Financial Risk
Investment risk
Investment risk is defined as the risk that actual investment returns will be lower than expected returns, and encompasses credit, equity, concentration and counterparty credit risks.
Credit risk
Definition
Credit risk is defined as the risk that the bank will suffer an economic loss because a client fails to meet its obligations in accordance with agreed terms.
Risk appetite and governance
For FMO’s emerging market loan portfolio, adverse changes in credit quality can occur due to specific client and product risk, or risks relating to the country in which the client conducts its business. The main source of credit risk arises from investments in emerging markets and off-balance instruments such as loan commitments and guarantees.
Management of credit risk is FMO’s core business, both in the context of project selection and project monitoring. In this process, a set of investment criteria per sector and product is used that reflects minimum standards for the required financial strength of FMO’s clients. This is further supported by credit risk models that are used for risk quantification, the IFRS9 expected credit loss, and the determination of economic capital use per transaction. The lending process is based on formal and strict procedures. Funding decisions depend on the risk profile of the client and financing instrument. For credit monitoring, FMO’s clients are subject to annual reviews at a minimum. FMO also monitors clients that are labelled as Reason for Concern through a quarterly Watch List process to proactively manage loans before they become non-performing. For distressed assets, the Special Operations department actively manages workout and restructuring.
FMO has set internal appetite levels for non-performing loans and specific impairments on loans. If any of the metrics exceed the appetite levels, Credit will assess the underlying movements and analyze trends per sector, geography and any other parameter. Credit will also consider market developments and peer group benchmarks. Based on its analysis, Credit will propose mitigating measures to the IRC. If any of the indicators deteriorate further, Risk will be involved to assess to what extent the trend is threatening FMO’s capital and liquidity ratios and Risk may impose remedy measures.
Developments
In 2019, FMO implemented a model to substantiate the expected credit loss (ECL) of defaulted or stage 3 loans, using the net present value (NPV) of (contractual) remaining cash flows, including interest and principal past due, on facility level. The respective model incorporates a four-scenario probability-weighted approach to the NPV. Moreover, the loss given default (LGD) models for all the client types were reviewed as a triennial process and externally validated leading to their calibration with historical observed losses. In addition, the probability of default (PD) models for all the client types were calibrated as an annual process leading to more proximity of predicted defaults with historical default rates.
Exposures and credit scoring
The following table shows FMO's total gross exposure to credit risk per year-end. The exposures, including derivatives, are shown gross, before impairments and the effect of mitigation using third-party guarantees, master netting, or collateral agreements. Regarding derivative financial instruments, only the ones with positive market values are presented. The maximum exposure to credit risk increased during the year to €8,777 as of year-end 2019 (2018: €8,165). There was a decrease in short term deposits at the Dutch Central Bank accompanied by a decrease in FMO’s credit exposure from loans to the private sector in emerging markets, which moved from €5,017 to €5,372.
Maximum exposure to credit risk, including derivatives |
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On-balance | ||
Banks | 64,626 | 54,642 |
Current accounts with State funds and other programs | 1,194 | 494 |
Short-term deposits | ||
-of which: Amortized cost | 95,176 | 66,531 |
-of which: Fair value through profit or loss | 926,769 | 756,216 |
Interest-bearing securities | 350,305 | 402,380 |
Short-term deposits – Dutch central bank | 351,532 | 325,104 |
Derivative financial instruments | 301,237 | 247,823 |
Loans to the private sector | - | |
-of which: Amortized cost | 4,627,637 | 4,288,609 |
-of which: Fair value through profit or loss | 742,888 | 727,886 |
Current tax receivables | 50,484 | 24,448 |
Other receivables | 25,824 | 20,597 |
Deferred income tax assets | 6,986 | 8,357 |
Total on-balance | 7,544,658 | 6,923,087 |
Off-balance | ||
Contingent liabilities (guarantees issued) | 98,370 | 75,066 |
Irrevocable facilities | 1,135,093 | 1,166,583 |
Total off-balance | 1,233,463 | 1,241,649 |
Total credit risk exposure | 8,778,121 | 8,164,736 |
In measuring the credit risk of the emerging market portfolio at client level, the main parameters are the credit quality of the counterparties and the expected recovery ratio in case of defaults. Credit quality is measured by scoring clients on various indicators of financial and company strength. FMO has a Customer Risk Rating (CRR) methodology. The model follows EBA guidelines regarding the appropriate treatment of a Low Default Portfolio and uses an alternative to statistical validation to perform the risk assessment of the models when there is limited or no default data.
The CRR models are based on quantitative and qualitative factors and are different for respective client types. The models for Banks and Non-Banking Financial Institutions (NBFIs) use factors including the financial strength of the client, franchise value, and the market and regulatory environment. The model for corporates uses factors including financial ratios, governance, and strategy. The Project Finance model uses factors focusing on the transaction characteristics, market conditions, political and legal environment, and financial strength of the borrower.
Based on these scores, FMO assigns ratings to each client on an internal scale from F1 (lowest risk) to F20 (default) representing the Probability of Default. This rating system is equivalent to the credit quality rating scale applied by Moody's and S&P. Likewise, the Loss Given Default is assigned by scoring various dimensions of the product specific risk and incorporating client characteristics. The probability of default and loss given default scores are also used as parameters in the IFRS9 expected credit loss model. Please refer to the section 'Significant accounting policies', for further details on the ECL calculation methodology.
The majority of our gross loan portfolio (82%) remains in the F11 to F16 ratings categories. Overall the credit quality of FMO’s loan portfolio had counteracting changes in 2019, with the proportion of the portfolio rated F17 or worse rising from 8% to 11%, and the portion of the portfolio rated F13 or better increasing from 49% to 54%. This was due both to worsened economic conditions, implying country rating deteriorations and reducing combined conservatism in FMO’s credit risk models. These ultimately affected the distribution of client ratings more to the extremes.
Credit quality analysis
Loans to the private sector at amortized cost at December 31, 2019 Indicative counterparty credit rating scale of S&P | Stage 1 | Stage 2 | Stage 3 | Fair value | Total | % |
F1-F10 (BBB- and higher) | 366,815 | 9,706 | - | 3,732 | 380,253 | 7.1 |
F11-F13 (BB-,BB,BB+) | 2,066,085 | 113,684 | - | 339,254 | 2,519,023 | 46.9 |
F14-F16 (B-,B,B+) | 1,224,431 | 242,040 | 94,248 | 301,565 | 1,862,284 | 34.7 |
F17 and lower (CCC+ and lower) | 54,303 | 166,690 | 289,635 | 98,337 | 608,965 | 11.3 |
Sub-total | 3,711,634 | 532,120 | 383,883 | 742,888 | 5,370,525 | 100.0 |
Less: amortizable fees | -45,542 | -5,055 | -2,990 | - | -53,587 | |
Less: ECL allowance | -32,524 | -25,227 | -182,190 | - | -239,941 | |
Plus: FV adjustments | - | - | - | -46,375 | -46,375 | |
Carrying amount | 3,633,568 | 501,838 | 198,703 | 696,513 | 5,030,622 |
Loans to the private sector at amortized cost at December 31, 2018 Indicative counterparty credit rating scale of S&P | Stage 1 | Stage 2 | Stage 3 | Fair value | Total | % |
F1-F10 (BBB- and higher) | 117,087 | 12,271 | - | 895 | 130,253 | 2.6 |
F11-F13 (BB-,BB,BB+) | 1,844,692 | 111,888 | - | 360,429 | 2,317,009 | 46.2 |
F14-F16 (B-,B,B+) | 1,582,796 | 235,828 | 93,830 | 259,965 | 2,172,419 | 43.3 |
F17 and lower (CCC+ and lower) | 16,654 | 86,442 | 187,121 | 106,597 | 396,814 | 7.9 |
Sub-total | 3,561,229 | 446,429 | 280,951 | 727,886 | 5,016,495 | 100.0 |
Less: amortizable fees | -42,073 | -3,754 | -2,256 | - | -48,083 | |
Less: ECL allowance | -30,580 | -16,767 | -108,157 | - | -155,504 | |
Plus: FV adjustments | - | - | - | -42,087 | -42,087 | |
Carrying amount | 3,488,576 | 425,908 | 170,538 | 685,799 | 4,770,821 |
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 if a customer cannot meet its obligations to third parties, carry similar credit risks as loans. Most of the guarantees are quoted in US Dollars. Guarantees on export facilities are collateralized by the underlying letters of credit, and therefore carry less credit risk than direct uncollateralized borrowing. The following table shows the credit quality and the exposure to credit risk of the financial guarantees for the period.
