RISK REPORT The Middelfart Sparekasse Group

Transcription

1 RISK REPORT 2008 The Middelfart Sparekasse Group In compliance with Basel II, Column 3 and appendix 20 to the Danish Executive Order on capital adequacy [kapitaldækningsbekendtgørelsen], the Middelfart Sparekasse Group is to publish information on its financial risks and its objectives and policies for managing financial risks. This risk report serves the purposes of meeting such information requirements. 1 Publication policy The Middelfart Sparekasse Group has decided to publish the information in the form of a hybrid version where part of the Column-3 requirements are incorporated into the financial annual report and the remaining information will be available from the website of Middelfart Sparekasse: The information is updated at least once annually. 2 Audit There is no requirement that the risk report must be audited, cf. the requirements specified in appendix 20, but there is a requirement, however, that the Group shall see to proper checking of information not covered by the standard auditing of the annual report. The information provided in Risk Report 2008 has not been audited by internal or external auditors. 3 Scope of application The Group presents its financial statements in compliance with the Danish Executive Order on financial reporting by credit institutions and investment companies etc. [bekendtgørelse om finansielle rapporter for kreditinstitutter og fondsmæglerselskaber m.fl.] and complies with the Danish Financial Services Act [lov om finanisiel virksomhed] when preparing the solvency statement. The following enterprises are fully consolidated according to both sets of rules: Middelfart Sparekasse, Et godt HJEM A/S, Trekantens Ejendomsselskab A/S, Ejendomsselskabet Teglgårdsparken A/S and Leasing Fyn Middelfart A/S. The following enterprise is fully consolidated according to the Executive Order on financial reporting by credit institutions and investment companies etc.: Forsikring Fyn A/S The following enterprise is consolidated on the proportionate basis according to both sets of rules: Leasing Bank Fyn A/S. The following enterprise is deducted from the capital base: For solvency purposes, Forsikring Fyn A/S is not fully consolidated as the capital requirement is to be deducted from the overall capital base for the Group which takes place according to the following sections of the Executive Order on capital adequacy: 50 per cent of the core capital, cf. section 131(2)(ii) of the Danish Financial Services Act 1

2 50 per cent of the capital base, cf. section 139(1)(i) of the Financial Services Act In addition to this, investments in credit and financing institutions are deducted where Middelfart Sparekasse holds more than 10 per cent of the share capital of the enterprise in question - cf. section 131(2)(ii) and section 139(1)(ii) of the Financial Services Act. 50 per cent is deducted from the core capital and capital base respectively. Objectives and risk policies 4 Credit risk and dilution risk 4.1 Objectives Middelfart Sparekasse wants to actively contribute to financing of the creditworthy private and corporate customers in the market areas in compliance with our basic values. One of Middelfart Sparekasse s six basic values (in Middelfart Sparekasse called a "commandment") is that: Both the customer and Middelfart Sparekasse must profit from the relationship. 4.2 Credit policy Middelfart Sparekasse has a business concept with the full range of advisory services within all essential financial areas. Middelfart Sparekasse basically wants full-customer relations and does not engage in speculative transactions. A "full-customer relation" is characterised by a customer whose need for financial services is basically covered by Middelfart Sparekasse. In principle, Middelfart Sparekasse is not interested in corporate customers outside its market area as Middelfart Sparekasse finds that lack of local knowledge makes credit assessment more difficult to control and thus more risky. A customer is credit-worthy when deemed able and willing to repay the amount borrowed, inclusive of the costs involved, over a period of several years. This means that the assessment of the customer s ability and willingness to meet his payments obligations at maturity under contracts concluded must be positive. It is the assessment of Middelfart Sparekasse that the customer risk profile is at the conservative end of the scale when compared to customer risk profiles of comparable commercial and savings banks in Denmark. Middelfart Sparekasse has set up a monitored credit policy which sets out the overall guidelines for the granting of credit and handling of commitments. The credit policy is reassessed at least once annually. The policy and the business procedure within the credit area include, for example, guidelines on customer profile, risk profile, size of exposure, lines of business, products, investment products, provision of security, prices and non-performing loans. Middelfart Sparekasse applies the standard method of credit risk, and the table below illustrates the risk-weighted assets of Middelfart Sparekasse. 2

