Investment risk

Risk appetite

Investment risk is defined as the risk that the actual return on an investment will be lower than the expected return. At FMO this includes both Credit Risk (Loan Portfolio) and Equity Risk. Management of Investment Risk is FMO’s core business, as FMO’s investment portfolio makes up the large majority of FMO’s (risk weighted) assets and generates the large majority of FMO’s income. In addition, the Portfolio has a risk of losses through provisions on loans and lower fair values of equity positions. FMO's appetite is to actively manage and diversify the investment risk in the emerging market portfolio. FMO has set internal appetite levels for the following risk metrics: 

  • Non-performing loans

  • Specific provisions on loans

Risk governance

FMO has enhanced its internal credit risk management process by publishing an Investment Risk Framework to fully describe its credit risk management approach and define key regulatory terms. Credit risk from loans in emerging market countries arises from a combination of counterparty risk, country risk and product specific risks. These types of risk are assessed during the credit approval and credit review process and administrated inter alia via internal scorecards. The lending process is based on formalized and strict procedures. Funding decisions depend on both the amount of economic capital and the risk profile of the financing instrument. 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 applies an advanced workout and restructuring approach.

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 is used that reflects benchmarks for the required financial strength of FMO’s clients. This is further supported by internal scorecards that are used for risk classification and the determination of capital use per transaction. For project monitoring FMO subjects its clients to periodic reviews. All credit limits and policies are annually reviewed and approved by the ALCO.

CREDIT RISK IN THE LOAN PORTFOLIO

In measuring the credit risk of the emerging market portfolio at counterparty level, the main parameters are the credit quality of the counterparties and the expected recovery ratio in case of defaults. Counterparty credit quality is measured by scoring counterparties on various dimensions of financial and company strength. Based on these scores, FMO assigns ratings to each counterparty on an internal scale from F1 (lowest risk) to F21 (highest risk), equivalent to credit quality rating scale applied by Moody’s, S&P and Fitch. Likewise, the recovery ratio is assigned by scoring various dimensions of the product specific risk.

Maximum exposure to credit risk of the gross loan portfolio decreased to EUR 4,353,253 in 2017 (2016: EUR 4,825,530). The vast majority of our gross loan portfolio (84%) remains in the F11 to F16 ratings categories.

Gross exposure distributed by internal ratings

Indicative counterparty credit rating scale of S&P and Fitch

Loans neither past due nor value adjusted

Loans past due not value adjusted

Loans counterparty value adjustment

2017

%

F1 – F10 (BBB- and higher)

178,108

-

-

178,108

4.1

F11 – F13 (BB-, BB, BB+)

1,686,766

-

-

1,686,766

38.7

F14 – F16 (B-, B, B+)

1,964,450

31,516

-

1,995,966

45.9

F17 and lower (CCC+ and lower ratings)

235,689

15,534

241,190

492,413

11.3

Total

4,065,013

47,050

241,190

4,353,253

 
      
      
      

Indicative counterparty credit rating scale of S&P and Fitch

Loans neither past due nor value adjusted

Loans past due not value adjusted

Loans counterparty value adjustment

2016

%

F1 – F10 (BBB- and higher)

245,849

13,978

-

259,827

5.4

F11 – F13 (BB-, BB, BB+)

1,804,783

3,621

-

1,808,404

37.5

F14 – F16 (B-, B, B+)

1,964,580

36,217

-

2,000,797

41.4

F17 and lower (CCC+ and lower ratings)

362,460

63,910

330,132

756,502

15.7

Total

4,377,672

117,726

330,132

4,825,530

 

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. 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 EUR 68,129 (2016: EUR 61,050). FMO has received guarantees for an amount of EUR 175,042 (2016: EUR 224,754). Provisions, amortized costs and obligations for guarantees add up to EUR 3,108 (2016: EUR 6,726).

Non-Performing Loans (NPL) are defined as loans with a counterparty-specific value adjustment and/or loans with interest and/or principal payments that are past due 90 days or more. FMO’s NPL ratio decreased from 7.5% to 5.6% inter alia as a result of higher write-offs in 2017. The write offs relate to loans that were contracted in the period from 2008 to 2013 and were already provisioned at least 90% at the beginning of the year, with one exception (EUR 20 mln write off, contracted in 2014). NPLs remain concentrated in Diverse Sectors (62% of NPLs) and geographically in India (27% of NPLs). Activities in diverse sectors were terminated during 2017 following a strategic reorientation, while approval procedures for India have been tightened in April 2017.

Note that for the NPL ratio is influenced by the recognition of a guaranteed amount which is thus deducted from the amount of the non-performing loans. When this guaranteed amount is not taken into account the overall NPL ratio increases to 6.1% (2016: 7.9%).

