The ghosts of reckless lending in the past are still haunting the banking sector. If you are investing in such asset-heavy corporations, you should pay special attention to their asset quality. Since loans form a major chunk of a bank's assets, the risk of loan losses becomes the single greatest risk to banks. As a savvy investor, you should take a closer look at a bank's loan portfolio to decide whether it is worth investing in.
In evaluating a bank's asset quality, we should consider both existing and potential loss exposure. Keeping this in mind, I decided to put BancorpSouth (NYSE: BXS ) through the wringer. Let's narrow things down by comparing the company with its closest peers along a few important parameters:
- Net Charge-Offs/Total Average Loans %: This metric reflects that part of the total loans that has been written off as uncollectible. High charge-offs often put a drag on earnings and question the bank's ability to underwrite quality loans. Hence, investors want to see this metric as low as possible.
- Nonperforming Loan/Total Loans %: The rate of NPLs is another good indicator of a bank's asset quality. Loans that remain delinquent longer than 90 days are tagged as nonperforming. A bank that has more than 3% of such loans is holding a lot of bad loans on its books.
- The price-to-book ratio (P/B): Widely linked with value investing, and a relevant metric for banks and other asset-heavy companies, P/B gives us a clear idea of a stock's valuation. It compares the stock's market price with its intrinsic value and indicates opportunities. Usually, there's a clear relationship between a bank's nonperforming loans and its P/B ratio. A bank holding a low percentage of bad loans typically gets awarded a higher P/B and vice versa.
Net Charge-Offs/Total Average Loans %
Nonperforming Loan/Total Loans %:
|Susquehanna Bancshares (Nasdaq: SUSQ )||1.33%||1.97%||0.39|
|Bank of Hawaii (NYSE: BOH )||0.45%||0.59%||1.85|
|PrivateBancorp (Nasdaq: PVTB )||1.86%||3.84%||0.58|
Source: Capital IQ, a Standard & Poor's company.
The table suggests that BancorpSouth has a rather risky loan portfolio. While its charge-offs percentage is slightly at the higher end, its nonperforming loans (NPLs) look perilously high. NPLs have, in fact, increased from 3.1% a year ago. As I said, banks with lower bad loan percentage usually have higher P/Bs. In this case, Bancorp has a high bad loan percentage and a low P/B. The market seems to have already factored in the bank's bad asset quality as it doesn't expect good return on its assets.
Although the bank has managed to pull off profits in its latest quarter on the back of declining provision for loan losses, its poor asset quality makes me wary of it. I believe BancorpSouth still has some work to do in reducing its bad loans.
This discussion should give you better insight into BancorpSouth's asset quality. But to get a better picture, you should probe further. A convenient way to do this and stay ahead of most investors is to add these stocks to your Watchlist: