One of the biggest risk DNB ASA (OB:DNB) faces as a bank is bad loans, also known as credit risk. With a øre257b market capitalisation, it falls in the large, commercial bank category. During the Global Financial Crisis, large financial institutions with commercial banking arms lost billions of dollars in equity due to their lending portfolios’ exposure to the turbulent credit market. The faith of investors in what were once considered blue-chip stocks were undermined. Since the level of risky assets held by DNB impacts the attractiveness of the bank as an investment, I will take you through three metrics that are insightful proxies for risk.
What Is An Appropriate Level Of Risk?DNB’s operations expose it to risky assets by lending to borrowers who may not be able to repay their loans. Loans that cannot be recovered by the bank are known as bad loans and typically 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 DNB’s bottom line. With a ratio of 1.64%, the bank has a reasonable level of bad loans, which could suggest prudent management.
Does DNB Understand Its Own Risks?
DNB’s ability to forecast and provision for its bad loans relatively accurately suggests it has a good understanding of the level of risk it is taking on. The bank may have poorly anticipated the factors contributing to higher bad loan levels if it writes off more than 100% of the bad debt it provisioned for. This begs the question – does DNB understand the risks it has taken on? With a relatively low non-performing loan allowance to non-performing loan ratio of 35.48%, DNB has under-provisioned by -64.52% which is a bit low for our liking. This may be due to a one-off bad debt occurrence or an underestimation of the factors contributing to its bad loan levels.
Is There Enough Safe Form Of Borrowing?DNB borrows money in many different forms to lend back out. Customer deposits are the least risky form of borrowing as they are less volatile in terms of interest rate paid and amount available. The general rule is the higher level of deposits a bank holds, the less risky it is considered to be. DNB’s total deposit level of 38% of its total liabilities is below the sensible margin for for financial institutions which generally has a ratio of 50%. This means the bank’s safer form of borrowing makes up less than half of its liabilities, indicating riskier operational activity.
DNB’s safer form of borrowing is undesirably low compared to the liabilities of the company. Also its cash flow could be negatively impacted by its below-average bad debt management. These risk metrics indicate that its operational risk management could be improved on in order to give investors higher conviction of the business. Keep in mind that a stock investment requires research on more than just its operational side. There are three relevant factors you should look at:
- Future Outlook: What are well-informed industry analysts predicting for DNB’s future growth? Take a look at our free research report of analyst consensus for DNB’s outlook.
- Valuation: What is DNB 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 DNB 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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