Note 33 - Risk management
The risks that originate from the Group’s operational activities are primarily attributable to Group assets in the form of acquired loan portfolios and consequently the payment capacity of Hoist Finance’s debtors. These risks are mitigated by a historically strong and predictable cash flow and through the continuous monitoring and evaluation of portfolio development. The Group is also exposed to operational risks as part of its daily operational activities and in connection with the Group’s rapid growth. These risks are managed using a framework for managing operational risks that is based on continuous improvements to procedures and processes, risk awareness in the organisation, duality in all important transactions and analyses, and a clear division of responsibilities. The Group is also exposed to exchange rate and interest-rate fluctuations. The Group has adopted policies, regulations and instructions governing the management, analysis, evaluation and monitoring of risks. The Group has also adopted risk management strategies built on the principle that the company, based on its extensive experience and expertise in acquiring loan portfolios, actively seeks to increase its volumes in this business area while minimising other exposures and risks (such as market, liquidity and operational risks) as far as is financially justifiable.
The Group’s Risk control function is responsible for working independently from Management to analyse, monitor and report all significant risks to the CEO and Board of Directors. The Risk control function also serves as an advisor to the Board on issues concerning risk management, risk appetite and risk strategies. This ensures that duality is achieved, as all significant risks are analysed, reported and monitored by the business operations as well as the independent Risk control function. Risks within the Group are managed and limited in accordance with policies and instructions adopted by the Board. The Risk control function is responsible for reporting and escalating deviations from the limits to both the CEO and the Board.
Risk exposures are calculated, analysed and compared with anticipated revenue to ensure the achievement of an attractive risk-adjusted return. Once defined, the Group’s risk profile is assessed and evaluated. Assessment and evaluation include the following steps:
1) Assessment of each risk category
Each risk category is individually assessed. The risk assessment is documented and always results in a qualitative assessment of the risk as well as a quantifiable amount if possible.
2) Stress testing: Assessment of unforeseen events
Unforeseen events are defined as events that are possible but highly unlikely. Such events may be designated as “stress test events” and their consequences simulated and documented. Simulation results are reviewed against the Group’s capital and liquidity. Unforeseen events may be based on historical experience, academic theory and/or hypothetical scenarios.
3) Assessment of how risks can be managed and controlled
Although not all risks can be quantified in an adequate way, an analysis is done to detail the way in which risks can be managed and controlled. When appropriate, measures are implemented to improve the management and control of the risk.
The most significant risks identified by the Group as being relevant to its business are:
- (i) credit risk
- (ii) operational risk
- (iii) market risk (FX risk and interest rate risk)
- (iv) liquidity risk
These risks are presented in separate sections below.
Credit risk is the risk to revenue and/or capital arising from a counterparty’s failure to repay principal or interest at the stipulated time or a failure to otherwise perform as agreed.
Credit risk on the Group’s balance sheet relates mainly to:
- Acquired loan portfolios, comprised of performing and non-performing loans. Details on the credit risk for these two categories are presented in separate sections below.
- Bonds and other securities.
- Lending to credit institutions.
- Counterparty risk exposure to institutions with which the Group conducts derivative transactions to hedge the Group’s FX and interest rate exposure.
Credit Risk for acquired non-performing loan portfolios
The non-performing loans are acquired in portfolios at prices that typically vary between 5 and 35 per cent of the nominal value outstanding at the acquisition date. The price depends on the portfolios’ specific characteristics and composition in terms of, inter alia, size, age, the existence of collaterals and type of loans, as well as debtor age, location, type, et cetera.
Measuring Credit Risk in the non-performing loan portfolios
Credit risk in the non-performing loan portfolios relates primarily to the Group overpaying for a portfolio — that is, recovering less from the portfolio than expected — resulting in higher than expected portfolio carrying amount impairments and lower revenue.