Financial guarantees1) | 2019 | 2018 | |||
Indicative counterparty credit rating scale of S&P | Stage 1 | Stage 2 | Stage 3 | Total | Total |
F1-F10 (BBB- and higher) | 33,473 | 7,156 | - | 40,629 | 28,808 |
F11-F13 (BB-,BB,BB+) | 192,706 | 72,057 | - | 264,763 | 166,210 |
F14-F16 (B-,B,B+) | 57,984 | 6,994 | - | 64,978 | 198,715 |
F17 and lower (CCC+ and lower) | 27,612 | - | 2,167 | 29,779 | 15,496 |
Sub-total | 311,775 | 86,207 | 2,167 | 400,149 | 409,229 |
ECL allowance | -1,067 | -483 | -542 | -2,092 | -3,009 |
Total | 310,708 | 85,724 | 1,625 | 398,057 | 406,220 |
- 1 1) Financial guarantees represent €98,370 classified as contingent liabilities and €301,779 classified as irrevocable facilities as per Note 'Irrevocable and contingent liabilities'
Additionally, irrevocable facilities represent commitments to extend finance to clients and consist of contracts signed but not disbursed yet which are usually not immediately and fully drawn.
The following table shows the credit quality and the exposure to credit risk of the loan commitments which are part of the irrevocable facilities for the period.
Loans commitments | 2019 | 2018 | ||||
Indicative counterparty credit rating scale of S&P | Stage 1 | Stage 2 | Stage 3 | Other 1) | Total | Total |
F1-F10 (BBB- and higher) | 21,919 | - | - | - | 21,919 | - |
F11-F13 (BB-,BB,BB+) | 425,585 | 51,282 | - | 4,133 | 481,000 | 356,806 |
F14-F16 (B-,B,B+) | 231,130 | 3,004 | - | 38,181 | 272,315 | 413,878 |
F17 and lower (CCC+ and lower) | 6,515 | 45,836 | 4,849 | - | 57,200 | 60,002 |
Total nominal amount | 685,149 | 100,122 | 4,849 | 42,314 | 832,434 | 830,686 |
ECL allowance | -3,187 | -3,087 | - | - | -6,274 | -4,485 |
Total | 681,962 | 97,035 | 4,849 | 42,314 | 826,160 | 826,201 |
- 1 Loan commitments for which no ECL is calculated (Fair Value loans or expired availability date).
Non-Performing Loans
Non-Performing Loans (NPL) are defined when any of the following occur:
When FMO judges that the client is "unlikely to pay" its credit obligation to FMO and IRC decides on a specific impairment on a loan (Stage 3);
Loans with interest, principal or fee payments that are past due for more than 90 days (Stage 3);
Forborne exposures which are economically performing but are still in probation (curing) period due to Regulatory Standards (Stage 2). Probation period before returning to performing status is one year;
Additional forbearance measures are applied for forborne performing loans which have exited the NPL probation (Stage 2);
Performing forborne loans which have exited the NPL probation period have past due amounts for more than 30 days (Stage 2);
One of the loans is classified as non - performing due to criteria mentioned above, all loans of the client will be identified as non - performing (Stage 2).
FMO’s NPL ratio increased from 8.4% to 9.8% as a result of several factors, but primarily new NPLs and relatively few write-offs.
The following figure summarizes the criteria used to identify a loan as non performing:
New NPLs cannot be attributed to a specific factor or country, and the vintage years range from 2009 to 2019. Overall, NPLs remain concentrated in the Industry, Manufacturing and Services (IMS) sector, although its share in total NPLs reduced from 53% of NPLs to 42%. Activities in the IMS sector were terminated during 2017 following a strategic reorientation. The share in NPLs of FMO’s existing focus sectors Energy and Agri increased to 31% and 25% respectively, while the share of the FI sector remained low and is only 2%. Overall, the NPL ratio for current focus sectors increased from 4.5% to 6.5%. Geographically, NPLs remained concentrated in India, although its share in total NPLs decreased from 25% to 22%. During 2019, FMO incurred several new NPLs in Argentina, which now makes up 19% of total NPLs. NPL levels in FMO’s portfolio partially reflect long recovery periods, which are inherent in FMO’s markets.
Among the NPLs, the loans with interest and/or principal payments that are past due more than 90 days amount to 6.6% (2018: 4.1%) of the gross loan portfolio that is caused by several reasons, mostly due to some new large NPLs and relatively few write-offs. Past due information related to FMO’s portfolio loans and receivables are presented in the table below. This categorization does not apply to financial assets other than loans, including interest-bearing securities and short-term deposits.
Loans past due and impairments 2019 | Stage 1 | Stage 2 | Stage 3 | Fair Value | Total |
Loans not past due | 3,687,277 | 512,658 | 111,047 | 650,788 | 4,961,770 |
Loans past due: | |||||
-Past due up to 30 days | 24,357 | 1,897 | - | 8,864 | 35,118 |
-Past due 30-60 days | - | - | - | - | - |
-Past due 60-90 days | - | 12,511 | - | 5,058 | 17,569 |
-Past due more than 90 days | - | 5,054 | 272,836 | 78,178 | 356,068 |
Subtotal | 3,711,634 | 532,120 | 383,883 | 742,888 | 5,370,525 |
Less: amortizable fees | -45,542 | -5,055 | -2,990 | - | -53,587 |
Less: ECL allowance | -32,524 | -25,227 | -182,190 | - | -239,941 |
Less: FV adjustments | - | - | - | -46,375 | -46,375 |
Carrying amount | 3,633,568 | 501,838 | 198,703 | 696,513 | 5,030,622 |
Loans past due and impairments 2018 | Stage 1 | Stage 2 | Stage 3 | Fair Value | Total |
Loans not past due | 3,561,229 | 430,595 | 103,306 | 662,310 | 4,757,440 |
Loans past due: | |||||
-Past due up to 30 days | - | - | 8,112 | - | 8,112 |
-Past due 30-60 days | - | - | - | - | - |
-Past due 60-90 days | - | - | 43,388 | - | 43,388 |
-Past due more than 90 days | - | 15,834 | 126,145 | 65,576 | 207,555 |
Subtotal | 3,561,229 | 446,429 | 280,951 | 727,886 | 5,016,495 |
Less: amortizable fees | -42,073 | -3,754 | -2,256 | - | -48,083 |
Less: ECL allowance | -30,580 | -16,767 | -108,157 | - | -155,504 |
Less: FV adjustments | - | - | - | -42,087 | -42,087 |
Carrying amount | 3,488,576 | 425,908 | 170,538 | 685,799 | 4,770,821 |
The table below presents the distribution of Stage 3 loans according to regions and sectors. As with non- performing loans, impairments are highest in the IMS sector. Geographically there is an elevated level of impairments in Latin America, due to a large impairment for an Agribusiness client in Argentina.
Stage 3 - ECL distributed by regions and sectors | |||||
December 31, 2019 | Financial Institutions | Energy | Agribusiness | Infrastructure, Manufacturing, Services | Total |
Africa | - | 30,165 | - | 8,661 | 38,826 |
Asia | - | 21,228 | - | 15,686 | 36,914 |
Latin America & the Caribbean | 1,127 | 4,249 | 61,946 | 19,440 | 86,762 |
Europe & Central Asia | 204 | 2,934 | 3,035 | 13,515 | 19,688 |
Non-region specific | - | - | - | - | - |
Total | 1,331 | 58,576 | 64,981 | 57,302 | 182,190 |
Stage 3 - ECL distributed by regions and sectors | |||||
December 31, 2018 | Financial Institutions | Energy | Agribusiness | Infrastructure, Manufacturing, Services | Total |
Africa | - | 10,055 | - | 9,259 | 19,314 |
Asia | - | 8,644 | - | 16,732 | 25,376 |
Latin America & the Caribbean | 1,961 | - | 18,449 | 23,704 | 44,114 |
Europe & Central Asia | 1,349 | 3,658 | 2,718 | 11,628 | 19,353 |
Non-region specific | - | - | - | - | - |
Total | 3,310 | 22,357 | 21,167 | 61,323 | 108,157 |
Modified financial assets
Changes in terms and conditions usually include extending the maturity, changing the interest margin and changing the timing of interest payments. When the terms and conditions are modified due to financial difficulties, these loans are qualified as forborne. Refer to paragraph related to 'Modification of financial assets' in Accounting Policies section
The watch-list process and the Credit department review modified loans periodically. When a loan is deemed no longer collectible, it is written off against the related loss allowance. In 2019, FMO’s write-offs equaled to €18 million due to 3 loans (2018: €18 million) corresponding to 0.3% (2018: 0.4%) of FMO's portfolio.
The following table provides a summary of FMO’s forborne assets, both classified as performing and not, as of December 31, 2019.
