Credit risk

Credit risk is defined as the risk that the bank will suffer economic loss because a counterparty cannot fulfill its financial or other contractual obligations arising from a financial contract. Credit risk is the main risk within FMO and occurs in two areas of its operations: (i) credit risk in investments in emerging markets and off-balance instruments such as loan commitments and guarantees; and (ii) credit risk in the treasury portfolio, mainly consisting of high-rated and liquid bonds in developed countries and derivative instruments.

The policies employed to control credit risk of investments include organizational and administrative procedures, investment criteria, and limits per country, sector and client. Similarly, credit policies and guidelines have been formulated covering treasury operations; these are reviewed regularly and approved by the ALCO.

The following table shows the maximum exposure to credit risk for FMO. The maximum exposure of balance sheet items, including derivatives, is shown gross, before provisioning and the effect of mitigation through the use of master netting and collateral agreements. Only derivative financial instruments with positive market values are presented. The maximum exposure to credit risk increased during the year from €5,964 million at 31 December 2010 to €6,808 million at 31 December 2011.

Maximum exposure to credit risk, including derivatives

On-balance	2011	2010
Banks	42,114	18,698
Short-term deposits	198,790	333,175
Short-term deposits - Dutch Central Bank	299,997	-
Derivative financial instruments	334,062	316,979
Loans to the private sector	2,870,781	2,540,913
Loans guaranteed by the State	70,082	63,402
Equity investments	837,318	690,156
Investments in associates	42,073	50,385
Interest-bearing securities	671,578	563,710
Deferred income tax assets	3,682	4,197
Current income tax receivables	4,560	8
Other receivables	32,896	31,461
Accrued income	82,116	71,150
Total on-balance	5,490,049	4,684,234
Off-balance
Credit risk exposures relating to off-balance sheet items are as follows:
Contingent liabilities	129,489	143,202
Irrevocable facilities	1,188,756	1,136,918
Total off-balance	1,318,245	1,280,120
Total credit risk exposure	6,808,294	5,964,354

 

Credit risk in the emerging markets loan portfolio

FMO's loan portfolio is exposed to emerging market countries. Concentration risks on individual counterparties, sectors or countries are mitigated due to stringent single client, sector and country limits. Limits are approved by the ALCO.

Gross exposure of loans distributed by region and sector

At December 31, 2011	Financial institutions	Energy	Housing	Agribusiness food and water	Diverse Sectors	Total
Africa	294,468	114,816	71,531	5,813	160,136	646,764
Asia	235,300	121,184	84,393	52,036	329,511	822,424
Europe & Central Asia	450,937	7,555	42,785	60,243	46,915	608,435
Latin America & the Caribbean	302,746	152,745	49,730	132,026	118,618	755,865
Non-region specific	18,583	-	-	-	18,710	37,293
Total	1,302,034	396,300	248,439	250,118	673,890	2,870,781

 

At December 31, 2010	Financial institutions	Energy	Housing	Agribusiness food and water	Diverse sectors	Total
Africa	240,888	92,237	34,591	6,310	144,863	518,889
Asia	205,707	119,418	68,903	42,618	272,304	708,950
Europe & Central Asia	372,482	3,738	56,720	46,162	51,929	531,031
Latin America & the Caribbean	228,548	112,985	70,685	130,028	224,849	767,095
Non-region specific	14,948	-	-	-	-	14,948
Total	1,062,573	328,378	230,899	225,118	693,945	2,540,913

 

Internal credit approval process

Credit risk from loans in emerging market countries arises due to a combination of counterparty risk and product specific risks. Both types of risk are assessed during the credit approval and credit review process and administrated via internal scorecards. The lending process is based on formalized and strict procedures. Decisions on authorizations depend on both the size of the facility and the risk profile of the financing instrument. For troubled investments, the department of special operations applies a sophisticated workout and restructuring approach.