Total credit risk exposure is equal to the carrying amount of the assets. The year-end carrying amount of Hoist Finance’s non-performing loan portfolios was SEK 20,322m (23,396). The majority of these loans are unsecured, although a number of portfolios have real estate properties as collateral. As at 31 December 2020, these portfolios had a carrying amount of SEK 3,458m (4,076).
Information on the loan portfolios’ geographical distribution is presented in Note 3 “Segment reporting”. Other information on acquired non-performing loan portfolios is presented in Note 18 “Acquired loan portfolios”. An important parameter for Hoist Finance’s credit risk management of non-performing loan portfolios is net cash flow forecasts, as presented in Note 18 ”Acquired loan portfolios”.
Impairment of non-performing loan portfolio values
The risk of loan portfolios failing to pay as expected is regularly monitored by the business operations and the Risk control function, by comparing actual outcome against forecasts. The process for identifying the need to impair portfolio values is regulated by a specific policy. The Risk control function monitors compliance with the policy and participates on the Revaluation Committee, which makes decisions on portfolio value impairment. Revaluation of portfolios and the difference between realised collections and forecasts is reported under “Impairment gains and losses”.
In 2019, Hoist Finance completed its first securitisation transactions backed by portfolios of unsecured non-performing loans. These transactions can be regarded as involving increased regulatory risk, given that Hoist Finance is obliged to continuously monitor and ensure that the requirements for ”significant risk transfer” are fulfilled at all times. The securitised assets are fully consolidated in Hoist Finance’s balance sheet and developments in the underlying loan portfolios are monitored in the same way as for non-securitised assets. The securitisation structure is funded with secured bonds. The bond’s capital requirements are determined by their rating and, for this reason, the rating is constantly monitored.
Expected credit loss measurement for acquired performing loan portfolios
For acquired performing loans IFRS 9 outlines a three-stage model for impairment based on changes in credit quality since initial recognition. The model is only applicable to the Group’s performing loan portfolios. Non-performing loan portfolios are always classified in Stage 3. The loss allowance for non-performing loans is detailed below in the section “Credit risk for acquired non-performing loan portfolios”.
The IFRS 9 three-stage model is presented in the adjacent table.
For Hoist Finance, initial recognition is the date on which a portfolio is acquired and subsequently recognised on the balance sheet. For acquired performing loan portfolios, all loans that are not considered credit-impaired are classified in Stage 1 at initial recognition. Criteria for migration to Stage 2 or Stage 3 are described under “Significant increase in credit risk” and “Definition of default and credit-impaired assets” respectively.
The general approach applied by Hoist Finance for measuring Expected Credit Losses (“ECL”) for acquired performing loan portfolios is component-based and builds upon an estimation of Exposure at Default (“EAD”), Loss Given Default (“LGD”), and Probability of Default (“PD”). These components are multiplied together each month to produce an ECL which is recognised in financial statements as a loss allowance.
At each reporting date, ECL is estimated on a 12-month and a lifetime basis for all acquired performing loan portfolios. For loans in stage 1, loss allowance is recognised for ECL over the next 12 months whereas for loans in Stage 2 and Stage 3, loss allowance is recognised for lifetime ECL.
The ECL for all acquired performing loans is measured on a collective basis, where a grouping is performed based on shared risk characteristics, type of product, type of counterparty and type of collateral. During the period, there have been no changes in estimation techniques or significant assumptions in the ECL measurement process.
Measuring ECL – explanation of inputs, assumptions and estimation techniques
When a performing portfolio is acquired, the ECL model components are estimated based on historical information both on a customer and on a debt level.
At initial recognition and at subsequent reporting dates, the lifetime and 12-month PD is estimated using transition matrices for modelling the probability of being in different survival states prior to default over the remaining lifetime of the loan. All loans are classified in a risk rating class system for which the probability of moving between different risk classes is estimated. The estimation of PD also includes incorporation of forward-looking macroeconomic information which is described under “Forward-looking information incorporated in ECL models”.
