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As a small cap company operating in a heavily regulated financial services sector, an investment in Spar Nord Bank A/S (CPH:SPNO) has many factors to consider. One of the biggest risk it faces as a bank is bad loans, also known as credit risk. The ability for borrowers to repay their loans depends on the stability of their salary and interest rate levels which is impacted by macroeconomic events and in turn impacts the profitability of small banks. This is because bad debt is written off as an expense and impacts Spar Nord Bank’s bottom line and shareholders’ value. Today we’re going to assess the level of bad debt and liabilities Spar Nord Bank currently has in order to properly analyse the risk involved with investing in Spar Nord Bank.
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Does Spar Nord Bank Understand Its Own Risks?
The ability for Spar Nord Bank to forecast and provision for its bad loans accurately serves as an indication for the bank's understanding of its own level of risk. If it writes off more than 100% of the bad debt it provisioned for, then it has poorly anticipated the factors that may have contributed to a higher bad loan level which begs the question – does Spar Nord Bank understand its own risk?. Spar Nord Bank’s low non-performing loan allowance to non-performing loan ratio of 55.13% means the bank has under-provisioned by -44.87%, indicating either an unexpected one-off occurrence with defaults or poor bad debt provisioning. We do note though, that many banks don't require 100% coverage of their non-performing loans, as banks often can seize collateral to cover their losses on bad loans.
What Is An Appropriate Level Of Risk?
If bad loans comprise of more than 3% of Spar Nord Bank's total loans, it has likely been taking on more risky loans. Bad loans are those that cannot be recovered and are directly expensed from the bank’s bottom line. With a ratio of 7.81%, the bank exhibits significant levels of bad debt relative to many other lenders. This illustrates a poor approach to risk taking or loan concentration and potentially exposes the bank to a high risk of permanent loss on these loans.
Is There Enough Safe Form Of Borrowing?
Spar Nord Bank makes money by lending out its various forms of borrowings. Deposits from customers tend to bear the lowest risk given the relatively stable amount available and interest rate. Generally, the higher level of deposits a bank retains, the less risky it is deemed to be. Since Spar Nord Bank’s total deposit to total liabilities is very high at 90% which is well-above the prudent level of 50% for banks, Spar Nord Bank may be too cautious with its level of deposits and has plenty of headroom to take on risker forms of liability.