Improving credit quality as a result of post-GFC recovery has led to a strong environment for growth in the banking sector. 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$1.9b, TowneBank’s (NASDAQ:TOWN) 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 TowneBank’s bottom line. Today I will take you through some bad debt and liability measures to analyse the level of risky assets held by the bank. Looking through a risk-lens is a useful way to assess the attractiveness of TowneBank's a stock investment.
Does TowneBank Understand Its Own Risks?
TowneBank’s forecasting and provisioning accuracy for its bad loans indicates it has a strong understanding of its own risk levels. If the bank provisions for more than 100% of the bad debt it actually writes off, then could be considered to be relatively prudent and accurate in its bad debt provisioning. Given its large non-performing loan allowance to non-performing loan ratio of over 500%, TowneBank has over-provisioned relative to its current level of non-performing loans, which could indicate the bank is expecting to incur further bad loans in the near future.
How Much Risk Is Too Much?
If TowneBank does not engage in overly risky lending practices, it is considered to be in relatively better financial shape. Ideally, loans that are “bad” and cannot be recuperated by the bank should comprise 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 TowneBank’s bottom line. Since bad loans only make up an insignificant 0.059% of its total assets, the bank may have very strict risk management - or perhaps the risks in its portfolio have not eventuated yet.
How Big Is TowneBank’s Safety Net?
TowneBank 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 TowneBank’s total deposit to total liabilities is very high at 87% which is well-above the prudent level of 50% for banks, TowneBank 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 TOWN, 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. The list below is my go-to checks for TOWN. 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.
- Future Outlook: What are well-informed industry analysts predicting for TOWN’s future growth? Take a look at our free research report of analyst consensus for TOWN’s outlook.
- Valuation: What is TOWN 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 TOWN 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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