The lifetime and 12-month EAD is estimated based on the contractual payment profile of the loan along with behavioural assumptions for possible prepayments, overpayments and underpayments.
The lifetime and 12-month LGD is determined on the basis of factors impacting the expected post default recoveries such as the probability of curing to a non-default state and the value of any underlying collateral. The estimation of LGD also includes the incorporation of forward-looking macroeconomic information which is described under “Forward-looking information incorporated in ECL models”.
Lifetime ECL is calculated as the present value of all cash shortfalls over the remaining lifetime of the loan, discounted using the effective interest rate (“EIR”). The 12-month ECL is quantified based on the lifetime ECL weighted by the probability that this loss will occur during the next 12 months.
The most significant assumptions affecting the ECL allowance are as follows:
- (i) The debtors’ historical and current payment patterns and ability to comply with their contractual obligations which is the main component used in estimating the PD of the debtors.
- (ii) The Loan-To-Value for collateralised loans mitigating the loss in the event of default (LGD).
Significant increase in credit risk
Hoist Finance has defined rating class staging criteria based on the PD rating class system used in the transition matrices utilised for PD estimation. Significant increase in credit risk (“SICR”) is defined as when a loan experiences a risk class migration increase of one risk grade as counted from its original risk class at initial recognition.
Hoist Finance is not rebutting the IFRS 9 presumption that a SICR has occurred when a loan contract is more than 30 days past due on contractual payments. However it should be noted that Hoist Finance applies this backstop criteria provided that the past due amount is considered material in accordance with the definition of default described under “Definition of default and credit-impaired assets”.
Hoist Finance has not used the low credit risk exemption for any acquired performing loan portfolios.
Definition of default and credit-impaired assets
Hoist Finance defines an acquired loan as in default, which is fully aligned with the definition of credit-impaired, when it meets any of the following criteria:
- The obligor is more than 90 days past due on its contractual payments by a material amount. Pursuant to the EBA’s guidelines on default of an obligor (article 178), material amounts are amounts exceeding EUR 100 plus 1 per cent of the outstanding amount
- When a concession is granted which modifies the contractual cash flows resulting in a material loss
- Bankruptcy of the obligor
- Confirmed death of the obligor
- An obligor’s sources of recurring income are no longer available to meet the payments of instalments
- Hoist Finance has called any collateral, including a guarantee
- There are justified concerns about an obligor’s future ability to generate stable and sufficient cash flow.
Concerning what is to be regarded as a purchased credit-impaired asset, the assessment is based on the information provided by the sellers of the acquired non-performing loan portfolios.
Forward-looking information incorporated in ECL models
The PD component incorporates forward-looking information through use of the macroeconomic variable proven to have the strongest impact on the default frequency of the portfolio. In the case of not having enough data a proxy default frequency may be used. The PD for each point in time is then adjusted in accordance with scenarios derived from that macroeconomic variable.
The LGD component incorporates forward-looking information by applying macroeconomic variable assumptions on the collateral valuation which impacts future recovery rates.
For the purpose of incorporating forward-looking macroeconomic information in the measurement of ECL, three different probability weighted scenarios are utilised.
- (i) A base economic scenario which builds upon the projected economic development as estimated by the International Monetary Fund (“IMF”). The probability weighting assigned to this scenario is 90 per cent.
- (ii) A negative economic downturn scenario. The probability weighting assigned to this scenario is 5 per cent.
- (iii) A positive favourable economic scenario. The probability weighting assigned to this scenario is 5 per cent.
The below table outlines how the most significant period-end economic variable assumptions as at 31 December 2020 have been applied for the different economic scenarios.
|Poland||GDP Current prices||1.1||-0.5||0.4||-0.1||-0.7|
|United Kingdom||GDP PPP (share of world)||-7.4||7.7||4.7||3.4||3.4|
The positive and negative economic scenarios are derived by applying +/– two standard deviations from the assumed future macroeconomic variable development in the basic scenario.
Set out in the table below are the changes to the ECL as at 31 December 2020 that would result if the negative and positive economic scenarios used for ECL measurement purposes, as described in section “Forward-looking information incorporated in ECL models”, materialised.
|ECL Scenario Sensitives|
For acquired secured performing loan portfolios, the collateral which serves as security for mitigation of credit risk consists of properties and to a minor extent car vehicles. Hoist Finance prepares a valuation of the collateral to be obtained as part of the transaction process. Hoist Finance monitors the development of the value of the collateral in secured portfolios through periodic revaluation on an annual basis. There is no case where the ECL for a loan is zero due to the value of collateral.
Hoist Finance’s policies for obtaining collateral have not significantly changed during the reporting period and there has not been any significant change in the overall quality of collateral held by Hoist Finance.
For acquired secured performing loans that subsequently have become credit-impaired, it becomes more likely that Hoist Finance might take possession of the collateral to mitigate potential credit losses. As at 31 December 2020 the value of collateral held for credit-impaired assets represents more than 100 per cent of the gross carrying amount of these loans which represents the maximum exposure to credit risk.
For acquired loan portfolios, Hoist Finance will, in whole or in part, derecognise assets where there is no reasonable expectation of recovery. As at 31 December 2020, there are no contractual amounts outstanding that are still subject to enforcement activity for written off acquired loans.
For acquired loan portfolios, Hoist Finance has the ability to modify the contractual terms of the loan which alters the contractual cash flows. As at 31 December 2020, no losses or gains arising from modifications of contractual cash flows for acquired loan portfolios have been recognised for the reporting period. Thus, modification of contractual cash flows have not had any impact on measurement of ECL.
Credit risk exposure and maximum exposure to credit risk
For acquired non-performing and performing loan portfolios, the maximum exposure to credit risk is represented by the gross carrying amount of the loan. The adjacent table contains an analysis of the credit risk exposure for acquired loan portfolios based on credit risk classes. The credit risk class for “high credit quality” corresponds to loans where the exposure weighted average 12 month PD is 0.3 per cent. The equivalent PD averages for “medium credit quality” and “low credit quality” are 1.2 per cent and 21.4 per cent respectively.
|ACQUIRED LOAN PORTFOLIOS 31 dec 2020|
|SEK m||Stage 1 |
|Stage 2 |
|Stage 3 |
|Credit grade for high credit quality||535||-||-||-||535|
|Credit grade medium credit quality||171||-||-||-||171|
|Credit grade for low credit quality||4||7||-||-||11|
|Gross carrying amount||710||7||41||20,430||21,188|
|Net carrying amount||709||7||37||20,322||21,075|
A full reconciliation of gross carrying amount and ECL movements can be found in note 18, “Acquired loan portfolios”.
Hoist Finance has receivables from a large number of counterparties, most of who are private individuals. The portfolio is also well diversified geographically, with receivables in 10 countries and no country accounting for more than 30 per cent of total loan portfolios. Limits are in place for banks and other financial counterparties and are monitored and reported on an ongoing basis. In light of this, Hoist Finance considers there to be no significant concentration risk.
Credit risk for the liquidity portfolio assets
The credit risk associated with exposures in Hoist Finance’s liquidity reserve is managed in accordance with the Group’s Treasury Policy, which regulates the portion that may be invested in assets issued by individual counterparties. Restrictions include limits on exposures to a given counterparty credit rating.
The table below shows S&P’s credit rating for the Group’s exposures in the liquidity reserve as per 31 December 2020 compared with 31 December 2019.
|Rating||31 Dec 2020||31 Dec 2019|
|Total SEK m||8,652||8,024|
|of which, in the liquidity portfolio||6,493||5,498|
As per 31 December 2020, the weighted average maturity for liquidity portfolio assets was 1.87 years (1.66) and the modified duration was 0.29 years (0.26). Maturity and modified duration are important measures for evaluating Hoist Finance’s credit spread risks and interest-rate risks.
