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Why First Merchants Corporation’s (NASDAQ:FRME) Risk Control Makes It Attractive

Cameron Brookes

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The banking sector has been experiencing growth as a result of improving credit quality from post-GFC recovery. As a small-cap bank with a market capitalisation of US$2.0b, First Merchants Corporation’s (NASDAQ:FRME) profit and value are directly affected by economic growth. This is because borrowers’ demand for, and ability to repay, their loans depend on the stability of their salaries and interest rates. Risk associated with repayment is measured by bad debt which is written off as an expense, impacting First Merchants’s bottom line. Today we will analyse First Merchants’s level of bad debt and liabilities in order to understand the risk involved with investing in the bank.

Check out our latest analysis for First Merchants

NASDAQGS:FRME Historical Debt February 20th 19

Does First Merchants Understand Its Own Risks?

The ability for First Merchants to accurately forecast and provision for its bad loans shows it has a strong understanding of the level of risk it is taking on. If the level of provisioning covers 100% or more of the actual bad debt expense the bank writes off, then the bank may be relatively accurate and prudent in its bad debt provisioning. With a non-performing loan allowance to non-performing loan ratio of 295.59%, the bank has extremely over-provisioned by 195.59% compared to the industry-average. We wonder if this might indicate the bank is expecting to incur further non-performing loans in the near future.

What Is An Appropriate Level Of Risk?

First Merchants’s operations expose it to risky assets by lending to borrowers who may not be able to repay their loans. Loans that cannot be recuperated by the bank, also known as bad loans, should typically form less than 3% of its total loans. When these loans are not repaid, they are written off as expenses which come directly out of the bank’s profit. Since bad loans only make up an insignificant 0.38% of its total assets, the bank may have very strict risk management – or perhaps the risks in its portfolio have not eventuated yet.

Is There Enough Safe Form Of Borrowing?

Handing Money Transparent

First Merchants 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. The general rule is the higher level of deposits a bank holds, the less risky it is considered to be. Since First Merchants’s total deposit to total liabilities is very high at 91% which is well-above the prudent level of 50% for banks, First Merchants may be too cautious with its level of deposits and has plenty of headroom to take on risker forms of liability.

Next Steps:

FRME’s acquisition will impact the business moving forward. Keep an eye on how this decision plays out in the future, especially on its financial health and earnings growth. The list below is my go-to checks for FRME. I use Simply Wall St’s platform to keep informed about any changes in the company and market sentiment, and also use their data as the basis for my articles.

  1. Future Outlook: What are well-informed industry analysts predicting for FRME’s future growth? Take a look at our free research report of analyst consensus for FRME’s outlook.
  2. Valuation: What is FRME 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 FRME 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.

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 editorial-team@simplywallst.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.