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 savvy investors, 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 Regions Financial (NYS: RF) through the wringer. Let's narrow things down by comparing the company and its closest peers against a few important parameters:
Net charge-offs/total average loans: It reflects the part of the total loans that has been written off as uncollectible. High charge-offs often put a drag on earnings and raise questions about the ability of the bank to underwrite quality loans. 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.
The price-to-book ratio: Widely linked with value investing and a relevant metric for banks and other asset-heavy companies, P/B gives us a clear idea about 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 awarded with a higher P/B and vice versa.
Net Charge-Offs/Total Average Loans
Nonperforming Loan/Total Loans
BB&T (NYS: BBT)
Fifth Third Bancorp (NAS: FITB)
M&T Bank (NYS: MTB)
Source: Capital IQ, a Standard & Poor's company.
The table suggests that Regions has a rather risky loan portfolio. It has high charge-offs and nonperforming loans compared to its peers. Its nonperforming loans, in fact, have grown by an astonishing 11-fold over five years, though they are now beginning to show some signs of decline.
The market seems to have already taken into account the bank's bad asset quality and factored it in its price. Investors, perhaps, don't believe that the assets are worth what the balance sheet claims they are. In my opinion, its low P/B is probably justified.
This discussion should give you a better insight about Regions' asset quality. But to get a better picture, you should probe further. A convenient way to do this and stay ahead of most investors would be to add it to your watchlist.
At the time thisarticle was published Fool contributor Zeeshan Siddique does not own any of the stocks mentioned in the article. The Motley Fool owns shares of Fifth Third Bancorp. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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