In measuring the credit risk of the emerging market activities at the counterparty level, the main parameters are the credit quality of counterparties and the expected recovery ratio in case of defaults. Counterparty credit quality is measured by scoring counterparties on various dimensions of financial strength. Based on these scores, FMO assigns ratings to each counterparty on an internal scale from 1 (lowest risk) to 7 (highest risk), approximately equivalent to BBB to CCC-ratings. Likewise, the recovery ratio is estimated by scoring on various dimensions of the product-specific risk.

Maximum exposure to credit risk of the gross loan portfolio increased to €2,871 million in 2011 (2010: €2,541 million). The largest sector within the loan portfolio is the sector Financial institutions. When the overall risk rating of the portfolio is considered, the average rating improved and the quality of the portfolio improved. Details can be found in the following tables.

Apart from its on-balance finance activities, FMO is also exposed to off-balance credit-related commitments. Guarantees, which represent contingent liabilities to make payments in the event that a customer cannot meet its obligations to third parties, carry the same credit risks as loans. The majority of the guarantees are quoted in US dollars or euros. Guarantees on export facilities are collateralized by the underlying letters of credit, and therefore carry less credit risk than a direct uncollateralized borrowing. The total outstanding guarantees add up to an amount of €129,489 (2010: €143,202). FMO has received guarantees for an amount of €97,407 (2010: €59,964). The increase in the received guarantees is related to FMO's objective of catalyzing funds. Provisions, amortized costs and obligations for guarantees add up to €14,188 (2010: €28,376).

Irrevocable facilities represent commitments to extend finance to clients. The irrevocable facilities increased to €1,189 million (2010: €1,137 million) corresponding to 35% (2010: 37%) of the net exposure in emerging markets (including loans, equity investments and contingent liabilities). Irrevocable facilities are usually not immediately and fully drawn by our clients, especially in the case of commitments to equity funds, which have a contractual investment period of several years.

Gross exposure distributed by internal ratings

Description of rating	FMO counterparty rating	2011	2010
Good financial sustainability	1, 2	1,051,949	813,569
Satisfactory financial sustainability	3, 4	1,142,364	938,803
Moderate financial sustainability	5, 6	504,931	658,714
Poor financial sustainability	7	171,537	129,827
Total		2,870,781	2,540,913

As of January 1, 2012, a new internal rating methodology has been implemented. This methodology is validated by one of the leading rating agencies and uses new scorecards that are in line with Basel II regulations. Compared to the old scorecards, the outcomes of the new methodology are more in line with expert opinions. The rating scale used is similar to the rating scale of rating agencies. This makes the outcome more transparent and comparable.

The new internal rating methodology enables FMO to participate in the Global Emerging Markets (GEM) datapool, making it possible to exchange valuable data with other development finance intitutions around the world.

One of the main differences compared to the current rating methodology is the introduction of more qualitative factors. In the new rating process, 15 to 25 factors are scored instead of approximately 10. Next to this, a more objective measurement of quantitative factors is introduced. In order to do so more focus is put on financial ratios. The outcome of the new risk rating process has a more detailed rating on a scale from F1 to F21, compared to the 7 rating classes in the previous model.

Gross exposure distributed by new internal ratings

Indicative counterparty credit rating	2011
BBB- and higher	187,582
BB-, BB, BB+	1,446,471
B-, B, B+	927,192
CCC+ and lower ratings	309,536
Total	2,870,781

 

Collateral, loans past due and value adjustments

In 2011, collateral was acquired on 37% (2010: 41%) of the gross amount of loans. Collateral mainly consists of real estate, business assets or financial instruments. The collateral obtained is used to support FMO's position in renegotiation of loan terms. Due to the nature of the markets in which FMO operates, it has been proven difficult to assign reliable fair values to the collateral used to mitigate credit risk due to the limited liquidity and enforceability.

