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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$1.32b, Enterprise Financial Services Corp’s (NASDAQ:EFSC) 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 Enterprise Financial Services’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.
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How Good Is Enterprise Financial Services At Forecasting Its Risks?
The ability for Enterprise Financial Services 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 299.78%, Enterprise Financial Services excessively over-provisioned by 199.78% above the appropriate minimum, indicating the bank may perhaps be too cautious with their expectation of bad debt.
How Much Risk Is Too Much?
By nature, Enterprise Financial Services is exposed to risky assets by lending to borrowers who may not be able to repay their loans. Generally, loans that are “bad” and cannot be recovered by the bank should make up 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 Enterprise Financial Services’s bottom line. The bank’s bad debt only makes up a very small 0.35% to total debt which means means the bank has very strict bad debt management and faces insignificant levels of default.
How Big Is Enterprise Financial Services’s Safety Net?
Enterprise Financial Services 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. As a rule, a bank is considered less risky if it holds a higher level of deposits. Since Enterprise Financial Services’s total deposit to total liabilities is very high at 86.06% which is well-above the prudent level of 50% for banks, Enterprise Financial Services may be too cautious with its level of deposits and has plenty of headroom to take on risker forms of liability.