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The banking sector has been experiencing growth as a result of improving credit quality from post-GFC recovery. Economic growth impacts the stability of salaries and interest rate level which in turn affects borrowers’ demand for, and ability to repay, their loans. As a small-cap bank with a market capitalisation of US$158m, The Community Financial Corporation’s (NASDAQ:TCFC) profit and value are directly affected by economic activity. Risk associate with repayment is measured by the level of bad debt which is an expense written off Community Financial’s bottom line. Today we will analyse Community Financial’s level of bad debt and liabilities in order to understand the risk involved with investing in the bank.
How Good Is Community Financial At Forecasting Its Risks?
Community Financial’s understanding of its risk level can be estimated by its ability to forecast and provision for its bad loans. The bank may have poorly anticipated the factors contributing to higher bad loan levels if it writes off more than 100% of the bad debt it provisioned for. This begs the question – does Community Financial understand the risks it has taken on? Community Financial’s low non-performing loan allowance to non-performing loan ratio of 98.79% means the bank has under-provisioned by -1.21%, 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.
How Much Risk Is Too Much?
Community Financial is considered to be in better financial shape if it does not engage in overly risky lending practices. So what constitutes as overly risk? 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. Loans are written off as expenses when they are not repaid, which comes directly out of Community Financial’s profit. A ratio of 0.82% may indicate the bank faces relatively low chance of default and exhibits strong bad debt management - or it could indicate risks in the portfolio have not fully matured.
How Big Is Community Financial’s Safety Net?
Community 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. Community Financial’s total deposit level of 93% 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.
How will TCFC’s recent acquisition impact the business going forward? Should you be concerned about the future of TCFC and the sustainability of its financial health? I’ve bookmarked TCFC’s company page on Simply Wall St to stay informed with changes in outlook and valuation. This is also the source of data for this article. The three main sections I’d recommend you check out are:
- Future Outlook: What are well-informed industry analysts predicting for TCFC’s future growth? Take a look at our free research report of analyst consensus for TCFC’s outlook.
- Valuation: What is TCFC 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 TCFC 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.