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DNB ASA (OB:DNB) is a large, commercial bank with a market capitalisation of ØRE245.37B. The biggest risk most large banks face is credit risk, measured by the level of bad debt it writes off. 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 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. Check out our latest analysis for DNB
How Much Risk Is Too Much?
By nature, DNB is exposed to risky assets by lending to borrowers who may not be able to repay their loans. Generally, loans that are “bad” and cannot be recovered by the bank should make up less than 3% of its total loans. When these loans are not repaid, they are written off as expenses which comes directly out of the bank’s profit. A ratio of 1.47% indicates the bank faces relatively low chance of default and exhibits strong bad debt management.
How Good Is DNB At Forecasting Its Risks?
DNB’s understanding of its risk level can be estimated by its ability to forecast and provision for its bad loans. If it writes off more than 100% of the bad debt it provisioned for, then it has inadequately estimated the factors that may have added to a higher bad loan level which begs the question – does DNB understand its own risk? Given DNB’s bad loan to bad debt ratio is 44.81%, the bank has extremely under-provisioned by -55.19% which well below the sensible margin of error. This may be due to a one-off bad debt occurence or a constant underestimation of the factors contributing to its bad loan levels.
How Big Is DNB’s Safety Net?
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. Generally, the higher level of deposits a bank retains, the less risky it is deemed to be. Since DNB’s total deposit to total liabilities is below the sensible margin at 39.14% compared to other banks’ level of 50%, this means the bank should increase its deposit levels or lower its liabilities in order to meet the prudent minimum level. At the current level, the bank’s safer form of borrowing makes up less than half of its liabilities, making it a riskier investment.