December 31, 2019 | Performing | of which: performing but past due > 30 days and <=90 days | of which: performing forborne | Non Performing | of which: non performing forborne | of which: impaired | Sub Total | Less: amortizable fees | Less: ECL allowance | Plus: fair value adjustments | Carrying value |
Loans to the private sector (Amortised Cost) | 4,216,428 | - | 67,189 | 411,189 | 87,688 | 224,605 | 4,627,637 | -53,587 | -239,941 | - | 4,334,109 |
Loans to the private sector (Fair value) | 629,973 | - | 34,087 | 112,915 | 78,573 | - | 742,888 | - | - | -46,375 | 696,513 |
Total | 4,846,401 | - | 101,276 | 524,104 | 166,261 | 224,605 | 5,370,525 | -53,587 | -239,941 | -46,375 | 5,030,622 |
December 31, 2018 | Performing | of which: performing but past due > 30 days and <=90 days | of which: performing forborne | Non Performing | of which: non performing forborne | of which: impaired | Sub Total | Less: amortizable fees | Less: ECL allowance | Plus: fair value adjustments | Carrying value |
Loans to the private sector (Amortised Cost) | 3,993,615 | - | 106,460 | 294,995 | 117,879 | 280,951 | 4,288,610 | -48,083 | -155,505 | - | 4,085,022 |
Loans to the private sector (Fair value) | 606,045 | - | 30,743 | 121,841 | 94,598 | - | 727,886 | - | -42,087 | 685,799 | |
Total | 4,599,660 | - | 137,203 | 416,836 | 212,477 | 280,951 | 5,016,496 | -48,083 | -155,505 | -42,087 | 4,770,821 |
The following table shows the movement of gross carrying amount and ECL impact of Stage 2 and Stage 3 loans which were modified during 2019.
Post - modification | Pre - modification | |||
December 31, 2019 | Gross outstanding amount | Corresponding ECL | Gross outstanding amount | Corresponding ECL |
Restored loans since forbearance and now in Stage 1 | - | - | - | - |
Loans that reverted to Stage 2/3 once restored | 7,186 | -181 | 7,052 | -195 |
There were no Stage 2 and Stage 3 loans, modified during 2019 which were restored to Stage 1 after modification.
The table below includes Stage 2 and Stage 3 assets for which terms and conditions were modified during 2019 with the related net modification profit.
| |
Amortised cost of financial assets modified during the period | 7,186 |
Net modification result | 96 |
Credit risk mitigation
As per December 31, 2019, the total carrying value of the FMO’s loan portfolio is €5,031; of which €500 is guaranteed by either the Dutch government or highly rated guarantors, of which the following table shows a breakdown of guarantee amounts received and carrying values of guaranteed loans per credit ranking of the guarantors.
2019 | 2018 | |||
Guarantor credit ranking based on rating scale S&P | Amount of guarantees received | Guaranteed loans - carrying amount | Amount of guarantees received | Guaranteed loans - carrying amount |
Dutch State | 15,218 | 18,146 | 25,244 | 30,094 |
AA- and higher ratings | 182,265 | 417,231 | 40,523 | 54,198 |
A+ to A- | - | - | 133,139 | 374,881 |
BBB+ to B- | 28,929 | 65,426 | 25,365 | 61,106 |
CCC+ and lower ratings | - | - | - | - |
Total | 226,412 | 500,803 | 224,271 | 520,279 |
Equity risk
Definition
Equity risk is the risk that the fair value of an equity investment decreases. It also includes exit risk, which is the risk that FMO’s stake cannot be sold for a reasonable price and in a sufficiently liquid market.
Risk appetite and governance
FMO has a long-term view on its equity portfolio, usually selling its equity stake within a period of 5 to 10 years. FMO can accommodate an increase in the average holding period of its equity investments and thereby wait for markets to improve again to realize exits. The equity portfolio consists of both direct or co-investments, primarily in the financial institutions and energy sectors, and indirect investments in private equity funds. The two types of investments require different risk assessments and selection criteria. The Private Equity department is responsible for assessing opportunities and performing extensive due diligence before investment decisions are made. Equity investments are approved by the Investment Committee in terms of specific customer as well as country risk. The IRC assesses the valuation of equity investments on semi-annual and annual basis. Diversification across geographical area, sector and equity type across the total portfolio is evaluated before new investments are made. The performance of the equity investments in the portfolio is periodically analyzed during the fair value process. Based on this performance and the market circumstances, exits are pursued in close cooperation with the co-investing partners.
The risk of building an equity portfolio has two main components:
1.Negative value adjustments due to currency effects (EUR/USD and USD/Local FX), negative economic developments in Emerging Markets (EM) and specific investee related issues (e.g. bad management, adverse changing market circumstances). This would negatively affect the profitability of FMO.
2. Liquidity of the portfolio –in case FMO is not able to liquidate(part) of its maturing equity portfolio by creating sufficient exits for its direct and co- investment portfolio. This is also reflected in the fund portfolio where some fund managers have to hold longer to their portfolio due to the lack of good exit opportunities. This requires FMO to maintain good portfolio management and not too add too many new investments in case the exits are not happening as otherwise the portfolio could grow too fast in comparison to FMO’s own equity position.
Developments
In 2019 the market was characterized by the negative impact of the US – China trade war, economic crisis in Argentina and Turkey, and continued strength of the USD versus the EUR. Commercial funding is still not flowing to the frontier emerging markets – being FMO’s focus markets – so liquidity stays limited in these markets. The high depreciation of some major emerging markets' currency in 2019 resulted in difficult market circumstances. The prices for commodities did not fully recover and in combination with uncertainty created by the trade war, world growth rates are in a down-ward trend.
In 2019 our committed equity portfolio grew to €2,813 million (€2,440 million in 2018). In line with our ambition, the percentage of direct investments versus fund investments grew from 40 % to 44 %. However, there was limited growth in the underlying values of equity investments mainly due to challenging market conditions in countries where FMO operates. Overall, the return of our portfolio was +6.9% (€81.3 million) consisting €29.6 million in dividends and €73.3 million in underlying value growth.
Exposures
The total outstanding equity portfolio at December 31, 2019, amounts to €2,165 (2018: €1,798) of which €988 (2018: €897) is invested in investment funds.
Equity portfolio including Associates distributed by region and sector | ||||||||||||
December 31, 2019 | Financial Institutions | Energy | Agribusiness | Multi-Sector Fund Investments | Infrastructure, Manufacturing, Services | Total | ||||||
Direct | Funds | Direct | Funds | Direct | Funds | Direct | Funds | Direct | Funds | Direct | Funds | |
Africa | 325,075 | 26,280 | 75,734 | 13,075 | 31,426 | 11,078 | - | 274,155 | 127,509 | - | 559,744 | 324,588 |
Asia | 167,706 | 23,140 | 40,997 | 103,091 | 24,763 | 10,321 | - | 255,925 | 55,529 | - | 288,995 | 392,477 |
Latin America & the Caribbean | 93,669 | - | - | 24,972 | 20,352 | 3,609 | - | 69,582 | 23,423 | - | 137,444 | 98,163 |
Europe & Central Asia | 3,625 | 4,285 | - | 11,312 | 3,288 | 17,833 | - | 72,687 | 42,316 | - | 49,229 | 106,117 |
Non-region specific | 37,003 | 41,507 | 23,258 | 11,060 | - | - | - | 12,799 | 83,050 | - | 143,311 | 65,366 |
Total | 627,078 | 95,212 | 139,989 | 163,510 | 79,829 | 42,841 | - | 685,148 | 331,827 | - | 1,178,723 | 986,711 |
Equity portfolio including Associates distributed by region and sector | ||||||||||||
December 31, 2018 | Financial Institutions | Energy | Agribusiness | Multi-Sector Fund Investments | Infrastructure, Manufacturing, Services | Total | ||||||
Direct | Funds | Direct | Funds | Direct | Funds | Direct | Funds | Direct | Funds | Direct | Funds | |
Africa | 272,447 | 20,778 | 68,874 | 12,643 | 30,557 | 13,312 | - | 256,229 | 115,079 | - | 486,957 | 302,962 |
Asia | 102,673 | 21,222 | 14,477 | 81,399 | 24,762 | 12,198 | - | 221,708 | 24,180 | - | 166,092 | 336,527 |
Latin America & the Caribbean | 70,354 | - | 1,121 | 21,660 | 17,398 | 14,502 | - | 68,869 | 23,665 | - | 112,538 | 105,031 |
Europe & Central Asia | 971 | 6,862 | - | 10,866 | 2,076 | 13,108 | - | 64,998 | 37,124 | - | 40,171 | 95,834 |
Non-region specific | 36,275 | 38,354 | 14,499 | 5,317 | - | - | - | 13,411 | 43,551 | - | 94,325 | 57,082 |
Total | 482,720 | 87,216 | 98,971 | 131,885 | 74,793 | 53,120 | - | 625,215 | 243,599 | - | 900,083 | 897,436 |
Concentration risk
Definition
Concentration risk is the risk that FMO’s exposures are too concentrated within or across different risk categories. Concentration risk may trigger losses large enough to threaten the institution’s health or ability to maintain its core operations or trigger material change in institution’s risk profile.
Risk appetite and governance
Strong diversification within FMO’s emerging market portfolio is ensured through stringent limits on individual counterparties (single and group risk limits), sectors, countries and regions. These limits are monitored by Risk, reviewed regularly and approved by the IRC. Diversification across countries, sector and individual counterparties is a key strategy to safeguard the credit quality of the portfolio.
Developments
Overall economic conditions in emerging markets were modest in 2019, with economic growth continuing in most markets. However, some of the markets experienced strong head winds due to specific circumstances. In Latin America several countries were going through an economic crisis. Being an important market for FMO, especially the developments in Argentina were intensively monitored. After a contraction of 2.5% in 2018, the economy of Argentina further worsened with an expected decline of 3.1% in 2019, according to the International Monetary Fund. Argentina is currently reforming its economy in order to comply with the largest IMF program in the country’s history ($57 billion).
