Improving credit quality as a result of post-GFC recovery has led to a strong environment for growth in the banking sector. As a small-cap bank with a market capitalisation of USD $1.95B, TowneBank (NASDAQ:TOWN)’s 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 TowneBank’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. Check out our latest analysis for TowneBank
Does TowneBank Understand Its Own Risks?
The ability for TowneBank 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 it is relatively accurate and prudent in its bad debt provisioning. Given its large bad loan to bad debt ratio of over 500%, TowneBank 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.
How Much Risk Is Too Much?
If TowneBank does not engage in overly risky lending practices, it is considered to be in good financial shape. Total loans should generally be made up of less than 3% of loans that are considered unrecoverable, also known as bad debt. 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 a very insignificant 0.08% of its total assets, the bank exhibits very strict bad loan management and is exposed to a relatively insignificant level of risk in terms of default.
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. As a rule, a bank is considered less risky if it holds a higher level of deposits. TowneBank’s total deposit level of 87.38% 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.
With positive measures for all three ratios, TowneBank shows a prudent level of managing its risky assets. It has maintained a sufficient level of deposits against liabilities and reasonably provisioned for the level of bad debt. TowneBank is deemed a less risky investment given its sound and sensible lending strategy which gives us more confidence in its operational risk management. Today, we’ve only explored one aspect of TowneBank. However, as a potential stock investment, there are many more fundamentals you need to consider. I’ve put together three essential factors you should further examine:
- 1. 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.
- 2. 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.
- 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.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.