Loans with interest and/or principal payments that are past due more than 90 days, amount to 4.8 % (2016: 5.0%) of the gross loan portfolio. Past due information related to our portfolio loans and receivables are presented in the table below. Apart from our loan portfolio past due is not applicable for other financial assets such as interest bearing securities and short-term deposits

Irrevocable facilities represent commitments to extend finance to clients. The irrevocable facilities amount to EUR 1,785,159 (2016: EUR 1,820,239) and is corresponding to 30% (2016: 28%) of the net exposure in emerging markets (including loans, equity investments and contingent liabilities). Irrevocable facilities are usually not immediately and fully drawn by clients, especially in case of commitments to equity funds, which have a contractual investment period of several years.

Loans past due and value adjustments 2017

  

Loans not value adjusted

Loans value adjusted

Gross exposure

Counterparty specific value adjustment

Total

       

Loans not past due

4,065,013

28,118

4,093,131

-13,390

4,079,741

Loans past due:

     

-

Past due up to 30 days

23,429

7,634

31,063

-5,726

25,337

-

Past due 30-60 days

19,282

-

19,282

-

19,282

-

Past due 60-90 days

-

-

-

-

-

-

Past due more than 90 days

4,339

205,438

209,777

-121,758

88,019

Subtotal

4,112,063

241,190

4,353,253

-140,874

4,212,379

Less: amortizable fees

-46,675

-1,994

-48,669

 

-48,669

Less: group-specific value adjustments

-63,285

-

-63,285

 

-63,285

Carrying value

4,002,103

239,196

4,241,299

-140,874

4,100,425

Loans past due and value adjustments 2016

  

Loans not value adjusted

Loans value adjusted

Gross exposure

Counterparty specific value adjustment

Total

       

Loans not past due

4,377,672

80,513

4,458,185

-18,810

4,439,375

Loans past due:

     

-

Past due up to 30 days

79,347

24,214

103,561

-14,716

88,845

-

Past due 30-60 days

4,122

-

4,122

-

4,122

-

Past due 60-90 days

3,079

13,828

16,907

-7,189

9,718

-

Past due more than 90 days

31,177

211,578

242,755

-160,143

82,612

Subtotal

4,495,397

330,133

4,825,530

-200,858

4,624,672

Less: amortizable fees

-48,681

-2,746

-51,427

-

-51,427

Less: group-specific value adjustments

-103,297

-

-103,297

-

-103,297

Carrying value

4,343,419

327,387

4,670,806

-200,858

4,469,948

When the terms and conditions of a loan have been modified significantly, FMO considers these loans as restructured. Changes in terms and conditions usually include extending the maturity, changing the interest margin and changing the timing of interest payments. The loans are assessed to determine if they qualify for derecognition and if that is the case, they are recognized as a new loan with valuation differences through profit and loss. Value adjustments related to restructured loans are being measured as indicated in the accounting policies under ‘Value adjustments on loans’. In 2017, our (partial) write-offs equaled to 9 (2016: 7) loans, corresponding to 2.0% (2016: 0.6%) of our portfolio.

At the end of 2017, the counterparty-specific value adjustments as a percentage of the gross loan portfolio equaled 3.2% (2016: 4.2%). The group-specific value adjustments equaled 1.5 % (2016: 2.1%), resulting in total value adjustments of 4.7% (2016: 6.3%) of the gross loan portfolio.

Counterparty-specific value adjustments distributed by regions and sectors

At December 31, 2017

Financial Institutions

Energy

Agri-business

Multi-sector Investment Funds

Infrastructure, Manufacturing, Services

Total

Africa

15,198

-

-

-

8,686

23,884

Asia

-

13,558

-

-

59,002

72,560

Latin America & the Caribbean

1,609

5,829

-

-

22,203

29,641

Europe & Central Asia

422

8,434

3,263

-

2,670

14,789

Non-region specific

-

-

-

-

-

-

Total

17,229

27,821

3,263

-

92,561

140,874

At December 31, 2016

Financial Institutions

Energy

Agri-business

Multi-sector Investment Funds

Infrastructure, Manufacturing, Services

Total

Africa

-

-

-

-

26,325

26,325

Asia

-

9,044

-

-

115,952

124,996

Latin America & the Caribbean

1,572

8,965

-

-

8,847

19,384

Europe & Central Asia

6,885

-

3,554

-

19,714

30,153

Non-region specific

-

-

-

-

-

-

Total

8,457

18,009

3,554

-

170,838

200,858

Offsetting financial assets and financial liabilities

The disclosures as set out in the tables below include fnancial assets and fnancial 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 fnancial instruments, irrespective of whether they are offset in the consolidated balance sheet.

FMO receives and pledges cash collateral only with respect to derivatives.

 

(a)

(b)

(c)=(a)-(b)

(d)

(e)=(c)-(d)

    

Related amounts not offset in the balance sheet

 

At December 31, 2017

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

255,492

-

255,492

   
       

FINANCIAL LIABILITIES

      

Derivatives

-147,424

-

-147,424

   

Total

108,068

-

108,068

-

73,240

34,828

 

(a)

(b)

(c)=(a)-(b)

(d)

(e)=(c)-(d)

    

Related amounts not offset in the balance sheet

 

At December 31, 2016

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

180,830

-

180,830

   
       

FINANCIAL LIABILITIES

      

Derivatives

-423,981

-

-423,981

   

Total

-243,151

-

-243,151

 

-258,029

14,878

Credit risk mitigation

At reporting date FMO obtained collaterals on 26% of the gross amounts of our loan portfolio (2016: 27%). 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. As a result, the value of the collaterals obtained is considered to be fairly limited compared to the total portfolio of loans and receivables.