Additionally, presidential elections of October 2019 have caused turmoil in the market, marked by a strong currency depreciation after the results of the primary elections, tightened capital controls and severe downgrades by external rating agencies. A default or debt restructuring of the country is possible and this is reflected in the country’s rating of F19 (2018: F15). At the end of 2019, FMO had 20 clients in Argentina, with a total loan exposure of €303 milion. Some of these clients are facing difficulties due to recent events. Developments on the mid- and long term are difficult to predict since the new administration was only recently elected. Other relevant economies in the Latin American region that are in contraction are Nicaragua (exposure of €114 million) and Ecuador (€126 million).
Next to the crisis in Latin America, economic and political conditions were turbulent in Turkey. According to the latest IMF outlook, Turkey fell into a recession in 2018 and it is projected to grow by just 0.2% in 2019. Various events occurred over the course of 2019, such as local elections in March where the ruling AKP party lost in several key municipalities and a military offensive against Kurdish militants in northeast Syria. At the end of 2019, FMO had 28 clients in Turkey with a total loan exposure of €405 million. Overall FMO’s portfolio in Turkey remains stable, with two non- performing loans, of which one is attributed to client-specific circumstances unrelated to the current economic crises.
The developments in both Turkey and Argentina are closely monitored by FMO’s Investment departments, Credit and the IRC.
Country, regional and sector exposures
Country risk arises from country-specific events that adversely impact FMO’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 currency crises, sovereign defaults and political risk events.
To ensure diversification within FMO’s emerging market portfolio across regions, a country limit framework is in place to minimize concentration risk from the perspective of the portfolio as a whole. Country limits range from 8% to 22% of FMO’s capital, depending on the country rating, where FMO sets higher limits in less risky countries. The assessment of the country rating (F-rating scoring in line with internal credit risk rating) is based on a benchmark of external rating agencies and other external information. In 2019, FMO has reviewed its country risk framework, based on a peer analysis and discussions with external parties. It was found that FMO was overly conservative regarding assigning country ratings, hence a less conservative approach is now applied. Consequently, the ratings of various countries were upgraded by one notch.
In determining the limit usage within a country for loans, the committed portfolio amount as well as underlying transaction specific elements - which may lead to effective reduction of country risk - are considered. The figure below provides an overview of the diversification over the countries of FMO’s gross outstanding in the loan portfolio.
In general, the loan portfolio remains well diversified across different countries. The single largest country exposure is under 10% of the total loan book. The three largest country exposures in the loan book at the end of 2019 were India, Turkey and Argentina, together 22% of the total exposure. Following the rating downgrades of S&P, Moody’s and Fitch, Argentina has now an internal rating of F19 (2018: F15). The ratings of India and Turkey did not change throughout the year. The loan portfolio in Argentina increased with €125 million due to new transactions across different sectors. Other noteworthy changes in country ratings are upgrades of Georgia to F12 (2018: F13), Armenia to F13 (2018: F14), Ghana to F15 (2018: F16) and Ukraine to F16 (2018: F17).
Overview country ratings loan book based on rating scale S&P | ||
Indicative external rating equivalent | 2019 (%) | 2018 (%) |
F9 and higher (BBB and higher ratings) | 4.5 | 5.3 |
F10 (BBB-) | 8.5 | 7.6 |
F11 (BB+) | 3.4 | - |
F12 (BB) | 6.5 | 3.5 |
F13 (BB-) | 10.5 | 13.8 |
F14 (B+) | 26.3 | 29.9 |
F15 (B) | 20.1 | 14.8 |
F16 (B-) | 11.2 | 17.0 |
F17 and lower (CCC+ and lower ratings) | 9.0 | 8.1 |
Total | 100.0 | 100.0 |
On top of country risk limits, FMO has additional limits in place to ensure adequate diversification across sectors and regions. Below an overview of the gross exposure of loans distributed by region and sector is given.
Gross exposure of loans distributed by region and sector | ||||||
Financial Institutions | Energy | Agribusiness | Multi-Sector Fund Investments | Infrastructure, Manufacturing, Services | Total | |
December 31, 2019 | ||||||
Africa | 406,122 | 622,533 | 141,149 | 31,848 | 212,289 | 1,413,941 |
Asia | 512,229 | 352,552 | 63,610 | - | 190,426 | 1,118,817 |
Latin America & the Caribbean | 522,356 | 480,201 | 261,775 | - | 118,264 | 1,382,596 |
Europe & Central Asia | 637,970 | 222,727 | 225,877 | 37,269 | 95,769 | 1,219,612 |
Non-region specific | 114,345 | 13,338 | 66,358 | - | 41,518 | 235,559 |
Total | 2,193,022 | 1,691,351 | 758,769 | 69,117 | 658,266 | 5,370,525 |
December 31, 2018 | ||||||
Africa | 362,631 | 550,786 | 79,364 | 26,189 | 234,851 | 1,253,821 |
Asia | 438,442 | 366,025 | 43,038 | - | 218,354 | 1,065,859 |
Latin America & the Caribbean | 542,839 | 444,813 | 208,260 | - | 134,683 | 1,330,595 |
Europe & Central Asia | 616,430 | 146,243 | 197,183 | 36,398 | 136,580 | 1,132,834 |
Non-region specific | 89,337 | 19,698 | 75,061 | - | 49,290 | 233,386 |
Total | 2,049,679 | 1,527,565 | 602,906 | 62,587 | 773,758 | 5,016,495 |
Single and group risk exposures
Regarding single and group risk exposures, FMO has set stringent internal limits where the maximum loss possible for one single client or group is set as a percentage of FMO’s shareholders’ equity. At year-end, all exposures are well within these limits. These internal single and group risk limits are set to be more stringent than the regulatory limits such as the ones foreseen under the CRR norm of 25% of eligible capital.
Counterparty credit risk
Definition
Counterparty credit risk in the treasury portfolio is the risk that FMO will suffer economic losses because a counterparty fails to fulfill its financial or other contractual obligations from open positions in the portfolio.
Risk appetite and governance
The main responsibility of FMO’s Treasury department is to fund the core business of FMO and to efficiently and effectively mitigate risks in line with the Treasury’s mandate. The main goal of the treasury portfolio is to maintain a liquidity buffer such that FMO can serve its liquidity needs in both on- going business and in stressed circumstances. FMO’s Treasury department does not have its own trading book and does not actively take open positions in the pursuit of profits. FMO aims to balance between keeping losses within its limited risk tolerance and supporting FMO's business strategy, thereby minimizing credit risk and concentration risk in the treasury portfolio, derivative portfolio, and several bank accounts.
The Treasury department is responsible for day-to-day counterparty risk management. Risk is the ‘second line of defense' and responsible for assessing, quantifying, and monitoring counterparty risk daily. Limit excesses and material findings are reported to the ALCO on a monthly basis, together with recommended mitigations and/or actions. The Risk Department is also responsible for updating related policies and processes and for setting up limits, including minimum credit rating requirements, exposure limits, as well as transaction limits. The policies, processes, relevant parameters, and limits are reviewed and approved by the ALCO annually.
Developments
FMO has followed developments since 2018 for the Brexit Action Plan and in addition, FMO set up a companywide project in early 2019 that captures the full impact of changes and discontinuation of Benchmark interest rates, such as Libor and Eonia. For more details please refer to the section 'Legal Risk'.
Exposures
Counterparty risk exposures in FMO’s treasury portfolios originate from short-term investments (deposits, investment in money market funds, CPs, and collaterals related to transacted derivatives), interest-bearing securities (bonds), and transacted derivatives for hedging purpose. The tables below show outstanding positions as of 31 December.
Overview interest-bearing securities based on rating scale S&P | ||
At December 31 |
|
|
AAA | 274,222 | 246,336 |
AA- to AA+ | 76,015 | 156,044 |
Total | 350,237 | 402,380 |
Geographical distribution interest-bearing securities | ||
At December 31 | 2019 (%) | 2018 (%) |
Finland | 18 | 3 |
France | 6 | 5 |
Germany | 28 | 32 |
Netherlands | 29 | 43 |
Philippines | 6 | 5 |
Sweden | 9 | 8 |
Supra-nationals | 4 | 4 |
Total | 100 | 100 |
Overview short-term deposits | |||
At December 31 | S&P rating (short-term) | 2019 | 2018 |
Dutch central bank | 351,532 | 325,104 | |
Financial institutions | A-1 | 874,328 | 635,925 |
A-2 | 17,573 | 20,956 | |
A-3 | - | - | |
Unrated | - | - | |
Money market funds | A-1+ | 130,044 | 165,866 |
Municipality | - | - | |
Total | 1,373,477 | 1,147,851 |
Supra-nationals are international organizations or unions in which member states delegate part of their national powers to a collective decision making body. As per year-end 2019, the largest exposure in this category is to the European Investment Bank (EIB).