At the end of 2011, the counterparty-specific value adjustments as a percentage of the gross loan portfolio equaled 3.5% (2010: 4.4%). The group-specific value adjustments equaled 7.5% (2010: 7.2%), resulting in total value adjustments of 11.0% (2010: 11.6%) of the gross loan portfolio. Our Non-Performing Loan (NPL) ratio increased from 2.3% to 3.4%. Of the non-performing loans as per December 31, 2011, an amount of €13,432 is guaranteed by a third party. When the guaranteed amount is included the NPL ratio will decrease to 2.9%. In general, the non-performing loans represent a fair cross-section of our portfolio and no correlation with respect to specific sector or geographic region has been identified. Although the NPL ratio increased during 2011 from 2.3% to 3.4%, the total value adjustments decreased from 11.7% to 11.0%. This reflects the high and stable quality of our portfolio.

In 2011, our (partial) write-offs were limited to three loans, corresponding to 0.6% of our portfolio. Looking at our overall portfolio and the limited number of non-performing loans, we see no trend that would indicate a material deterioration of asset quality.

Loans past due and value adjustments 2011

	Loans not value adjusted	Loans value adjusted	Gross exposure	Counterparty specific value adjustment	Total
Loans not past due	2,695,653	60,632	2,756,285	-34,245	2,722,040
Loans past due:
Past due up to 30 days	-	-	-	-	-
Past due 30-60 days	-	-	-	-	-
Past due 60-90 days	1,564	15,582	17,146	-11,686	5,460
Past due more than 90 days	-	97,350	97,350	-54,529	42,821
Sub total	2,697,217	173,564	2,870,781	-100,460	2,770,321
Less: amortizable fees	-28,997	-3,655	-32,652	-	-32,652
Less: group-specific value adjustments	-215,557	-	-215,557	-	-215,557
Carrying value	2,452,663	169,909	2,622,572	-100,460	2,522,112

 

Loans past due between 60 and 90 days consists of one loan that has not been provisioned, as it is expected that the company will receive the contractual cash flows from the client.

 

Loans past due and value adjustments 2010	Loans not value adjusted	Loans value adjusted	Gross exposure	Counterparty specific adjustment	Total
Loans not past due	2,280,234	119,716	2,399,950	-59,845	2,340,105
Loans past due:
• Past due up to 30 days	55,515	11,215	66,730	-2,804	63,926
• Past due 30-60 days	-	-	-	-	-
• Past due 60-90 days	-	15,662	15,662	-7,031	8,631
• Past due more than 90 days	-	58,571	58,571	-45,078	13,493
Sub total	2,335,749	205,164	2,540,913	-114,758	2,426,155
Less: amortizable fees	-30,840	-916	-31,756	-	-31,756
Less: group-specific value adjustments	-181,686	-	-181,686	-	-181,686
Carrying value	2,123,223	204,248	2,327,471	-114,758	2,212,713

 

 

Counterparty-specific value adjustments distributed by regions and sectors
(% based on the gross exposure of loans)

Country risk

Apart from counterparty risk, country risk is another important element of the portfolio in emerging markets. Country risk arises from country-specific events that adversely impact the company's exposure in a specific country. Within FMO, country risk is broadly defined. It includes all relevant factors that have a common impact on FMO's portfolio in a country such as economic, banking and FX crises, sovereign default and political risk events. The assessment of the country rating is based on a benchmark of external rating agencies and other external information.

The level of the country limits depends on the country rating. FMO recognizes that the impact of country risk differs across the financial products it offers. In order to calculate group-specific value adjustments, country-specific provisions are established on the investment credit portfolio based on country risk and estimated recovery rates. With respect to the geographical diversification in the portfolio, reference is made to the segment information paragraph. With respect to the sector diversification in the portfolio, reference is made to notes 4, 5, and 6 of the notes to the consolidated balance sheet.

Overall, the country ratings improved during 2011. For example, Georgia had an improvement of two notches, and countries like Indonesia, Panama, Ukraine and Kazakhstan had an improvement of one notch.

