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$261m, MutualFirst Financial, Inc.’s (NASDAQ:MFSF) 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 MutualFirst 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.
How Good Is MutualFirst Financial At Forecasting Its Risks?
MutualFirst 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 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. Given its high non-performing loan allowance to non-performing loan ratio of 145.85% MutualFirst Financial has cautiously over-provisioned 45.85% above its current level of non-performing loans. This could indicate a prudent forecasting methodology, or indicate that further bad loans are expected.
How Much Risk Is Too Much?
If MutualFirst Financial does not engage in overly risky lending practices, it is considered to be in relatively better financial shape. Generally, loans that are “bad” and cannot be recovered by the bank should make up less than 3% of its total loans. When these loans are not repaid, they are written off as expenses which comes out directly from MutualFirst Financial’s profit. A ratio of 0.60% 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 MutualFirst Financial’s Safety Net?
MutualFirst Financial operates by lending out its various forms of borrowings. Customers’ deposits tend to carry the smallest risk given 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. MutualFirst Financial’s total deposit level of 82% 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.
MFSF’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. I’ve bookmarked MFSF’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 MFSF’s future growth? Take a look at our free research report of analyst consensus for MFSF’s outlook.
- Valuation: What is MFSF 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 MFSF 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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