Credit risk management
Credit risk at NIBC comes in very different shapes and forms, and it is the single most important risk for NIBC. Almost every activity at NIBC is related to credit risk: credit risk is present in the corporate loan portfolio, the residential mortgage portfolio, debt investments portfolios and counterparty credit risk. Credit risk is also present in the bank’s mezzanine portfolio. This portfolio is discussed in the investment risk management paragraph.
Corporate loans
The corporate loan portfolio is one of the core portfolios of NIBC and has a size of EUR 8,098 million as at 31 December 2008.
The credit quality is concentrated in the BBB, BB and single B categories. Another important element in the corporate loan portfolio is the assessment of collateral. Almost all loans have some form of collateralisation. Loans can be collateralised by mortgages on real estate and ships, by receivables, leases, liens on machinery and equipments, or by third-party guarantees and other similar agreements.
The assessment of both the probability of default (PD) and the loss in event of default (Loss Given Default) (LGD) is supported by the Rating Monitoring System (RMS). Within NIBC, RMS has been in use since 2000 and both the PD and the LGD ratings are used in the Basel II solvency report.
The basis for both the PD and the LGD methodologies is the application of expert judgement on a number of rating indicators. We consider our corporate loan products to fall within four asset classes (Corporate Lending, Asset Finance, Leveraged Finance and Project Finance), and for each of these asset types the relevant credit drivers and parameters are captured in our models.
With respect to the PD framework, the general methodology is based on several qualitative and quantitative rating indicators, such as the analysis of the business and financial profile of the counterparty, a cash flow analysis, a sovereign risk analysis, a peer-group analysis and a rating benchmark based on third-party models. Expert judgement is applied at the end of the rating process and determines what the final rating of the counterparty will be, taking into account the rating indicators of the various models.
NIBC’s LGD philosophy is similar to the PD approach. The LGD methodology is also based on a combination of qualitative and quantitative rating indicators that range from the assessment of the available collateral to the seniority of the loan, the legal aspects of recovery, the quality of the counterparty’s assets, etc. Once the various LGD drivers have been assessed, the final LGD rating is based upon expert judgement.
The pie charts that follow show the corporate loan portfolio split in industry sectors and regions as at 31 December 2008 and 31 December 2007. The commercial real estate figures include an amount of EUR 630 million in securitised loans. This concerns the Mesdag Delta securitisation; NIBC has retained notes for an amount of EUR 127 million, whereas EUR 503 million has been sold. The term Exposure includes both on- and off-balance sheet amounts and applies to all graphs in this section.
The impact of the credit crisis on the corporate loan portfolio has, until year-end 2008, remained fairly limited. There has been some increase in the level of provisioning, particularly in leveraged finance, but they have not reached extreme levels, in part due to the high level of collateralisation.
The following table shows the average losses in basis points since 2001. Losses are attributed to the year in which the counterparty enters default (Basel II definition). The losses are based on the actual write-off on the loans and on the outstanding provision (31 December 2008) in case the default was unresolved at year-end. The losses are related to the non-defaulted portfolio at the start of the year, containing on- and off-balance sheet amounts. With the exception of 2007, in which average losses were extremely low, the average losses at year-end 2008 remained relatively stable compared to previous years.
Note 56 to the Financial Statements contains additional information on the corporate loan portfolio.
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Overview of average losses, Corporate Loan portfolio |
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IN BASIS POINTS |
2008 |
2007 |
2006 |
2005 |
2004 |
2003 |
2002 |
2001 |
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Average loss |
34 |
7 |
26 |
23 |
25 |
37 |
47 |
76 |
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Leveraged Finance
During 2008 we continued to focus on mid-market transactions in north-western European markets. Because of the economic climate the number of new transactions was relatively low. All new transactions were made on a club-deal basis with relatively low final takes because of the illiquid syndication market.
The new transactions were conservatively structured in terms of leverage and interest coverage; they required equity contribution from the financial sponsor and from management and strict documentation, while pricing was considerably higher. To further mitigate the risks, we continue to focus on a number of reputable private equity sponsors that are known for their hands-on support to their investments.
The size of the leveraged finance portfolio managed by NIBC decreased from EUR 1,260 million at year-end 2007 to EUR 986 million at year-end 2008. The total portfolios is spread over 63 different assets in 12 different business segments. Exposure is located within the EU. Over the last year, impairment amounts increased by EUR 28 million to EUR 42 million. The Leveraged Finance portfolio is strictly monitored on a monthly basis.
The following pie charts show the exposure breakdown of the leveraged finance portfolio over the different industry sectors and regions as at 31 December 2008.
