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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 US$645m, ConnectOne Bancorp Inc’s (NASDAQ:CNOB) 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 ConnectOne Bancorp’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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Does ConnectOne Bancorp Understand Its Own Risks?
The ability for ConnectOne Bancorp to forecast and provision for its bad loans accurately serves as an indication for the bank’s understanding of its own level of risk. If it writes off more than 100% of the bad debt it provisioned for, then it has poorly anticipated the factors that may have contributed to a higher bad loan level which begs the question – does ConnectOne Bancorp understand its own risk?. ConnectOne Bancorp’s low bad loan to bad debt ratio of 65.55% means the bank has under-provisioned by -34.45%, indicating either an unexpected one-off occurence with defaults or poor bad debt provisioning.
How Much Risk Is Too Much?
If ConnectOne Bancorp does not engage in overly risky lending practices, it is considered to be in good financial shape. 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 ConnectOne Bancorp’s bottom line. Since bad loans make up a relatively small 1.19% of total assets, the bank exhibits strict bad debt management and faces low risk of default.
Is There Enough Safe Form Of Borrowing?
ConnectOne Bancorp 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. Since ConnectOne Bancorp’s total deposit to total liabilities is very high at 84% which is well-above the prudent level of 50% for banks, ConnectOne Bancorp may be too cautious with its level of deposits and has plenty of headroom to take on risker forms of liability.