Credit risks arising from bond holdings or derivative transactions
Credit risks arising from bond holdings or derivative transactions are treated in the same way as other credit risks, that is, they are analysed, managed, limited and controlled.
The Group uses FX and interest-rate derivatives to hedge its exchange-rate and interest-rate exposure (see Note 16, “Derivatives”). To avoid counterparty risks associated with these derivatives, the Group uses ISDA and CSA agreements for all derivative counterparties. These agreements allow for netting and daily settlement of credit risk and, accordingly, counterparty risk with derivative counterparties corresponds at most to a one-day fluctuation of the derivative’s value. The CSA agreement is backed by cash collateral. Derivative transactions are only conducted with stable counterparties with a minimum credit rating of A-, which also serves to limit the counterparty risk.
The tables below show financial assets and liabilities subject to setoff and covered by legally binding netting or similar agreements.
Financial per type of financial instrument
Financial assets and liabilities subject to set-off and covered by legally binding netting or similar agreements.
|31 Dec 2020|
|RELATED AMOUNTS NOT OFFSET IN THE BALANCE SHEET|
|SEK m||Gross amount of financial assets and liabilities||Amount offset in the balance sheet||Net amount presented in the balance sheet||Cash collateral||Net amount|
|31 Dec 2019|
|RELATED AMOUNTS NOT OFFSET IN THE BALANCE SHEET|
|SEK m||Gross amount of financial assets and liabilities||Amount offset in the balance sheet||Net amount presented in the balance sheet||Cash collateral||Cash collateral|
Operational risk is the risk of loss resulting from inadequate or failed internal processes, personnel, IT systems or from external events, and includes legal and compliance risk.
The operational risk that Hoist Finance is mainly exposed to is divided into the following seven categories:
- Unauthorised activities and internal fraud
- External fraud
- Employment practices and workplace safety
- Clients, products and business practices
- Damage to physical assets
- Business disruption and system failures
- Execution, delivery and process management
The Group manages operational risk by continuously improving its internal procedures and day-to-day controls, and by training employees in risk management and risk management techniques. The Group also applies the dual-control principle which means that a business flow or transaction must always be managed by at least two independent units/individuals.
To identify and mitigate operational risks within the Group, the Risk control function in each country has established routines, including the following:
- All employees are required to submit incident reports via a Groupwide risk management system, where incidents and actions taken are monitored by the Risk control function. Significant reported incidents are included in the risk report submitted to the Board and the Management in the relevant country.
- Annual evaluation and identification of operational risks, and controls to reduce risks. This is a process to identify, quantify, analyse and thereby determine measures to reduce operational risks in Hoist Finance to an acceptable level. The analysis includes an assessment of a given risk’s probability of occurrence and what its consequences (impact) would be, it lists the steps taken by Hoist Finance to manage the risks, and details additional measures that need to be taken. Assessments are not made by a single person – they are made in groups, since discussion and different perspectives are vital to the identification of relevant risks.
- The process for approval and quality assurance of new and amended products, services, markets, processes, IT systems and major changes in Hoist Finance’s operations and organisation.
- Business Continuity Management (BCM) provides a framework for planning for and responding to events and business disruptions to ensure the continuation of business operations at an acceptable predefined level. The Group’s BCM comprises disruption and crisis management:
- Disruptions are managed by having business continuity plans in place.
- Crises are managed by predefined crisis management teams.
- Key risk indicators are reported to Management and the Board on a regular basis in order to follow up measurable operational risks and provide early warning when risks have increased.
- Regular training in operational risks is conducted in key areas.
Market risk is defined as the risk that FX and interest-rate fluctuations may negatively affect a company’s results or equity level.
The FX risk that has an adverse impact on the Group’s income statement, balance sheet and/or cash flow arises primarily as a result of:
- Certain income and expense items arising in different currencies, resulting in a transaction risk.
- Any imbalance between the value of assets and liabilities in different currencies gives rise to a translation risk or balance-sheet risk.
Group Treasury has overall responsibility for continuous management of these risks.
In each country, most revenue and operating expenses are in local currency. Currency fluctuations therefore have only a limited impact on the company’s operating profit in local currency. Revenue and expenses in national currency are therefore hedged in a natural way, which limits the transaction risk exposure.
The Group’s presentation currency is SEK, while its three main functional currencies are EUR, GBP and PLN. The Group’s loan portfolios (assets) are mainly denominated in foreign currency, while the Group’s deposits from the public (liabilities) are denominated in SEK and EUR. This imbalance between assets and liabilities in different currencies entails a translation risk (balance-sheet risk). To manage translation risk, the Group calculates its unhedged exposure to the aggregate value of net assets denominated in currencies other than SEK. The Group’s translation exposure is then managed through linear derivative contracts. The Group uses hedge accounting for the net investment in foreign operations. Additional information regarding hedge accounting in the Accounting Principles section 10 “Hedge accounting” and in note 16, “Derivatives”.
The tables below show the Group’s exposure per currency. The Group has no significant positions in currencies other than EUR, GBP and PLN. The tables also present the translation risk expressed as sensitivity to a movement of 10 per cent in the exchange rate between SEK and each currency.
|Group FX risk in EUR||31 Dec 2020||Impact on equity||31 Dec 2019||Impact on equity|
|Net assets on the balance sheet, EUR m||65||162|
|Currency forwards, EUR m||-68||-167|
|Net exposure, EUR m||-3||-5|
|A 10 per cent increase in the EUR/SEK FX rate impacts Group results by (SEK m)||-3||-0.06 %||-6||-0.12 %|
|A 10 per cent decrease in the EUR/SEK FX rate impacts Group results by (SEK m)||3||0.06 %||6||0.12 %|
|Group FX risk in PLN||31 Dec 2020||Impact on equity||31 Dec 2019||Impact on equity|
|Net assets on the balance sheet, PLN m||1,818||1,839|
|Currency forwards, PLN m||-1,814||-1,822|
|Net exposure, PLN m||4||17|
|A 10 per cent increase in the PLN/SEK FX rate impacts Group results by (SEK m)||1||0.02 %||4||0.09 %|
|A 10 per cent decrease in the PLN/SEK FX rate impacts Group results by (SEK m)||-1||-0.02 %||-4||-0.09 %|
|Group FX risk in GBP||31 Dec 2020||Impact on equity||31 Dec 2019||Impact on equity|
|Net assets on the balance sheet, GBP m||502||547|
|Currency forwards, GBP m||-499||-545|
|Net exposure, GBP m||3||3|
|A 10 per cent increase in the GBP/SEK FX rate impacts Group results by (SEK m)||4||0.07 %||4||0.07 %|
|A 10 per cent decrease in the GBP/SEK FX rate impacts Group results by (SEK m)||-4||-0.07 %||-4||-0.07 %|
Interest rate risk
The Group’s interest-rate risk originates from changes in interest rates that may affect the company’s revenues and expenses to varying degrees. Changes in interest rates could affect the company’s revenues from loan portfolios as well as the liquidity reserve, while the cost of funding these assets may also change.
A sudden and permanent interest-rate increase may adversely impact the Group’s profit to the extent interest rates and interest expense for loans and deposits from the public are affected more by the increase than are revenues from loan portfolios and the liquidity reserve. To ensure that the exposure is within the company’s risk appetite, Group Treasury manages and reduces these interest-rate risks by continuously hedging the Group’s interest-rate exposure through linear interest-rate derivatives denominated in EUR, GBP and PLN. Hoist Finance does not apply hedge accounting for the interest rate risk hedging.