3 4.3 Risk assessment The individual customer commitment must be reasonable in view of the customer's overall financial position, inclusive of financial circumstances, debt relative to income, and disposable amount. Middelfart Sparekasse applies a segmentation model for classification and credit assessment of the individual customer relation. Seven categories of corporate customers and six categories of private customers are applied. The model is managed by the credit operations department of Middelfart Sparekasse, and the individual account manager determines the customer category on the basis of factual information on, for example, assets, disposable amount and debt relative to income. A weak customer assessment means increased awareness and attention on the part of both the account manger and the credit operations department. The following may be stated in terms of credit risk and dilution risk: a) When defining defaulted exposures and impaired exposures, sections of the Executive Order on financial reporting by credit institutions and investment companies etc., to which reference is made, are complied with. b) The overall value of exposures after writing down and before taking into consideration the effects of credit-risk reduction amounts to DKK 4,076,026,000 as at 31 December c) The average value of the exposures for the 4th calendar quarter has been calculated at DKK 4,231,797,000. d) Exposures broken down by geography and by important exposure categories have not been reviewed as 95 per cent or more of the exposures are in Denmark. e) The relative distribution of exposures, broken down by exposure categories as stipulated in section 93 of the Executive Order on financial reporting by credit institutions, is illustrated in note 10 of the annual report f) The distribution of term to maturity broken down by categories is illustrated in notes 9 and 10 of the annual report g) The definition of impaired exposures complies with section 52(3) of the Executive Order on the presentation of financial statements. Impaired exposures and write-downs broken down by sectors: DKK 1,000 Individually assessed Public authority Agriculture, hunting, forestry Fisheries Manufacturing industries, extraction of raw materials etc. Building and construction Trade, restaurants and hotels Transport, post, telephone Credit and financing activities Defaulted exposures Loan, advances and guarantee debtors which have been written down/for which provision has been made Write-downs/provisions at year-end Amounts charged to the income statement for value adjustments and write-downs during the period 15,258 10,437 3,754 9,540 3, ,045 14,114 3, ,236 4,019 2, ,088 3

4 Property administration, purchase and sale 37,063 45,818 21,145 18,045 Other corporate lending 5,807 50,769 5,521-4,614 Total corporate lending 44, ,754 59,226 24,032 Private individuals 28,984 32,586 26,370 9,373 Total, individually assessed Collectively assessed Public authority 72, ,340 85,595 33,405 Corporate lending 1,635,221 3,565 Private individuals 1,659, Total, collectively 3,294,633 4,458 assessed h) The total value of defaulted exposures and impaired exposures respectively, broken down by important geographical areas, has been left out as more than 95 per cent of all exposures are in Denmark. i) Changes in impaired exposures resulting from value adjustments and write-downs: Accumulated write-downs/ provisions for loans and advances and on guarantee debtors at the beginning of the year Changes throughout the year: 1. Foreign-exchange adjustment 2. Write-downs/provisions throughout the year 3. Reversal of writedowns/provisions made in previous financial years for which there is no longer any objective indication of impairment or where Individual write-downs/ provisions impairment has been reduced 4. Other changes 4, Value adjustment of assets taken over 6. Finally lost (written off), previously written down/provisions made on an individual basis Accumulated writedowns/provisions at the end of the year on loans and advances and on guarantee debtors The sum of loans and advances and of guarantee debtors for which write-down/provisions have been made on an individual basis (calculated prior to write-down/provisions) Collective write-downs/ provisions 63, ,893 3,916 21,609 11,232 85,595 4, ,683 3,294,633 Write-downs/provisions for amounts owed by credit institutions and other items involving a credit risk 4