FMO mitigates its counterparty credit risk through various means. Minimum requirements of credit quality are set for counterparties of treasury activities. Netting and collateral agreements are also utilized to reduce counterparty credit risk originating from derivative transactions. FMO has Credit Support Annexes (CSAs) with all derivative counterparties. Additionally, part of the derivative portfolio, particularly EUR and USD interest rate swaps, is cleared through central counterparties, as required by the European Market Infrastructure Regulations (EMIR).
Derivative financial instruments distributed by rating, based on rating scale S&P | ||||
2019 | 2018 | |||
Net exposure | CSA (%) | Net exposure | CSA (%) | |
AA- to AA+ | - | - | ||
A to A+ | 58,414 | 100 | 79,845 | 100 |
BBB | - | - | ||
Central cleared | 25,853 | 100 | 12,427 | 100 |
Total | 84,267 | 100 | 92,272 | 100 |
The exposure of derivative financial instruments is presented for only 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 shown in the table above does not equal the exposure presented in the other tables.
The disclosures as set out in the tables below include financial assets and financial liabilities that:
are offset in the consolidated balance sheet of FMO; or
are subject to an enforceable master netting arrangement or similar agreement that covers similar financial instruments, irrespective of whether they are offset in the consolidated balance sheet.
FMO receives and pledges only cash collateral with respect to derivatives.
(a) | (b) | (c)=(a)-(b) | (d) | (e)=(c)-(d) | ||
Related amounts not offset in the balance sheet | ||||||
December 31, 2019 | Gross amounts recognized in balance sheet | Gross amount of financial assets/liabilities offset in the balance sheet | Net amount presented in the balance sheet | Financial instruments (including non-cash collateral) | Cash collateral1) | Net amount |
FINANCIAL ASSETS | ||||||
Derivatives | 301,237 | - | 301,237 | - | - | - |
FINANCIAL LIABILITIES | ||||||
Derivatives | -257,171 | - | -257,171 | - | ||
Total | 44,066 | - | 44,066 | - | -816 | 46,580 |
(a) | (b) | (c)=(a)-(b) | (d) | (e)=(c)-(d) | ||
Related amounts not offset in the balance sheet | ||||||
December 31, 2018 | Gross amounts recognized in balance sheet | Gross amount of financial assets/liabilities offset in the balance sheet | Net amount presented in the balance sheet | Financial instruments (including non-cash collateral) | Cash collateral1) | Net amount |
FINANCIAL ASSETS | ||||||
Derivatives | 247,823 | - | 247,823 | |||
FINANCIAL LIABILITIES | ||||||
Derivatives | -217,174 | - | -217,174 | |||
Total | 30,649 | - | 30,649 | - | 9,519 | 21,130 |
Liquidity risk
Definition
Liquidity risk is defined as the risk for FMO not being able to fulfill its financial obligations due to insufficient availability of liquid means.
Risk appetite and governance
FMO’s risk appetite is to maintain adequate liquidity buffers to fulfill FMO’s current and future financial obligations. The appetite follows a similar rationale as for capital and it is aimed to maintain enough liquidity to ensure FMO would never need to fall back on the guarantee provided by the Dutch State to our investors. To realize this ambition, minimum liquidity requirements apply as prescribed by the regulator.
FMO’s Liquidity Risk Policy Framework is built on four Pillars.
Minimum liquidity buffer under stress
Maturity matched funding
Diversified funding
Meet regulatory requirements
Based on these four pillars. FMO’s risk appetite levels are defined for a 7-month minimum survival period under stress, a liquidity coverage ratio (LCR) to exceed 135%, a Net Stable Funding Ratio (NSFR) to exceed 110%, and restrictions on failed funding periods and cost of wholesale funding above peers. Additional thresholds such as matching funding and liquidity in specific currencies are also in place for managing and monitoring the risk profile of the bank. These monitoring metrics are delegated to Director Risk and Director Treasury and are subject to a formal sign- off procedure and reported to the ALCO. The ALCO is also responsible to approve the Liquidity Risk Policy.
FMO traditionally has a conservative liquidity policy and funding strategy that is well suited to its business. Stress tests are conducted on FMO’s liquidity position on weekly basis to ensure this conservative position is maintained. For the annual Internal Liquidity Adequacy Assessment Process (ILAAP), FMO performs additional stress tests including a severe stress scenario provided by DNB and includes reverse stress testing. A continuous review is performed on the liquidity position, FMO’s assumptions, internal expectations and external market conditions to ensure that FMO’s liquidity planning is accurate.
The Liquidity Contingency Plan sets out FMO’s strategy for addressing liquidity needs in the case of a crisis, ensuring that various sources of emergency liquidity are available to meet all current and future financial obligations, whilst avoiding excessive funding costs, incurring unacceptable losses and significantly changing the business profile. The liquidity sources include a long-term bond portfolio and a portfolio of short-term instruments such as cash, Money Market Funds, Commercial Paper (CP) and Treasury Bills. The long-term bonds and CP can be used as collateral in repurchase agreements to obtain short-term cash from the Dutch Central Bank or from commercial parties.
Developments
FMO reviewed its 2019-2022 funding strategy to increase diversification across funding sources and instruments. Moreover, the Sustainability Bonds Framework was also updated to include new categories for green and social projects and to allow FMO to issue Green Bonds, Social Bonds or Sustainability Bonds. As a result of this, in February 2019, FMO issued its first green bond, a 5-year fixed rate US$500 mln transaction, having previously pioneered the Sustainability Bond market with three EUR-denominated, and one SEK- denominated, sustainability bond issuances. The transaction was characterized by high quality and diverse orderbook supported by strong demand from green motivated investors. Bank treasuries took 51% of allocations, followed by central banks and official institutions (31%), asset managers (15%), insurance and pension funds (2%) and private banks (1%). The proceeds will be mainly allocated to Renewable and Energy Efficiency projects contracted in 2018.
Over the past few years, FMO has established a key role in local currency frontier markets and is keen to continue issuances in 2020, fostering capital markets development in line with its mandate. In total, FMO issued approximately US$250 mln equivalent funding in local currency transactions during 2019. Among these funding transactions were a number of deals that were new to FMO and, in some cases, new to the whole market. Examples of the currencies for which FMO was able to find investor interest are the Haitian Gourde, the Guatemalan Quetzal and the Uzbekistani Soum.
Regarding liquidity risk management, FMO made steps to improve the internal monitoring and forecasting tools, leading to a more efficient liquidity management.
Liquidity position
Throughout the course of 2019, FMO's liquidity position has been compliant with internal and regulatory metrics.
The following table shows the categorization of the balance sheet per maturity bucket. This table shows the timing of the undiscounted principal cash flows, and not the market values, per instrument. The totals per instrument may therefore differ from the totals on the balance sheet. Expected cash flows resulting from irrevocable facilities being drawn are not included in the liquidity gap. For internal liquidity planning and management, cash flows from irrevocable facilities are included in the cash flow forecasts.