Overview country ratings

Description of rating	FMO country rating	Portfolio exposure 2011 (%)	Portfolio exposure 2010 (%)
Good financial sustainability	1, 2	34.5	31.9
Satisfactory financial sustainability	3, 4	34.2	32.2
Moderate financial sustainability	5, 6	25.9	32.6
Poor financial sustainability	7	5.4	3.3
Total		100.0	100.0

 

As of January 1, 2012, the rating scales for countries will be brought into line with the counterparty ratings. The country limit framework has been changed accordingly. Due to the fact that the outcome of the risk rating process is a more detailed rating on a scale from F1 to F21, compared to the 7 rating classes in the old model, some countries fall into a different category.

Overview new country ratings

Indicative external rating equivalent	Portfolio exposure 2011 (%)
BBB and higher ratings	18.1
BBB-	12.5
BB+	3.5
BB	10.2
BB-	11.1
B+	17.6
B	11.0
B-	7.6
CCC+ and lower ratings	8.4
Total	100.0

Credit risk in the treasury portfolio

The main responsibility of FMO's treasury is to fund the activities of FMO and to efficiently and effectively mitigate risks in line with treasury's mandate. Credit risk in the treasury portfolio stems from short-term deposits, interest-bearing securities and derivative instruments. Derivatives are primarily used for hedging interest rate risk and foreign exchange risks.

The treasury risks are reviewed on a monthly basis by the ALCO. The credit quality of the exposures from treasury activities is monitored on a daily basis by the Risk Management department. In cases where the creditworthiness of securities deteriorates to levels below the standard eligibility criteria for new exposures, the risk management department provides the ALCO with recommended actions.

Risk Management approves each obligor to which FMO is exposed through its treasury activities and sets a maximum limit to the credit exposure of that obligor. Depending on the obligor's short and long-term rating, limits are set for the total and long-term exposure. For derivatives, a separate limit is set for the weighted nominal value of the contract, the weight being dependent on the type of contract (as market volatility differs among the products).

In order to reduce credit risk stemming from 'in the money' derivative contracts, FMO has entered into Credit Support Annexes (CSA) with almost all derivative counterparties. A CSA is a legal document which regulates credit support (collateral) between derivative counterparties. In the case of FMO the accepted collateral is cash (USD or EUR).

FMO pursues a conservative investment policy. The majority of the interest-bearing securities have a AAA rating.

Overview interest-bearing securities

At December 31	2011	2010
AAA	453,586	392,374
AA- to AA+	217,992	171,336
A+ or lower	-	-
Total	671,578	563,710

 

Geographical distribution interest-bearing securities

At December 31	2011 (%)	2010 (%)
Australia	8	10
Belgium	2	3
France	7	13
Germany	8	5
Great Britain	12	14
Netherlands	34	41
Supra-national	27	12
United States of America	2	2
Total	100	100

Most of the investments in interest-bearing securities made in 2011 are investments in supra-national bonds. These are bonds issued by institutions larger than a single country and are regarded as being very safe investments.

Overview short-term deposits

At December 31	Rating (short term)	2011	2010
Dutch Central Bank		299,997	-
Dutch government	A1	-	49,995
Financial institutions	A1	74,530	237,268
	A2	1,050	1,050
Money market funds	AAAmmf	53,964	44,862
Supra-nationals	A1	69,246	-
Total		498,787	333,175

 

Derivative financial instruments distributed by rating¹⁾

		2011		2010
	Net exposure	CSA (%)	Net exposure	CSA (%)
AAA	90	-	34,956	100
AA- to AA+	60,661	96	70,589	68
A to A+	221,190	100	170,808	100
Not rated	-	-	6,178	-
Total	281,941	99	282,531	90

¹⁾ The exposure of derivative financial instruments is presented for all derivatives with positive market value, if possible, netted with derivatives with a negative market value if it concerns the same counterparty. For this reason the total amount under derivative financial instruments does not equal the exposure presented in the other tables.