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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 HK$13b, Chong Hing Bank Limited’s (HKG:1111) 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 Chong Hing Bank’s bottom line. Today we will analyse Chong Hing Bank’s level of bad debt and liabilities in order to understand the risk involved with investing in the bank.
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How Good Is Chong Hing Bank At Forecasting Its Risks?
Chong Hing Bank’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 it is considered to be relatively prudent and accurate in its bad debt provisioning. With a bad loan to bad debt ratio of 104.77%, the bank has cautiously over-provisioned by 4.77%, which illustrates a safe and prudent forecasting methodology, and its ability to anticipate the factors contributing to its bad loan levels.
What Is An Appropriate Level Of Risk?
Chong Hing Bank is considered to be in a good financial shape if it does not engage in overly risky lending practices. So what constitutes as overly risky? 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. When these loans are not repaid, they are written off as expenses which comes out directly from Chong Hing Bank’s profit. Since bad loans make up a relatively small 0.52% of total assets, the bank exhibits strict bad debt management and faces low risk of default.
How Big Is Chong Hing Bank’s Safety Net?
Chong Hing Bank 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. Since Chong Hing Bank’s total deposit to total liabilities is very high at 89% which is well-above the prudent level of 50% for banks, Chong Hing Bank may be too cautious with its level of deposits and has plenty of headroom to take on risker forms of liability.