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)

At December 31, 2011

Financial institutions

%

Energy

%

Housing

%

Agribusiness food and water

%

Diverse sectors

%

Total

%

Africa

11,686

4

656

1

-

0

2,375

41

5,618

4

20,335

3

Asia

-

0

977

1

10,141

12

2,698

5

13,953

4

27,769

3

Europe & Central Asia

16,289

4

-

0

-

0

-

0

17,500

37

33,789

6

Latin America & the Caribbean

5,047

2

3,855

3

6,003

12

3,662

3

-

0

18,567

2

Non-region specific

-

0

-

0

-

0

-

0

-

0

-

0

Total

33,022

3

5,488

1

16,144

6

8,735

3

37,071

6

100,460

3

At December 31, 2010

Financial institutions

%

Energy

%

Housing

%

Agribusiness food and water

%

Diverse sectors

%

Total

%

Africa

14,682

6

2,023

2

-

0

47

1

800

1

17,552

3

Asia

-

0

3,047

3

-

0

-

0

16,692

6

19,739

3

Europe & Central Asia

20,311

5

-

0

-

0

-

0

17,500

34

37,811

7

Latin America & the Caribbean

6,784

3

2,804

2

22,516

32

7,552

6

-

0

39,656

5

Non-region specific

-

0

-

0

-

0

-

0

-

0

-

0

Total

41,777

4

7,874

2

22,516

10

7,599

3

34,992

5

114,758

5

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.