As a AU$71b market capitalisation company operating in the financial services sector, National Australia Bank Limited (ASX:NAB) has benefited from strong economic growth and improved credit quality as a result of post-GFC recovery. Growth stimulates demand for loans and impacts a borrower’s ability to repay which directly affects the level of risk National Australia Bank 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. Since the level of risky assets held by a bank impacts its cash flow and therefore the attractiveness of its stock as an investment, I will take you through three metrics that are insightful proxies for risk.
How Much Risk Is Too Much?National Australia Bank’s operations expose it to risky assets by lending to borrowers who may not be able to repay their loans. Ideally, loans that are “bad” and cannot be recuperated by the bank should comprise less than 3% of its total loans. When these loans are not repaid, they are written off as expenses which comes out directly from National Australia Bank’s profit. Since bad loans only make up an insignificant 0.27% of its total assets, the bank may have very strict risk management – or perhaps the risks in its portfolio have not eventuated yet.
How Good Is National Australia Bank At Forecasting Its Risks?
National Australia Bank’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 level of provisioning covers 100% or more of the actual bad debt expense the bank writes off, then the bank may be relatively accurate and prudent in its bad debt provisioning. With a non-performing loan allowance to non-performing loan ratio of 230.97%, the bank has extremely over-provisioned by 130.97% compared to the industry-average. We wonder if this might indicate the bank is expecting to incur further non-performing loans in the near future.
Is There Enough Safe Form Of Borrowing?National Australia Bank 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. As a rule, a bank is considered less risky if it holds a higher level of deposits. National Australia Bank’s total deposit level of 60% 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.
NAB’s acquisition will impact the business moving forward. Keep an eye on how this decision plays out in the future, especially on its financial health and earnings growth. I’ve bookmarked NAB’s company page on Simply Wall St to stay informed with changes in outlook and valuation. This is also the source of data for this article. The three main sections I’d recommend you check out are:
- Future Outlook: What are well-informed industry analysts predicting for NAB’s future growth? Take a look at our free research report of analyst consensus for NAB’s outlook.
- Valuation: What is NAB worth today? Has the future growth potential already been factored into the price? The intrinsic value infographic in our free research report helps visualize whether NAB is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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