Commercial Real Estate
The commercial real estate loan portfolio has a size of EUR 2,350 million at year-end 2008, of which EUR 2,183 million (93%) was drawn. These figures include an amount of EUR 630 million in securitised loans. This concerns the Mesdag Delta securitisation. NIBC has retained notes for an amount of EUR 127 million whereas EUR 503 million has been sold. The portfolio consists of 179 mortgages loans to 48 counterparties. It is diversified across various commercial real estate classes and countries. Multi-family property financing accounts for 37% of the portfolio, which reduces significantly the one-obligor exposure risk. Office property accounts for 16% and retail property financing for 12%. Hotel financing and construction financing constitute 6% and 7% respectively. The remainder (22%) of the portfolio consists of financing of miscellaneous properties, including mixed use and industrial properties.
In terms of geographical distribution, 71% of the commercial real estate portfolio is located in the Netherlands, 26% in Germany and 3% in other EU countries.
The current market outlook is less favourable compared to the previous years, resulting in a slow-down in demand, higher yields and consequently some downward pressure on the value of the assets. The generated cash flow within the portfolio (rental income), however, remains largely unchanged, resulting in sufficient debt service capacity. Only 9% of the portfolio is due for refinancing in 2009; the great majority of th rest of the portfolio matures in 2014 or later.
Note 56 to the Financial Statements contains additional information on the impairment amounts of the commercial real estate loan portfolio.
Shipping
The shipping portfolio (EUR 1,402 million at year-end 2008) involves 222 secured loans to 86 counterparties. At year-end 2008, EUR 1,188 million (85%) of the total exposure was drawn. The portfolio is diversified across different geographical areas and various shipping sub-sectors. Exposure to the three main shipping sub-sectors tankers, container vessels and bulk vessels amounts to 51%, 22% and 17% of the entire portfolio, respectively. The remainder of the portfolio (10%) includes, among others, financing of LNG tankers, container boxes and oil and gas support vessels, such as towing vessels. The weighted average loan-to-value of the entire portfolio at year-end 2008 was 57%, which is relatively low due to lower advance rates in anticipation of a shipping market decline. This percentage was already negatively affected by an adverse movement in the shipping market during the second half of 2008. This was, in particular, the case for the bulk shipping sector. For the coming year, a further downturn of the shipping market is expected. Regarding our portfolio, potential negative effects are, to a large extent, mitigated by a focus on transactions with fixed long-term employment contracts.
Note 56 to the Consolidated Financial Statements contains additional information on the impairment amounts of the shipping portfolio.
Residential Mortgages
The Residential Mortgage portfolio at year-end 2008 amounted to EUR 11,451 million and consists of residential mortgage loans originated in the Netherlands and Germany. The majority (94%) of the Residential Mortgage portfolio consists of Dutch mortgages. The other 6% comprises German mortgages. The total Dutch mortgage book of EUR 10,759 million is funded for EUR 5,250 million by external securitisations.
In terms of regional distribution, the Dutch mortgages are evenly distributed throughout the Netherlands. The majority of the German mortgage portfolio is located in former West Germany.
The following chart shows the development of the outstanding balance of the Residential Mortgage portfolio between year-end 2007 and year-end 2008. The portfolio size has remained stable in this period.
Mortgage acceptance follows certain acceptance criteria when screening residential mortgage applications, further specified in note 56 to the Consolidated Financial Statements.
NIBC handles the arrears management of 70% of its Dutch portfolio itself, while 30% is handled by one of the major mortgage servicers. Over the past couple of years, NIBC has significantly strengthened the arrears management by insourcing the arrears management process of the mortgages. This process of insourcing initially started in 2004 and will continue in 2009.
Risk of loss is measured by assigning PD and LGD estimates for every loan. The PD expresses the probability of any borrower entering into default, whereas the LGD measures the loss incurred when a default has taken place. These parameters are determined by an in-house developed model, which has been in use since 2006. As of 1 January 2008, NIBC’s rating methodology for residential mortgages has received approval from the DNB to use the AIRB for calculating solvency requirements and reporting to DNB.
2008 has not shown an increase in either defaults or losses. The defaults and actual credit losses in the Dutch portfolio have been extremely low in the past years. The German portfolio has not shown any credit losses at all. The following table shows an overview of the actual losses in the Dutch portfolio since 2005. Losses are expressed as a percentage of outstanding balance.
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Overview of actual losses, Dutch residential mortgage portfolio |
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In % |
2008 |
2007 |
2006 |
2005 |
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Actual loss |
0.02 |
0.02 |
0.02 |
0.03 |
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Debt investments and counterparty credit risk
Along with the credit risk stemming from loans to customers, NIBC is also exposed to credit risk from cash management and trading and hedging positions. The following three categories can be identified:
- Issuer risk on debt investments;
- Issuer risk related to cash management activities; and
- Counterparty risk on derivatives.
