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 Midwest-based Huntington Bancshares (Nasdaq: HBAN ) 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%: 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 ability of the bank 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 having more than 3% of such loans is holding a lot of bad loans on its books.
- Price-to-book (P/B) ratio: 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 its 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 rewarded with a higher P/B and vice versa.
Net Charge-Offs/Total Average Loans
Nonperforming Loan/Total Loans %
|Regions Financial (NYSE: RF )
|Zions Bancorporation (Nasdaq: ZION )
|Synovus Financial (NYSE: SNV )
Source: Capital IQ, a Standard & Poor's company.
The table suggests that Huntington has a healthier loan portfolio than its peers. It has a relatively lower percentage of charge-offs and nonperforming loans than its rivals. This has helped the bank reduce its provision for credit losses significantly. The latest quarter witnessed an 81% decline in provisions, as compared to the year-ago period. In fact, it has reached its lowest level since the first quarter of 2007. That decline in provisions eventually led to a boost in the company's bottom line. And I believe this trend will continue in the upcoming quarters.
As I said, banks with high credit quality usually have higher price-to-book multiples. In this case, Huntington not only has a low bad loan percentage, it is also priced low compared to its book value. It seems the market hasn't fully factored in the advantages of its improved asset quality yet. This could be an opportunity for investors.
This discussion should give you a better insight about Huntington'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: