SWDBY - DNB Bank: Increased Profit By 30% In H1 2023 (Rating Downgrade)

2023-08-19 06:23:31 ET

Summary

• DNB Bank ASA posted strong financial results in H1 2023.
• Their net interest income and income from commissions and fees showed positive trends on a quarterly basis.
• The bank has a generous dividend policy, distributing 50% of its earnings, plus a share buyback program.
• In this analysis, we compare it to that of Sweden's large bank Swedbank.

Investment Thesis

With roughly 40% of our portfolio in real estate and another 40% in financials, we have experienced both some good and some bad H1 results this year.

Even though we own low-leveraged real estate companies, the increases in interest costs have hurt the results and distribution to shareholders. Fortunately, as a counterbalance, financials are gaining from the higher interest rate environment. That is why diversification is rightly described as the only "free lunch" we get in investing.

Some of the financials that posted a good set of results in H1 2023 were the Nordic banks, such as Norway’s largest bank DNB Bank ASA ( DNBBY ).

In this article, we will go through their financials and see how they fundamentally compare to Sweden’s Swedbank ( SWDBY ).

H1 2023 Financial Results

DNBBY delivered a profit attributable to shareholders of NOK19.34 billion in H1 of 2023, compared to NOK14.91 billion the year before. That is an increase of 29.7%.

In comparison, SWDBY managed to increase their profit to shareholders in the same period by a whopping 86% from SEK8.99 billion in H1 of 2022 to SEK16.68 billion in H1 of 2023. The main reason for the large increase was the jump in interest income from SEK13.87 billion to SEK24.70 billion.

The two main components of a bank's profit come from interest income and from commissions and fees.

With a higher interest rate environment, banks can get a higher Net Interest-rate Margin, referred to as NIM. It also spurs higher volumes of deposits, as it becomes more attractive to put money in the bank. Loans are also repriced at higher rates.

On a quarterly basis, DNBBY's NIM and net interest income have shown a positive trend.

The bank also managed to improve income from commissions and fees on a quarterly basis by 7% from NOK2,634 million to NOK2,819 million.

DNBBY took an impairment of NOK792 million in H1 2023, against a reversal of impairment of NOK798 million in 2022.

When banks assess their maximum exposures to losses on their credit, they put each loan and other estimated credit losses into three stages, with stage 3 holding the credit which has the highest risk of an ECL.

DNBBY defines Stage 3 as follows (bold letters by author):

The Estimate Credit Loss, or ECL, in stage 3 is calculated for corporate customers with loans below NOK 50 million using the bank’s ECL model, which aims to estimate an expected credit loss without any limitation on the time horizon . The model is based on the probability that a loan will be “recovered“, expressed as Cure Rate – ((CR)) and an estimated loss given that the loan remains in default, expressed as Loss Given Loss – ((LGL)). Both CR and LGL consider customer and agreement-specific information, as well as a forward-looking component like the methodology for customers in stages 1 and 2. The change in methodology had no significant effect on the Group’s overall ECL. For private individuals with loans of more than NOK 5 million as defaults , an individual assessment of collateral and debt-servicing capacity is carried out to determine the ECL. For private individuals with loans of less than NOK 5 million, a portfolio approach is used to calculate ECL in stage 3. The estimate is calculated using a discounted expected collateral value that provides expected recovery rates for a representative sample of customers in default. The expected recovery rates are then applied to customers with similar characteristics to the customers in the sample. When a customer is in the 3- or 12-month return to-non-default period, the customer will continue to be presented in stage 3, but with stage 2 lifetime ECL from the ECL model.”

As of the end of H1 2023, Stage 3 exposure was NOK 22 billion, which constitutes 0.8% of their total exposure.

DNBBY’s CET1 capital ratio as of Q2 of 2022 was 18.9%, with a 180 basis-point headroom to Norway’s Financial Supervisory Authority’s expectations.

Return of Capital to Shareholders

DNBBY is 34% owned by the Norwegian governmen t. It is often a misconception amongst many investors that state-owned companies are “bad for investors”. This is, from our own experiences, not true. Large state-owned companies often contribute large amounts of money to all countries' increasing need for money for their expanding budgets.

DNBBY are quite generous with their dividend policy. They aim to distribute more than 50% of their profit in dividends. Here is their dividend history, in comparison to that of SWDBY.

In terms of share buyback programs, the two banks are choosing different paths, with DNBBY having used share buyback to return capital to shareholders, while SWDBY has not gone down that road. One reason for this is SWDBY's uncertainty surrounding the size of the fines and penalties they had to pay, which stems from past problems with AML.

DNBBY just announced that they have put in place a share buy-back program, comprising up to 1.5% of the company’s own shares, which represents a total of 23.14 million shares.

Fundamentals and Valuation

We do like both banks. But are they good value at present share price levels?

One good yardstick is to look at their ROE.

And there has been a big improvement in ROE over the last couple of years for many banks, including DNBBY and SWDBY.

We can see that SWDBY has generally been able to deliver a higher ROE over the last 10 years.

Now to the return, being the increase in share price plus the dividend received.

Here, the divergence is really large. DNBBY’s share price has gone down 3.5% over the last 1-year period. When we compare this against SWDBYs rise in share price and dividend of 30%, it is clear which bank has been the best place to be invested in over the last year.

Even though SDWDY’s share price has increased the most of the two, it still has a more attractive P/E.

When we also consider that DNBBY has a Price/Tangible Book ratio of 1.45, it is slightly less attractive than SWDBY’s ratio of 1.30.

However, this is information about the past, and as we all know we are investing for the future.

Conclusion

As earlier stated, both banks are good banks, hence worth investing in.

The interest rate margin has mostly likely peaked, and could potentially start to fall next year. This will impact the top line for the banks. In addition, we all know that there is a lag between increases in interest rates and the pain felt by lenders. By the end of this year and early into next year, we should see whether there will be an uptick in non-performing loans.

There are uncertainties about the economy and how resilient companies and consumers will be to the new interest rate environment.

As such, we would downgrade DNBBY from a Buy to a Hold stance for now, to put it on par with our present stance on SWDBY.

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