Issuer risk on debt investments
Issuer risk measures the risk of losing the principal amount on products like bonds and CDS positions (where it concerns sold protection) and it is calculated based on the book value. These positions are held in the debt investments and trading portfolios. NIBC identifies the following three categories:
- Debt from Financials, Sovereigns, Corporate entities and Structured Investments;
- Structured Credits; and
- Credit Fixed Income Funds.
Debt from Financials, Sovereigns, Corporate entities and Structured Investments
As part of NIBC’s risk mitigation strategy, the credit risk on debt issued by Financial Institutions, Sovereigns, Corporate entities and Structured Investments was reduced significantly from EUR 2,663 million at 31 December 2007 to EUR 1,458 million at 31 December 2008. In particular, the amount of debt issued by corporate entities was reduced from EUR 240 million as at 31 December 2007 to zero as at 31 December 2008.
Through the Structured Investments portfolio, NIBC invests in highly-rated debt. These debt investments are mostly issued by A or AA-rated financial institutions. All investments in this portfolio have to be approved by the RMC on a case-by-case basis. During 2008, the portfolio was reduced significantly from EUR 1,415 million as at 31 December 2007 to EUR 694 million as at 31 December 2008. A breakdown of the portfolio can be found in note 56 to the Financial Statements.
Structured Credits
Issuer risk on structured credits (RMBS, CMBS, CDO, CLO, etc.) decreased from EUR 1,374 million as at 31 December 2007 to EUR 898 million as at 31 December 2008, as a direct result of NIBC’s risk policy. The current policy was implemented in late 2007 and holds that, in principle, no new debt investments will be made and that repayments will not be re-invested. A geographical breakdown of the portfolio can be found in note 56 to the Financial Statements.
Credit Fixed Income Funds
The Credit Fixed Income Funds portfolio contains investments in fixed income funds managed by hedge funds and asset managers. During 2008, the portfolio was reduced significantly. Its total book value was reduced from EUR 133 million as at 31 December 2007 to EUR 35 million as at 31 December 2008. This reduction is in line with the decision of the bank to reduce the exposure to these funds as much as possible.
Issuer risk related to cash management activities
In addition to issuer risk from debt investments, NIBC also runs issuer risk as a result of cash management activities. In 2008, NIBC’s risk management framework for cash management was adjusted by incorporating a more conservative attitude that took into account the deteriorated global markets and concern about numerous financial entities.
NIBC only places its excess cash with a selected number of sovereigns and investment-grade financial institutions. Limits currently only exist for short-term maturities up to one week, and vary per counterparty. If there are not enough counterparties in the market to place all excess cash, NIBC deposits it with the DNB, for which no limit is set. For the approved financial counterparties, a monitoring process has been set up within ALM/MR. Ratings of financial counterparties are verified on a daily basis, and limits are possibly adjusted in case of a perceived decline in creditworthiness.
NIBC also runs credit risk on accounts with other banks. These accounts are used for correspondent banking or third-party account providers, e.g. for Special Purpose Entities.
Counterparty risk on derivatives
Counterparty risk measures the risk of having to replace the counterparty in derivative contracts. NIBC manages counterparty risk, based upon the mark-to-market value plus an add-on. The add-on reflects a potential future change in mark-to-market value during the remaining lifetime of the derivative contract.
Limits are set and monitored per counterparty on a discrete basis and compared to the mark-to-market plus add-on, taking into account collateral postings under a Credit Support Annex (CSA). Note 56 to the Financial Statements provides more information on the risk monitoring of counterparty risk on derivatives.
The counterparties can be split into financial institutions and corporate entities. With respect to financial institutions, NIBC only enters into OTC derivatives with investment-grade counterparties. NIBC has bilateral collateral contracts in place for all the major financial institution counterparties. These contracts aim to mitigate credit risk on the derivatives by means of CSA.
Under the CSA agreements, (cash) collateral is exchanged to account for changes in the mark-to-market value of the underlying contracts, usually on a weekly basis. In the later part of 2008, volatility in several key market drivers (interest and foreign-exchange rates) increased drastically. This resulted in significant exposures between collateral exchange moments. To limit this risk, several relevant CSA agreements have been modified to settle on a daily basis.
Changes in interest rates also affected the mark-to-market valuation of corporate derivative transactions, increasing the positive mark-to-market values and therefore also NIBC’s counterparty risk exposure on corporate entities. No CSAs are in place for these contracts.
The following pie chart shows the breakdown of corporate derivatives in different regions as at 31 December 2008.