5 4.4 Security In order to reduce the credit risk involved in the individual exposure, the best possible security on the customer's assets is always to be established in due consideration of the individual customer relation. The most standard elements of reducing risks are mortgages, pledges and guarantees. The most frequently used forms of charges are mortgage on fixed property, pledge on financial assets in the form of shares and bonds and charge on motor vehicles. The value attributed to such security is currently updated, for example market-value changes and impairment resulting from age, use etc. 4.5 Credit organisation The credit operations department of Middelfart Sparekasse monitors the compliance with guidelines and business procedures, for example through current supervision of the loans and advances and through review of the loan exposures of the individual branches. The credit operations department continuously informs the Supervisory Board of Middelfart Sparekasse on large exposures. All the major exposures of Middefart Sparekasse are reviewed annually. 5 Market policy 5.1 Objectives The purpose of assuming a market risk is to achieve a reasonable return on the Group's own portfolio. In its instructions to the Executive Board, the Supervisory Board has set out the limits for the market risks of the Group. 5.2 Definitions The market risk is the risk of incurring a loss as the result of changing market conditions and thus changes in the market value of the Group s assets and liabilities as well as of other financial contracts and off-balance sheet exposures. Market risk includes interest-rate, foreignexchange and share-price risks Interest-rate risk The interest-rate risk is the risk of incurring a loss as the result of increasing or decreasing interest rates. The interest-rate risk is measured as the expected capital loss on interest-rate positions that will follow from an immediate increase or decrease of 1 percentage point in all interest rates Foreign-exchange risk The foreign-exchange rate risk is the risk of incurring a loss on the Group s positions in foreign currency when the exchange rates change. The risk is calculated at an overall level as the larger sum of positions in currencies in which the Group has net receivables and the sum of positions in currencies in which the Group has net payables respectively. The risk is reported for each currency involved Share-price risk The share-price risk is the risk of incurring a loss resulting from changes in share prices. The share-price risk can be determined as the net sum of short-term and long-term positions in shares and share-related instruments. 5

6 5.3 Trading portfolio The Group s trading portfolio constitutes a minor part of its own portfolio. The positions in the trading portfolio are held with a view to trading, although attempts are made to limit the trading portfolio, cf. below. The following business procedure applies specifically to the trading portfolio: the maximum total market value of the trading portfolio is DKK 20m and this value is included in the above interest-rate risk table. In the event that the maximum market value is exceeded, the head of the securities trading department is contacted who will then assess whether the securities involved should possibly be included in the Group's own portfolio or whether the risk should be covered through a hedging contract. The positions in the trading portfolio arise as follows: Flows from borrowing and repayment of loans in connection with the financing of housing. Portfolio of and flow from the purchase/sale of securities on the recommended list of Middelfart Sparekasse which has been worked out according to the customers risk profiles. Flow from customers purchase/sale of other securities. Residual securities from sales campaigns conducted for selected securities. As for the two latter groups of positions, the rule applies that all share positions are basically to be resold immediately so that no position arises. In situations where the size of shares is smaller than the smallest size of sales unit, accumulation up to the smallest sales unit is allowed with regard to the trading costs. 5.4 Structure/policies of risk management In its instructions to the Executive Board, the Supervisory Board has set up a clear limit for market risks. The overall risk is managed within such limit at a fixed monthly liquidity meeting in which Hans Erik Brønserud, chief executive officer, the human resource manager, the head of finance and management and the head of securities trading participate. Prior to the meeting, the head of securities trading works out a written market-information report and a proposal for a position, and after the meeting the head of securities trading prepares minutes of resolution of the meeting. The head of securities trading then makes any alterations to positions within the limits specified in the minutes of resolution. In addition to this, the head of securities trading calls extraordinary liquidity meetings if the market conditions change more than anticipated in the minutes of resolution. The head of securities trading also prepares minutes of the extraordinary liquidity meetings. 5.5 Risk reporting and risk measuring Twice monthly an interest-rate risk table is prepared (at the end of the month and as per the date prior to the meeting of the Supervisory Board). The head of securities trading updates the interest-rate risk table which is subsequently checked by the accounts department. The table is presented at the monthly Supervisory Board meetings. On the same day as financial contracts are concluded, the head of securities trading notifies the accounts department of the position in writing. The accounts department updates the price adjustment of shares and bonds on a daily basis, both as for Middelfart Sparekasse's own portfolio and the trading portfolio. An overview of the price adjustments is sent to all members of the Executive Board, the head of finance and management and to the head of securities trading on a daily basis. In addition to this, the current price adjustment is presented at the monthly Supervisory Board meetings. 6