Categorization of principal cash flows per maturity bucket | |||||||
December 31, 2019 | < 3 months | 3-12 months | 1-5 years | >5 years | Maturity undefined | Total | |
Assets | |||||||
Banks | 64,626 | - | - | - | - | 64,626 | |
Current accounts with State funds and other programs | - | - | - | - | 1,194 | 1,194 | |
Short-term deposits | |||||||
-of which: Amortized cost | 351,532 | - | - | - | 95,176 | 446,708 | |
-of which: Fair value through profit or loss | 927,675 | - | - | - | - | 927,675 | |
Interest-bearing securities | 49,854 | 26,880 | 222,175 | 60,270 | - | 359,179 | |
Derivative financial instruments | 49,735 | 48,960 | 85,704 | 36,615 | - | 221,014 | |
Loans to the private sector | |||||||
-of which: Amortized cost | 210,701 | 578,738 | 2,532,199 | 1,208,601 | - | 4,530,239 | |
-of which: Fair value through profit or loss | 55,203 | 60,928 | 374,078 | 253,378 | - | 743,587 | |
Equity investments | |||||||
-of which: Fair value through OCI | - | - | - | - | 122,921 | 122,921 | |
-of which: Fair value through profit or loss | - | - | - | - | 1,756,644 | 1,756,644 | |
Investments in associates | - | - | - | - | 285,867 | 285,867 | |
Current tax receivables | 46,484 | - | - | - | - | 46,484 | |
Other receivables | 25,823 | - | - | - | - | 25,823 | |
Property, plant and equipment | - | - | - | - | 28,289 | 28,289 | |
Intangible assets | - | - | - | - | 17,585 | 17,585 | |
Deferred income tax assets | - | - | - | - | 6,986 | 6,986 | |
Total assets | 1,781,633 | 715,506 | 3,214,156 | 1,558,864 | 2,314,662 | 9,584,821 | |
Liabilities and shareholders’ equity | |||||||
Short-term credits | - | - | - | - | 94,339 | 94,339 | |
Current accounts with State funds and other programs | 2,832 | - | - | - | - | 2,832 | |
Derivative financial instruments | 36,862 | 8,349 | 98,370 | 77,771 | - | 221,352 | |
Debentures and notes | 509,182 | 758,623 | 3,601,706 | 890,063 | - | 5,759,574 | |
Wage tax liabilities | 412 | - | - | - | - | 412 | |
Accrued liabilities | 22,983 | - | - | - | - | 22,983 | |
Other liabilities | 21,244 | 2,386 | 10,731 | 9,598 | - | 43,959 | |
Provisions | - | - | - | - | 49,440 | 49,440 | |
Deferred income tax liabilities | - | - | - | - | 5,638 | 5,638 | |
Shareholders’ equity | - | - | - | - | 3,127,037 | 3,127,037 | |
Total liabilities and shareholders’ equity | 593,515 | 769,358 | 3,710,807 | 977,432 | 3,276,454 | 9,327,566 | |
Liquidity gap 2019 | 1,188,118 | -53,852 | -496,651 | 581,432 | -961,792 | 257,255 | |
14 |
Categorization of principal cash flows per maturity bucket | ||||||
December 31, 2018 | < 3 months | 3-12 months | 1-5 years | >5 years | Maturity undefined | Total |
Assets | ||||||
Banks | 54,642 | - | - | - | - | 54,642 |
Current accounts with State funds and other programs | - | - | - | - | 494 | 494 |
Short-term deposits | ||||||
-of which: Amortized cost | 325,091 | - | - | - | 66,544 | 391,635 |
-of which: Fair value through profit or loss | 528,153 | 231,340 | - | - | - | 759,493 |
Interest-bearing securities | 19,544 | 35,695 | 211,528 | 135,500 | - | 402,267 |
Derivative financial instruments | 27,722 | 21,488 | 133,611 | 31,016 | - | 213,837 |
Loans to the private sector | ||||||
-of which: Amortized cost | 219,497 | 498,966 | 2,312,089 | 1,105,188 | - | 4,135,740 |
-of which: Fair value through profit or loss | 29,374 | 34,302 | 350,922 | 267,479 | - | 682,077 |
Equity investments | ||||||
-of which: Fair value through OCI | - | - | - | - | 77,553 | 77,553 |
-of which: Fair value through profit or loss | - | - | - | - | 1,504,427 | 1,504,427 |
Investments in associates | - | - | - | - | 215,539 | 215,539 |
Current tax receivables | 24,448 | - | - | - | - | 24,448 |
Other receivables | 20,597 | - | - | - | - | 20,597 |
Property, plant and equipment | - | - | - | - | 1,677 | 1,677 |
Intangible assets | - | - | - | - | 13,505 | 13,505 |
Deferred income tax assets | - | - | - | - | 8,357 | 8,357 |
Total assets | 1,249,068 | 821,791 | 3,008,150 | 1,539,183 | 1,888,096 | 8,506,288 |
Liabilities and shareholders’ equity | ||||||
Short-term credits | - | - | - | - | 76,051 | 76,051 |
Current accounts with State funds and other programs | 4,173 | - | - | - | - | 4,173 |
Derivative financial instruments | 31,158 | 19,550 | 64,779 | 77,801 | - | 193,288 |
Debentures and notes | 30,748 | 1,123,126 | 3,343,957 | 640,405 | - | 5,138,236 |
Wage tax liabilities | 262 | - | - | - | - | 262 |
Accrued liabilities | 10,086 | - | - | - | - | 10,086 |
Other liabilities | 1,331 | - | - | - | - | 1,331 |
Provisions | - | - | - | - | 54,547 | 54,547 |
Deferred income tax liabilities | - | - | - | - | 2,801 | 2,801 |
Shareholders’ equity | - | - | - | - | 2,983,808 | 2,983,808 |
Total liabilities and shareholders’ equity | 77,758 | 1,142,676 | 3,408,736 | 718,206 | 3,117,207 | 8,464,583 |
Liquidity gap 2018 | 1,171,310 | -320,885 | -400,586 | 820,977 | -1,229,111 | 41,705 |
The tables below are based on the final availability date of the contingent liabilities and irrevocable facilities.
Contractual maturity of contingent liabilities and irrevocable facilities | |||||
December 31, 2019 | < 3 months | 3-12 months | 1-5 years | >5 years | Total |
Contingent liabilities | - | - | 68,444 | 29,926 | 98,370 |
Irrevocable facilities | 2,331 | 34,122 | 496,189 | 1,250,240 | 1,782,882 |
Total off-balance1) | 2,331 | 34,122 | 564,633 | 1,280,166 | 1,881,252 |
December 31, 2018 | < 3 months | 3-12 months | 1-5 years | >5 years | Total |
Contingent liabilities | 0 | 10,161 | 45,044 | 19,861 | 75,066 |
Irrevocable facilities | 81,988 | 669,092 | 674,525 | 383,584 | 1,809,189 |
Total off-balance1) | 81,988 | 679,253 | 719,569 | 403,445 | 1,884,255 |
- 1 FMO expects that not all of these off-balance items will be drawn before expiration date.
FMO complies with DNB’s Pillar 2 liquidity requirements methodology for Less Significant Institutions (LSIs) which have been applied from the supervisory review and evaluation process (SREP). The liquidity requirements are a survival period of at least 6 months based on internal stress testing methodology, a Net Stable Funding Ratio (NSFR) of 100% and a specific Liquidity Coverage Ratio (LCR) requirement of 100%. FMO's internal liquidity appetite levels include a safety cushion over and above these minimum requirements as described in the section above.
Following the risk appetite, FMO's liquidity position has been well above regulatory requirements and internal appetite levels throughout 2019. Per reporting date, FMO has a survival period of 48 months (2018: over 9 months), an LCR of 252% (2018: 965%) and a NSFR of 119.6% (2018: 112%).
FMO’s major liquidity exposures are in EUR and USD currencies. However, some transactions are denominated – and may be settled - in local currencies. These exposures are specifically hedged using financial instruments to minimize liquidity and settlement risks.
Funding and sustainability bonds
Treasury aims to ensure good market access by diversifying FMO’s funding sources. The result of this is a balanced funding mix in terms of geography, instrument and maturity.
Eurodollar (i.e. USD investors outside the United States) constitute key markets for FMO. Treasury has identified USD and EUR as strategic funding markets. Other markets to attract funding include Australia, Sweden and local frontier currencies. Typical investors in FMO paper, either through public or private issues, are hold to maturity investors. A final important factor to note about FMO funding, except for our Tier II issuance, is that it is plain vanilla; it is all senior unsecured funding. The liquidity profile of our funding notes is therefore very straightforward.
Thematic bonds are an important part of FMO’s funding strategy, that accounts for about 30% of the total capital market issuances as of December 2019. The FMO Sustainability Bonds Framework was updated in December 2018 in order to issue Green Bonds, Social Bonds or Sustainability Bonds to support FMO’s Strategy. In February 2019, FMO has issued its first US$500 mln Green Bond maturing by 20 February 2024.
Market risk
Market Risk is the risk that the value and/or the earnings of the bank decline because of unfavorable market movements. At FMO, it encompasses interest rate risk and currency risk.
Interest rate risk in the banking book
Definition
Interest rate risk is the risk of potential loss due to adverse movements in interest rates. Changing interest rates mainly influence the fair value of fixed interest balance sheet items.
Risk appetite and governance
FMO has no trading book and all assets (loans and investments) are part of the banking book. FMO’s policy is to match assets and liabilities within set boundaries. As the loan portfolio is more granular, loans are pre-funded and new funding is obtained periodically and matched to the asset portfolio in terms of expected maturity and interest rate sensitivity. Interest rate risk arises from the residual tenor mismatch, mismatch in fixed rate assets funded by floating rate liabilities, and differences in reference rates or currencies resulting in basis risk. FMO has little optionality in its portfolio and has no material exposure to rates-driven prepayment risk. The volatility of the market value of assets and liabilities over the holding period due to interest rate movements is of lesser concern as these are held until maturity.
Interest rate risk management falls under the responsibility of the ALCO. The day-to-day management of interest rate risk, particularly quantification and monitoring, is delegated to Risk Management. Treasury department acts as the first line of defense and is responsible for daily transacting activities. Interest rate risk is monitored using earnings-based metrics and value-based metrics.
Earnings-based methods capture short-term effects of interest rate re-fixing or re-pricing that may impact net interest incomes. The metrics below are used for this purpose.
The interest rate gap provides a static overview of the full balance sheet’s repricing and refinancing characteristics. The gap is monitored over different time buckets where limits are in place both per bucket and on cumulative level, for all currencies (aggregate and currency-by-currency).
Earnings-at-Risk (EaR) provides a dynamic projection of net interest income sensitivity to yield curve shocks. FMO monitors EaR on a 2-year forward looking basis and applies different scenarios simultaneously that allow for identification of basis risk as well.
Economic value methods capture changes in net present values of assets, liabilities and off-balance sheet items to changes in yield curves. Value-based metrics measure long-term effects of interest rate changes over the full tenor of the balance sheet. The following economic value metrics are calculated:
Basis Point Value (BPV) provides the change in market value of assets, liabilities and interest-rate risk sensitive off-balance items for a one basis point change in yield curves. Limits are in place for the whole balance sheet, and for main currencies (EUR and USD) separately.
Equity Value at Risk (EVaR) provides changes in the economic value of the shareholder’s equity given certain shifts in yield curves. The impacts of both a 200 basis-points parallel shift and a 200 basis-points gradual shift are reported.
