The banking sector has been experiencing growth as a result of improving credit quality from post-GFC recovery. Oak Valley Bancorp (NASDAQ:OVLY) is a small-cap bank with a market capitalisation of US$145m. Its profit and value are directly impacted by its borrowers’ ability to pay which is driven by the level of economic growth. This is because growth determines the stability of a borrower’s salary as well as the level of interest rates. Risk associated with repayment is measured by bad debt which is written off as an expense, impacting Oak Valley Bancorp’s bottom line. Since the level of risky assets held by the bank impacts the attractiveness of it as an investment, I will take you through three metrics that are insightful proxies for risk.

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Does Oak Valley Bancorp Understand Its Own Risks?

The ability for Oak Valley Bancorp 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 bank provisions for more than 100% of the bad debt it actually writes off, then it is considered to be relatively prudent and accurate in its bad debt provisioning. Given its large bad loan to bad debt ratio of over 500%, Oak Valley Bancorp has excessively over-provisioned above the appropriate minimum of 100%, indicating the bank is extremely cautious with their expectation of bad debt and should adjust their forecast moving forward.

How Much Risk Is Too Much?

Oak Valley Bancorp 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? Total loans should generally be made up of less than 3% of loans that are considered unrecoverable, also known as bad debt. When these loans are not repaid, they are written off as expenses which comes directly out of the bank’s profit. Since bad loans only make up a very insignificant 0.14% of its total assets, the bank exhibits very strict bad loan management and is exposed to a relatively insignificant level of risk in terms of default.

How Big Is Oak Valley Bancorp’s Safety Net?

Oak Valley Bancorp 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. Since Oak Valley Bancorp’s total deposit to total liabilities is very high at 99% which is well-above the prudent level of 50% for banks, Oak Valley Bancorp may be too cautious with its level of deposits and has plenty of headroom to take on risker forms of liability.

Next Steps:

OVLY’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 OVLY’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:

1. Future Outlook: What are well-informed industry analysts predicting for OVLY’s future growth? Take a look at our free research report of analyst consensus for OVLY’s outlook.

2. Valuation: What is OVLY 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 OVLY is currently mispriced by the market.

3. 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.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.