The banking sector has been experiencing growth as a result of improving credit quality from post-GFC recovery. Paragon Commercial Corporation (NASDAQ:PBNC)is a small-cap bank with a market capitalisation of USD $305.57M. Its profit and value are directly impacted by its borrowers’ ability to pay which is driven by the level of economic growth. This is because growth determines the stability of a borrower’s salary as well as the level of interest rates. Risk associated with repayment is measured by bad debt which is written off as an expense, impacting Paragon Commercial’s bottom line. Today I will take you through some bad debt and liability measures to analyse the level of risky assets held by the bank. Looking through a risk-lens is a useful way to assess the attractiveness of Paragon Commercial’s a stock investment. Check out our latest analysis for Paragon Commercial
Does Paragon Commercial Understand Its Own Risks?
Paragon Commercial’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 bank provision covers more than 100% of what it actually writes off, then it is considered sensible and relatively accurate in its provisioning of bad debt. Given its large bad loan to bad debt ratio of over 500%, Paragon Commercial 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?
By nature, Paragon Commercial is exposed to risky assets by lending to borrowers who may not be able to repay their loans. Loans that cannot be recuperated by the bank, also known as bad loans, should typically form 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 Paragon Commercial’s bottom line. Since bad loans only make up a very insignificant 0.03% 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 Paragon Commercial’s Safety Net?
Paragon Commercial 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. Since Paragon Commercial’s total deposit to total liabilities is very high at 80.77% which is well-above the prudent level of 50% for banks, Paragon Commercial may be too cautious with its level of deposits and has plenty of headroom to take on risker forms of liability.