Aggregate exposure

The following table shows FMO's total gross exposure to credit risk. The exposures, including derivatives, are 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 decreased during the year to EUR 8,706,438 in 2017 (2016: EUR 8,954,682).

Maximum exposure to credit risk, including derivatives

2017

2016

   

On-balance

  

Banks

71,763

58,178

Short-term deposits

853,717

1,156,496

Interest-bearing securities

362,916

575,117

Short-term deposits – Dutch central bank

690,401

86,108

Derivative financial instruments

259,402

186,510

Loans to the private sector

4,353,255

4,825,530

Loans guaranteed by the State

39,528

59,154

Deferred income tax assets

10,587

10,618

Current income tax receivables

7458

-

Current accounts with State funds and other programs

274

1,901

Other receivables

120,713

21,753

Accrued income

83,136

92,028

Total on-balance

6,853,150

7,073,393

   

Off-balance

  

Contingent liabilities(guarantees issued)

68,129

61,050

Irrevocable facilities

1,785,159

1,820,239

Total off-balance

1,853,288

1,881,289

Total credit risk exposure

8,706,438

8,954,682

EQUITY RISK

With regard to equity risk that results from equity investments, a distinction can be made between:

  • Exit risk, the risk that FMO’s equity stake cannot be sold for a reasonable price and in a sufficiently liquid market;

  • Equity risk, the risk that the fair value of an equity investment decreases.

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 realise exits. Equity investments are assessed by the Investment Committee in terms of specific obligor as well as country risk. The Investment Review Committee assesses the valuation of the majority of equity investments quarterly. 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 our co-investing partners. The total outstanding equity portfolio at December 31, 2017, amounts to EUR 1,710,315 (2016: EUR 1,828,172) of which EUR 854,747 (2016: EUR 904,309) is invested in investment funds. Compared to the annual report of 2016 we included the associates in the equity investments to better align with internal management information.

The markets for exits from equity investments improved in 2017 leading to a significant increase in equity exits. Below the main (partial) exits of particular relevance to FMO are listed:

  • In March, FMO exited from TBC Bank in Georgia, which was a highly impactful transaction with one of our long-standing partners. JSC TBC Bank is the first bank in Georgia. FMO has been a shareholder in TBC Bank for seven years and held a 5.2% stake pre-IPO, which has been diluted to 4.4% due to the primary issue (in 2014).

  • In March, FMO sold its stake in Cambodia's PRASAC Microfinance Institution Limited. At the end of 2006 the small Cambodian micro finance company PRASAC (initiated as a project by the European Union), with a loan book of US dollar 23 million, attracted various international shareholders with the purpose to assist the company to grow and transform itself in a modern professional entity. Since 2006 FMO has assisted the company with loans, syndicated loans, biogas loan, technical assistance for various programs like E&S and experienced board members. We sold our interest together with most other shareholders to one new shareholder and one existing shareholder.

  • In December, FMO partially exited from Equis, including SoleQ Holdings and Energon Holdings. FMO invested in 2010 in Equis Fund I, a Fund focussed on developing renewable energy in Asia. In just 7 years the Fund manager created a platform of renewable energy assets and FMO stepped in as investor in two investment vehicles (Soleq and Energon) and also in a second Fund of Equis. Equis sold all its wind and solar assets to Global infrastructure fund, a world-wide operating Fund which focusses on managing renewable assets.

Equity portfolio including Associates distributed by region and sector

At December 31, 2017

Financial Institutions

Energy

Agribusiness

Multi-Sector Fund Investments

Infrastructure, Manufacturing, Services

Total

Africa

269,587

64,521

39,348

223,105

95,647

692,208

Asia

123,905

107,175

41,260

211,280

30,183

513,803

Latin America & the Caribbean

60,309

24,053

31,341

99,874

39,499

255,076

Europe & Central Asia

15,890

10,194

3,372

74,126

10,133

113,715

Non-region specific

65,242

12,681

79

13,869

43,642

135,513

Total

534,933

218,624

115,400

622,254

219,104

1,710,315

At December 31, 2016

Financial Institutions

Energy

Agribusiness

Multi-Sector Fund Investments

Infrastructure, Manufacturing, Services

Total

Africa

186,392

53,805

28,456

201,998

94,295

564,946

Asia

200,838

168,268

53,636

227,357

25,470

675,569

Latin America & the Caribbean

61,737

28,621

41,638

117,967

45,080

295,043

Europe & Central Asia

52,464

9,957

3,570

101,307

10,839

178,137

Non-region specific

56,737

6

895

13,969

42,870

114,477

Total

558,168

260,657

128,195

662,598

218,554

1,828,172