The interest rate gap and BPV exposure are monitored on weekly basis against limits set by the ALCO. Limits are defined dynamically to accommodate a 200 basis-points shock within 5% of shareholder’s equity. The EVaR limit is defined in the Risk Appetite Framework and set at 5% of shareholder’s equity. The EaR is used for monitoring purposes only and thresholds are defined based on 5% of projected net interest income.
Developments
No material developments occured in 2019. The Benchmark reform and discontinuation of LIBOR is closely monitored by FMO's BMR & IBOR ending project. FMOs interest rate position will be affected by the transition of contract reference rates and in the valuation of derivatives. FMO is closely monitoring this transition and will take appropriate actions to ensure that the impact on interest rate risk is not material.
Exposures
The limits with respect to interest rate risk were not breached in 2019. The following table summarizes the interest re-pricing characteristics for FMO’s assets and liabilities.
Interest re-pricing characteristics | ||||||
December 31, 2019 | < 3 months | 3-12 months | 1-5 years | > 5 years | Non-interest-bearing | Total |
Assets | ||||||
Banks | 64,626 | - | - | - | - | 64,626 |
Current accounts with State funds and other programs | - | - | - | - | 1,194 | 1,194 |
Short-term deposits | ||||||
-of which: Amortized cost | 446,708 | - | - | - | - | 446,708 |
-of which: Fair value through profit or loss | 926,769 | - | - | - | - | 926,769 |
Interest-bearing securities | 46,295 | 24,846 | 217,442 | 59,786 | 1,868 | 350,237 |
Derivative financial instruments1 | 79,142 | 109,287 | 62,654 | 3,105 | 47,049 | 301,237 |
Loans to the private sector | - | |||||
-of which: Amortized cost | 1,847,317 | 1,331,809 | 692,762 | 401,839 | 60,382 | 4,334,109 |
-of which: Fair value through profit or loss | 292,700 | 211,020 | 109,766 | 63,670 | 19,357 | 696,513 |
Equity investments | - | |||||
-of which: Fair value through OCI | - | - | - | - | 122,921 | 122,921 |
-of which: Fair value through profit or loss | - | - | - | - | 1,756,644 | 1,756,644 |
Investment in associates | - | - | - | - | 285,867 | 285,867 |
Current tax receivables | - | - | - | - | 46,484 | 46,484 |
Other receivables | - | - | - | - | 25,824 | 25,824 |
Property, plant and equipment | - | - | - | - | 28,289 | 28,289 |
Intangible assets | - | - | - | - | 17,585 | 17,585 |
Deferred income tax assets | - | - | - | - | 6,986 | 6,986 |
Total assets | 3,703,557 | 1,676,962 | 1,082,624 | 528,400 | 2,420,450 | 9,411,993 |
Liabilities and shareholders’ equity | ||||||
Short-term credits | 94,339 | - | - | - | - | 94,339 |
Current accounts with State funds and other programs | - | - | - | - | 2,832 | 2,832 |
Derivative financial instruments1 | 181,315 | 10,937 | 24,656 | 4,618 | 35,645 | 257,171 |
Debentures and notes | 1,110,742 | 751,707 | 2,981,528 | 919,354 | 44,851 | 5,808,182 |
Wage tax liabilities | - | - | - | - | 412 | 412 |
Accrued liabilities | - | - | - | - | 22,983 | 22,983 |
Other liabilities | - | - | - | - | 43,959 | 43,959 |
Provisions | - | - | - | - | 49,440 | 49,440 |
Deferred income tax liabilities | - | - | - | - | 5,638 | 5,638 |
Shareholders’ equity | - | - | - | - | 3,127,037 | 3,127,037 |
Total liabilities and shareholders’ equity | 1,386,396 | 762,644 | 3,006,184 | 923,972 | 3,332,797 | 9,411,993 |
Interest sensitivity gap 2018 | 2,317,161 | 914,318 | -1,923,560 | -395,572 | -912,347 |
- 1 Fair value of individual components (e.g. individual swap legs) of derivative financial instruments is allocated to the relevant interest re-pricing category.
Interest re-pricing characteristics | ||||||
December 31, 2018 | < 3 months | 3-12 months | 1-5 years | > 5 years | Non-interest-bearing | Total |
Assets | ||||||
Banks | 54,642 | - | - | - | - | 54,642 |
Current accounts with State funds and other programs | - | - | - | - | 494 | 494 |
Short-term deposits | - | |||||
-of which: Amortized cost | 391,635 | - | - | - | - | 391,635 |
-of which: Fair value through profit or loss | 756,216 | - | - | - | - | 756,216 |
Interest-bearing securities | 17,460 | 35,695 | 211,528 | 135,500 | 2,197 | 402,380 |
Derivative financial instruments1 | -615,701 | -1,431,140 | 1,725,010 | 545,591 | 24,063 | 247,823 |
Loans to the private sector | - | |||||
-of which: Amortized cost | 1,653,597 | 1,325,039 | 684,131 | 363,217 | 59,038 | 4,085,022 |
-of which: Fair value through profit or loss | 272,739 | 218,547 | 112,838 | 59,908 | 21,767 | 685,799 |
Equity investments | - | |||||
-of which: Fair value through OCI | - | - | - | - | 77,553 | 77,553 |
-of which: Fair value through profit or loss | - | - | - | - | 1,504,427 | 1,504,427 |
Investment in associates | - | - | - | - | 215,539 | 215,539 |
Current tax receivables | - | - | - | - | 24,448 | 24,448 |
Other receivables | - | - | - | - | 20,597 | 20,597 |
Property, plant and equipment | - | - | - | - | 1,677 | 1,677 |
Intangible assets | - | - | - | - | 13,505 | 13,505 |
Deferred income tax assets | - | - | - | - | 8,357 | 8,357 |
Total assets | 2,530,588 | 148,141 | 2,733,507 | 1,104,216 | 1,973,662 | 8,490,114 |
Liabilities and shareholders’ equity | ||||||
Short-term credits | 76,051 | - | - | - | - | 76,051 |
Current accounts with State funds and other programs | - | - | - | - | 4,173 | 4,173 |
Derivative financial instruments1 | 255,039 | 243,092 | -313,859 | 2,732 | 30,170 | 217,174 |
Debentures and notes | 1,940,285 | 245,975 | 2,286,840 | 640,572 | 26,209 | 5,139,881 |
Wage tax liabilities | - | - | - | - | 262 | 262 |
Accrued liabilities | - | - | - | - | 10,086 | 10,086 |
Other liabilities | - | - | - | - | 1,331 | 1,331 |
Provisions | - | - | - | - | 54,547 | 54,547 |
Deferred income tax liabilities | - | - | - | - | 2,801 | 2,801 |
Shareholders’ equity | - | - | - | - | 2,983,808 | 2,983,808 |
Total liabilities and shareholders’ equity | 2,271,375 | 489,067 | 1,972,981 | 643,304 | 3,113,387 | 8,490,114 |
Interest sensitivity gap 2018 | 259,213 | -340,926 | 760,526 | 460,912 | -1,139,725 |
- 1 Fair value of individual components (e.g. individual swap legs) of derivative financial instruments is allocated to the relevant interest re-pricing category.
Currency risk
Definition
Currency risk is defined as the risk that changes in foreign currency exchange rates have an adverse effect on the value of FMO’s financial position and future cash flows. FMO also reviews currency risk in terms of impact on the capital ratios.
Risk appetite and governance
FMO offers loans and attracts funding in a wide range of currencies. This is done to provide financing in the currency best fitting FMO’s clients and to reduce currency risks on their side. To ensure proper diversification, FMO attracts funding in different currencies, both on-shore and off-shore, including emerging market and frontier market currencies which contribute to FMO’s goal to develop local currency markets.
FMO has limited appetite for currency risk. Exposures are hedged through matching currency characteristics of assets with liabilities, or through derivative transactions such as cross-currency swaps and FX forwards conducted with either commercial parties or with The Currency Exchange Fund (TCX Fund N.V.). Most currency exposures are hedged to US dollars on a micro-hedge basis, whereby the US dollar position is managed on a portfolio basis accordingly. FMO does not take any active positions in any currency for purpose of making a profit. Each individual currency is managed within a strict position limit and an overall appetite level is set at 1% of shareholder’s equity for the total open position across all currencies. Both the individual and overall open positions are monitored by Risk Management on a daily basis. Additionally, FMO maintains a deliberately unhedged foreign currency position for the purpose of structural hedge which is reported by Risk Management to the ALCO monthly. Please refer to structural hedge sub-section for further details.
Developments
No material developments occurred in 2019.
Exposures
Individual and total open currency positions were within risk appetite in 2019. The table below illustrates that the currency risk sensitivity gap per December 2019 is almost completely part of FMO's equity investments and investments in associates.