7 The accounts department updates an overview of the current liquidity and of the known liquidity for the coming months on a daily basis. At the monthly liquidity meetings, the liquidity overview is discussed to see if this gives rise to any purchase or sale of bonds, and in the event of unexpected liquidity fluctuations of more than DKK 100m between the liquidity meetings, the accounts department will get in touch with the head of securities trading. 6 Liquidity risks and risks of the capital base 6.1 Capital plan According to the overall objectives of the Middelfart Sparekasse Group, attempts must be made to achieve a solvency ratio of at least 12 per cent. In the event of a decrease in the guarantee capital, initiatives will be taken to raise subordinate capital if the overall solvency ratio is calculated at 12 per cent or less. According to the articles of association of Middelfart Sparekasse, subordinate capital in the form of equity funding is to amount to DKK 500m at a maximum. The Executive Board is responsible for procuring the necessary capital to comply with the objectives. If the situation in the market does not improve, the market for equity funding will be closed. In such case it will be necessary to slim the balance sheet. However, we are in a position where we meet the statutory requirement of 8 per cent solely with our reserves carried forward. We thus have a time horizon of 5 7 years before we, other things being equal, need to raise equity funding, i.e. when the current subordinate loans fall due for repayment. The calculation of the capital base and the solvency ratio is reported to the Supervisory Board and the Executive Board on a bi-annual basis or when the conditions change. Loans and advances/deposits are updated on a daily basis, inclusive of any changes in the guarantee capital. Such calculations are prepared by the finance department. The excess cover compared to the liquidity requirement stipulated in section 152 the Financial Services Act 1 is calculated monthly and reported to the Supervisory Board and the Executive Board by the finance department. Based on the latest known excess cover ratio and the daily update of the balance sheet, compliance with the liquidity requirement is checked indirectly on a daily basis. The management itself is handled by the Executive Board, the finance department and the securities trading department at a monthly liquidity meeting or on an ad hoc basis when required by the circumstances. Efforts are made to distribute amounts owed to other banks between short-term (< 1 year), medium-term (1<5 years) and long-term (> 5 years) debts. At the moment, the market for funding exceeding 2 years hardly exists, and compensation for this is made by holding additional capital whereby the liquidity risk is reduced. In addition to this, we have applied for a borrowing limit of approx. DKK 350m in the Danish central bank on which we are entitled to draw until the expiry of the government guarantee on 30 September In the planning of the liquidity procurement in both the short and the long term, the composition of both the balance sheet and equity is taken into consideration. The Executive Board is responsible for procuring liquidity and for compliance with the liquidity requirement. 6.2 Emergency plan for the procurement of capital / liquidity In the event that the solvency ratio is reduced to 12 per cent and/or the excess cover of liquidity is reduced to less than 50 per cent, initiatives are to be taken to improve these key ratios. This emergency plan includes the following initiatives: 1 Liquidity: cash balance + amounts owed by the Danish central bank and other commercial and savings banks + securities in proportion to: The liquidity requirement: the larger sum of debts < 1 month x 15% and reduced debts x 10% (reduced debts = balance sheet sum + guarantees equity subordinate capital that may be included in the capital base) 7

8 Bonds may be sold off from the bond portfolio in order to improve the solvency. This requires, however, that there is sufficient excess cover of liquidity as this key ratio, other things being equal, will be reduced. The solvency is improved owing to a reduced interest-rate risk and market risk. Additional funding may be raised. Loans and advances to customers may be called in. Other assets, for example shares, may be sold. We can be converted into a limited liability enterprise. In extreme cases, it is possible to merge with another similar commercial or savings bank. 6.3 Solvency requirement and sufficient capital According to statutory requirements, the Supervisory Board and the Executive Board are to determine the individual solvency requirement of the Middelfart Sparekasse Group. The Group has implemented a model for determining the solvency requirement. In the model, capital is allocated within four risk areas (credit risk, market risk, real property risk and other risks). The first part of the model includes a number of stress tests. In these tests, the accounting figures of the Group are exposed to a number of negative events in order to test the consequences of the given scenarios. In these stress tests, the individual items are stressed via seven variables: Capital for covering credit risks Capital for covering liquidity risks Capital to cover risk of own properties Capital to cover other risks Increase in loss on customers Decline in share prices Increase in interest rates Decrease in property prices General decline in revenue Increase in currency risk Increase in counterparty risk It is the task of the management to define which risks the Middelfart Sparekasse Group should be able to withstand and consequently which variables should be stress-tested. The result of the stress tests performed is included in the solvency-requirement model in the way that the Group must, as a minimum, be able to keep the capital required to cover the loss that would arise in the event of the scenario in question occurring. The overall effect of the stress test on the solvency requirement is calculated by relating the overall effect on results to the weighted items. Thereby a measure is obtained of how much capital is required for Middelfart Sparekasse to be able to survive the scenario envisaged. In addition to the risk areas that are included via stress tests, there are a number of risk areas which the Group has found relevant to include in its assessment of the solvency requirement: Additional capital for covering credit risks Additional capital to cover market risks Large exposures Weak exposures Geographical concentration Commercial concentration Concentration of securities 8

