-above the prudent level of 50% for banks, Central Pacific Financial may be too cautious with its level of deposits and has plenty of headroom to take on risker forms of liability.
The recent acquisition is expected to bring more opportunities for CPF, which in turn should lead to stronger growth. I would stay up-to-date on how this decision will affect the future of the business in terms of earnings growth and financial health. Below, I’ve listed three fundamental areas on Simply Wall St’s dashboard for a quick visualization on current trends for CPF. I’ve also used this site as a source of data for my article.
- Future Outlook: What are well-informed industry analysts predicting for CPF’s future growth? Take a look at our free research report of analyst consensus for CPF’s outlook.
- Valuation: What is CPF 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 CPF 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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