Currency risk exposure (at carrying values) | ||||||
December 31, 2019 | EUR | USD | INR | GEL | Other | Total |
Assets | ||||||
Banks | 41,831 | 15,672 | 5,101 | 12 | 2,010 | 64,626 |
Current accounts with State funds and other programs | 1,194 | - | - | - | - | 1,194 |
Short-term deposits | ||||||
-of which: Amortized cost | 445,823 | - | - | - | 885 | 446,708 |
-of which: Fair value through profit or loss | - | 926,769 | - | - | - | 926,769 |
Interest-bearing securities | 251,692 | 98,545 | - | - | - | 350,237 |
Derivative financial instruments1 | 789,864 | -209,130 | -255,392 | -55,846 | 31,741 | 301,237 |
Loans to the private sector | ||||||
-of which: Amortized cost | 521,130 | 3,077,423 | 303,591 | 138,926 | 293,039 | 4,334,109 |
-of which: Fair value through profit or loss | 113,791 | 521,079 | 57,787 | - | 3,856 | 696,513 |
Equity investments | ||||||
-of which: Fair value through OCI | 10,595 | 112,326 | - | - | - | 122,921 |
-of which: Fair value through profit or loss | 274,819 | 1,227,427 | 116,250 | - | 138,148 | 1,756,644 |
Investments in associates | - | 285,867 | - | - | - | 285,867 |
Current tax receivables | 46,484 | - | - | - | - | 46,484 |
Other receivables | 16,909 | 7,538 | 1 | - | 1,376 | 25,824 |
Property, plant and equipment | 28,289 | - | - | - | - | 28,289 |
Intangible assets | 17,585 | - | - | - | - | 17,585 |
Deferred income tax assets | 6,986 | - | - | - | - | 6,986 |
Total assets | 2,566,992 | 6,063,516 | 227,338 | 83,092 | 471,055 | 9,411,993 |
Liabilities and shareholders’ equity | ||||||
Short-term credits | 72,140 | 22,199 | - | - | - | 94,339 |
Current accounts with State funds and other programs | 2,832 | - | - | - | - | 2,832 |
Derivative financial instruments1 | -716,416 | 2,076,851 | 144,529 | -76,009 | -1,171,784 | 257,171 |
Debentures and notes | 1,824,061 | 2,347,883 | - | 171,929 | 1,464,309 | 5,808,182 |
Wage tax liabilities | 564 | - | - | - | -152 | 412 |
Accrued liabilities | -46,964 | 1,720 | 263 | - | 67,964 | 22,983 |
Other liabilities | 28,754 | 15,141 | - | - | 64 | 43,959 |
Provisions | 41,839 | 6,805 | 69 | - | 727 | 49,440 |
Deferred income tax liabilities | 5,638 | - | - | - | - | 5,638 |
Shareholders’ equity | 3,127,037 | - | - | - | - | 3,127,037 |
Total liabilities and shareholders’ equity | 4,339,485 | 4,470,599 | 144,861 | 95,920 | 361,128 | 9,411,993 |
Currency gap 2019 | 1,592,917 | 82,477 | -12,828 | 109,927 | ||
Currency gap 2019 excluding equity investments and investments in associates | -32,707 | -33,773 | -12,828 | -28,217 |
- 1 Fair value of individual components (e.g. individual swap legs) of derivative financial instruments is allocated to the relevant currency category.
Currency risk exposure (at carrying values) | ||||||
December 31, 2018 | EUR | USD | SEK | INR | Other | Total |
Assets | ||||||
Banks | 32,980 | 15,384 | 2 | 4,232 | 2,044 | 54,642 |
Current accounts with State funds and other programs | 494 | - | - | - | - | 494 |
Short-term deposits | - | |||||
-of which: Amortized cost | 391,661 | -26 | - | - | - | 391,635 |
-of which: Fair value through profit or loss | - | 756,216 | - | - | - | 756,216 |
Interest-bearing securities | 275,165 | 127,215 | - | - | - | 402,380 |
Derivative financial instruments1 | 1,436,244 | -1,279,012 | 323,390 | -135,486 | -97,313 | 247,823 |
Loans to the private sector | - | |||||
-of which: Amortized cost | 447,947 | 3,090,290 | - | 183,630 | 363,155 | 4,085,022 |
-of which: Fair value through profit or loss | 109,512 | 514,093 | - | 60,041 | 2,153 | 685,799 |
Equity investments | - | |||||
-of which: Fair value through OCI | 10,551 | 67,002 | - | - | - | 77,553 |
-of which: Fair value through profit or loss | 285,137 | 1,062,602 | - | 25,170 | 131,518 | 1,504,427 |
Investments in associates | 1,529 | 214,010 | - | - | - | 215,539 |
Current tax receivables | 24,448 | - | - | - | - | 24,448 |
Other receivables | 8,792 | 11,425 | - | 2 | 378 | 20,597 |
Property, plant and equipment | 1,677 | - | - | - | - | 1,677 |
Intangible assets | 13,505 | - | - | - | - | 13,505 |
Deferred income tax assets | 8,357 | - | - | - | - | 8,357 |
Total assets | 3,047,999 | 4,579,199 | 323,392 | 137,589 | 401,935 | 8,490,114 |
Liabilities and shareholders’ equity | ||||||
Short-term credits | 71,373 | 4,678 | - | - | - | 76,051 |
Current accounts with State funds and other programs | 4,173 | - | - | - | - | 4,173 |
Derivative financial instruments1 | -417,605 | 1,251,058 | -113,765 | 127,429 | -629,943 | 217,174 |
Debentures and notes | 1,802,944 | 1,983,374 | 433,563 | - | 920,000 | 5,139,881 |
Wage tax liabilities | 407 | - | - | - | -145 | 262 |
Accrued liabilities | 19,148 | -7,865 | - | 191 | -1,388 | 10,086 |
Other liabilities | 253 | 1,034 | - | - | 44 | 1,331 |
Provisions | 47,853 | 5,488 | - | 5 | 1,201 | 54,547 |
Deferred income tax liabilities | 2,801 | - | - | - | - | 2,801 |
Shareholders’ equity | 2,983,808 | - | - | - | - | 2,983,808 |
Total liabilities and shareholders’ equity | 4,515,155 | 3,237,767 | 319,798 | 127,625 | 289,769 | 8,490,114 |
Currency gap 2018 | 1,341,432 | 3,594 | 9,964 | 112,166 | ||
Currency gap 2018 excluding equity investments and investments in associates | -2,182 | 3,594 | -15,206 | -19,352 |
- 1 Fair value of individual components (e.g. individual swap legs) of derivative financial instruments is allocated to the relevant currency category.
As described above, FMO’s loan assets in local currencies, such as Indian Rupee (INR), are fully swapped to US dollar on a cash flow basis. The positions in these currencies are therefore fully hedged. For IFRS reporting, however, the loans are recorded at (amortized) cost, while the related swaps are recorded at fair value, leading to an accounting mismatch in these currencies.
Sensitivity of profit & loss account and shareholders’ equity to main foreign currencies | ||||
December 31, 2019 | December 31, 2018 | |||
Change of value relative to the euro1) | Sensitivity of profit & loss account | Sensitivity of shareholders’ equity2) | Sensitivity of profit & loss account | Sensitivity of shareholders’ equity2) |
USD value increase of 10% | 148,059 | 11,233 | 127,333 | 6,700 |
USD value decrease of 10% | -148,059 | -11,233 | -127,333 | -6,700 |
SEK value increase of 10% | - | - | 359 | - |
SEK value decrease of 10% | - | - | -359 | - |
INR value increase of 10% | 8,248 | - | 996 | - |
INR value decrease of 10% | -8,248 | - | -996 | - |
GEL value increase of 10% | -1,283 | - | - | - |
GEL value decrease of 10% | 1,283 | - | - | - |
- 1 The sensitivities employ simplified scenarios. The sensitivity of profit & loss account and shareholders’ equity to possible changes in the main foreign currencies is based on the immediate impact on the financial assets and liabilities held at year-end, including the effect of hedging instruments.
- 2 Shareholders’ equity is sensitive to the currency sensitivity gap, including the equity investments valued at cost minus impairments.
Structural Hedge
FMO maintains a deliberately unhedged foreign currency position for purpose of managing the volatility of the capital ratio (structural hedge). These foreign currency positions stem from the private equity investments, and act as a hedge against an adverse effect of the exchange rate on the regulatory capital ratios. A depreciation of FMO's reporting currency (Euro) can significantly affect the capital ratio since FMO’s assets - and hence also the risk weighted assets - are mainly denominated in foreign currencies. The long open position in the equity portfolio thereby functions as a partial hedge for FMO’s regulatory capital ratios. In addition, the uncertainty in the size and the timing of the cash flows for equity investments makes micro- hedging less effective, hence these positions are better fit for use as a capital ratio hedge. With respect to equity investments, the expected returns in local currencies are assessed in terms of their sufficiency to compensate for the currency risk.
Article 352(2) of the CRR allows DNB to authorize, on an ad-hoc basis, the exclusion of FX positions taken deliberately by firms to hedge against the adverse effect of exchange rates on capital ratios where those positions are of a non-trading or structural nature (i.e. the waiver), where properly substantiated and justified. As of 2019, FMO does not have a waiver for its structural hedge positions under Article 352(2) of the CRR.