9 Additional capital to cover risk of own properties Additional capital to cover other risks Operational risk and control environment Strategic risks Reputation risks Risks in relation to size and capital procurement Liquidity risks Group risks Winding-up risks The determination of the effect of these areas on the solvency ratio is either calculated directly via supplementary calculations or by a management estimate of the effect of such risk areas on the solvency requirement. In the opinion of Middelfart Sparekasse, the risk factors included in the model cover all the risk areas which the management is required by statute to take into consideration when determining the solvency requirement as well as the risks which the management finds that the Middelfart Sparekasse Group has undertaken. In addition to this, the Supervisory Board and the Executive Board are to assess whether the capital base is sufficient to support future activities. In the Middelfart Sparekasse Group, this assessment is also part of the general determination of the solvency requirement. Therefore the management assesses each year how the growth expectations affect the calculation of the solvency requirement. In the model this specifically means that the management is to estimate the future growth rate, the average solvency weight and the earnings margin after tax. The impact of the estimated growth on solvency will have a direct effect in the model on the solvency requirement in the form of an addition. However, the solvency impact is disregarded in cases where a capital increase has already been initiated which will be able to absorb the increase in lending. 6.4 Risk-weighted exposures The table below illustrates the Group s risk-weighted assets and capital requirement for each exposure category. Risk-weighted exposures DKK 1,000 Risk-weighted exposures Capital requirement 8% of exposures Business enterprises etc. 1,468, ,514 Retail customers 1,476, ,082 Exposures secured through mortgage on real 154,743 12,379 property Exposures involving outstanding or overdrawn 97,120 7,770 amounts Exposures in other items, inclusive of assets without counterparties 389,888 31, Market risk the solvency requirements The table below illustrates the Group's solvency requirement in terms of market risks. 9

10 Risk-weighted items involving market risk DKK 1,000 Risk-weighted items Capital requirement 8% of exposures Weighted items involving market risk 942,097 75, Counterparty risk The Middelfart Sparekasse Group applies the market value method in respect of the counterparty risk to calculate the extent of the exposure for derivative financial instruments that are covered by appendix 17 to the Executive Order on capital cover and for credit derivatives within the trading portfolio. The market value method is described below and complies with the description in section 14(3) of the Executive Order on capital cover, No of 1 March The market value method includes the market value of contracts with a positive market value and the principal amounts of all contracts in the capital cover statement. The market value of the contracts is included at the weight of the time until maturity of the contracts in question and at the weight of the counterparties in question. In connection with the Group s determination of the sufficient capital base, capital equalling 8 per cent of the positive market value of the derivatives is held. The procedure for granting loans etc. of Middelfart Sparekasse and its ordinary supervision of commitments take into account the calculated exposure value so as to ensure that the latter does not exceed the credit limit granted on the counterparty. The value of the Group s total counterparty risk has been calculated at DKK 447,038,000 on the basis of the market-value method. 6.7 Capital base The table below illustrates how the Group s capital base is composed of core capital and supplementary capital plus additions to and deductions from these. Calculation of capital base Middelfart Sparekasse Group DKK 1,000 DKK 1, Core capital 599, , Guarantee capital 149, , Reserves Retained earnings 449, , Minority interests -1, Primary deductions from core capital 4,271 4, Intangible assets 1,725 2, Deferred activated tax assets 2,546 2, Core capital after primary deductions 595, , Other deductions 22,112 22, Half of the participating interests relating to insurance 12,000 12, Half of total participating interests etc. > 10 p.c. 10,112 10,112 10

