Post-GFC recovery has strengthened economic growth and credit quality, benefiting large banks such as Wells Fargo & Company (NYSE:WFC.PRV), with a market capitalisation of $305.97B. Growth stimulates demand for loans and impacts a borrower’s ability to repay which directly affects the level of risk Wells Fargo takes on. With stricter regulations as a consequence of the recession, banks are more conservative in their lending practices, leading to more prudent levels of risky assets on the balance sheet. The level of risky assets a bank holds on its accounts affects the attractiveness of the company as an investment. So today we will focus on three important metrics that are insightful proxies for risk. View our latest analysis for Wells Fargo
How Much Risk Is Too Much?Wells Fargo is considered to be in a good financial shape if it does not engage in overly risky lending practices. So what constitutes as overly risky? 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 Wells Fargo’s bottom line. Since bad loans make up a relatively small 0.84% of total assets, the bank exhibits strict bad debt management and faces low risk of default.
How Good Is Wells Fargo At Forecasting Its Risks?
The ability for Wells Fargo 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. With a bad loan to bad debt ratio of 136.93%, the bank has cautiously over-provisioned by 36.93%, which illustrates a safe and prudent forecasting methodology, and its ability to anticipate the factors contributing to its bad loan levels.
How Big Is Wells Fargo’s Safety Net?Wells Fargo 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. The general rule is the higher level of deposits a bank holds, the less risky it is considered to be. Wells Fargo’s total deposit level of 76.62% of its total liabilities is within the sensible margin for for financial institutions which generally has a ratio of 50%. This indicates a prudent level of the bank’s safer form of borrowing and a prudent level of risk.
Wells Fargo shows prudent management of risky assets and lending behaviour. It seems to have a clear understanding of how much it needs to provision each year for lower quality borrowers and it has maintained a safe level of deposits against its liabilities. Wells Fargo is deemed a less risky investment given its sound and sensible lending strategy which gives us more confidence in its operational risk management.
Now that you know to keep in mind these risk factors when putting together your investment thesis, I recommend you check out our latest free analysis report on Wells Fargo to see its growth prospects and whether it could be considered an undervalued opportunity.
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