11 5. Core capital inclusive of hybrid core capital after deduction 573, , Supplementary capital 309, , Subordinated capital 308, , Revaluation reserves 1,402 1, Included supplementary capital 309, , Capital base prior to deductions 882, , Deductions from the capital base 22,112 22, Half of the participating interests relating to insurance 12,000 12, Half of total participating interests etc. > 10 p.c. 10,112 10, Capital base after deductions 860, ,831 7 Operational risk According to the Executive Order on capital requirement, commercial and savings banks must cover operational risks capital-wise. The capital requirement of operational risks must cover: The risk of loss resulting from inadequate or defective internal procedures, human errors and system failure or as a result of external events, inclusive of legal risks". The Middelfart Sparekasse Group applies the basis-indicator method for calculating the capital requirement for the operational risks, cf. appendix 18 to the Executive Order on capital cover. This means that the capital requirement for the operational risks is calculated at 15 per cent of the average basic income of the latest 3 years. The basic income is the sum of net interest income and non-interest related net income. However, the Middelfart Sparekasse Group currently performs an assessment of the capital requirement for the operational risks. If the capital requirement is estimated to be higher than specified above, this will be taken into account in the Group's determination of the solvency requirement. It is the policy of the Middelfart Sparekasse Group to cover such risks to the greatest extent possible, for example through insurance and by continuously assessing the appropriateness of internal procedures, system failure and the risk of external events as well as legal risks. However, a certain deductible is expected. The need for insurance is monitored through the involvement of an insurance broker. Efforts are made to separate executive and monitoring functions; moreover, a legal function has been established for monitoring, for example, the legal risk. As for IT, Middelfart Sparekasse has joined SDC which has double security on systems and operations in all critical areas. The table below illustrates the solvency requirement in respect of operational risk. Risk-weighted items involving operational risk DKK 1,000 Risk-weighted items Capital requirement 8% of exposures Weighted items involving operational risk 450,335 36,027 11

12 8 Business risks Business risks mean the risk of incurring a loss or of decreasing income resulting from changes in the conditions of carrying on business, be it changes to the competitive situation, cyclical fluctuations, amendments to statutes or damage to the reputation of the Group etc. Such risks are constantly monitored, although specific tools are used for measuring the risks only when it comes to the reputation risk. In terms of the reputation risk, for example the annual social-ethical report of Middelfart Sparekasse has been used where employees, customers and the local population express their view of Middelfart Sparekasse. In this manner, indicators are currently obtained, showing whether or not Middelfart Sparekasse lives up to its own expectations and to the expectations of the surroundings in terms of reputation. In replacement of the social-ethical report, CSR reporting will be introduced as from In the event that the reputation of the Group might be threatened owing to a suddenly occurring situation, the Executive Board will obtain the relevant advisory services, and there are clear instructions as to communication with the general public. Middlefart Sparekasse runs a savings bank with 9 branches distributed throughout the local so-called Triangular Region. Today our number of customers is in the vicinity of 38,500, and our loans and advances are close to evenly divided between private individuals and corporate customers. For corporate customers the aim is a diversification across business sectors, which is constantly monitored. For private individuals we focus on diversification across age, and here too we constantly seek to find the most appropriate balance in terms of business. The Middelfart Sparekasse Group applies a concept of "full service" according to which the customers are offered a wide range of other services in addition to banking services, inclusive of insurance provided by Forsikring Fyn A/S, housing sale through the chain of estate agents Et Godt Hjem and leasing products through Leasing Fyn A/S. Moreover, the Group has a number of co-operation partners who will be able to provide the products that we ourselves are not immediately in a position to provide. Moreover, it is an essential element of the business philosophy of the Middelfart Sparekasse Group to involve itself in the local community in order to enhance a positive development within the market area of the Group and thus to sustain a sound business basis. Through its membership of various trade associations, the Middelfart Sparekasse Group finds support to handle sector-related conditions and challenges, and the internal, legal departments of the Group monitor, for example, legal conditions. Middelfart, March