Pursuant to accounting policies, however, the effects of interest-rate changes are taken up as income at different times. For instance, the Group’s liquidity reserve and interest derivatives are measured at fair value, so changes in interest rates have an instantaneous impact on the book value and hence on Group results. Loan portfolios, on the other hand, are generally valued under the amortised cost principle, so changes in interest rates have an impact over time (rather than instantaneous) on asset value and Group results. The Group’s liabilities are valued under the amortised cost principle, so changes in interest rates have an impact over time (rather than instantaneous) on Group results.
Hoist Finance has strict limits for maximum allowed interest-rate exposure. Limits are in place to reduce earnings risk and economic value risk.
The table below shows the effect on various assets and liabilities of a sudden and permanent parallel shift of 100 basis points in market interest rates.
|Total impact on net interest income over 3 years|
|Impact on profit/loss|
31 dec 2020
|impact on equity||Impact on profit/loss|
31 dec 2019
|impact on equity|
|-100 bps||+100 bps||-100 bps||+100 bps|
|Impact on net interest income (over 3 years)||-29||31||168||-165|
|Impact on derivatives (instantaneous impact)||-54||54||-79||79|
|Total impact of change in short-term interest rate||-83||85||+/-1.61 %||89||-86||+/-1.76 %|
The table below shows the instantaneous impact on profit/loss of a parallel shift of 100 basis points in market interest rates.
|Total items measured at fair value including derivatives, SEK m|
|Impact on profit/loss|
31 dec 2020
|impact on equity||Impact on profit/loss|
31 dec 2019
|impact on equity|
|-100 bps||+100 bps||-100 bps||+100 bps|
|Total||-34||34||+/-0.65 %||-71||71||+/-1.44 %|
Liquidity risk is the risk of difficulties in obtaining funding, and thus not being able to meet payment obligations at maturity without a significant increase in the cost of obtaining means of payment.
The Group’s cash flow from acquired loan portfolios is in its nature positive. The group normally receive a cash flow of ca 1.8 times the invested amount over time. Major cash outflows stem from a deliberate decision to invest in a new portfolio or from unexpected cash outflows. The latter can result from outflow of deposits or from outflow due to mark-to-market of hedging derivatives or from outflow of existing wholesale funding (refinancing risk).
The Group’s overall liquidity strategy is to maintain a liquidity reserve of highly liquid assets designed to mitigate Hoist Finance’s liquidity risks and, in addition, to make liquidity available for financial obligations related to loan portfolio acquisitions.
The Group’s general funding strategy is to maintain a sustainable, cost-efficient and well diversified funding structure while at the same time upholding a sound structural risk level – including liquidity, interest rate and FX risk – which is appropriate, and proportionate to Hoist’s business model. Diversification between different types of sources of funding in various markets, currencies and forms of funding instruments is a key component of the funding strategy. Maintaining an investment grade rating is another cornerstone to Hoist funding strategy, and potential rating implications are taken into consideration in financial and business strategic decisions.
The Group has a diversified funding base with a diversified maturity structure. Funding is mainly raised in the form of deposits from the public and through the capital markets through the issuance of senior unsecured debts, own funds instruments and equity. Hoist Finance offers retail deposits in Sweden and Germany. 30 per cent (41) of deposits from the public are payable on demand (current account), while approximately 70 per cent (59) of the Group’s deposits from the public are locked into longer maturities (fixed-term deposits) ranging from one to five years. More than 99 percent of deposits are backed by the deposit guarantee scheme. The retail deposits give the Group a competitive advantage, as they are stable, flexible and provide access to funding at relatively low cost.
Details of the Group’s funding base are presented in the table below.
|Funding, SEK m||31 Dec 2020||31 Dec 2019|
|Current account deposits||5,422||8,871|
|Debt securities issued||6,355||5,900|
|Additional Tier 1 capital||1,106||690|
|Balance sheet total||31,864||34,387|
In addition to having a diversified funding structure with respect to funding sources and maturity structure, the Group has implemented a number of measures to minimise liquidity risk:
- Centralised liquidity management: Management of liquidity risk is centralised and handled by Group Treasury.
- Independent analysis: The Group’s Risk control function serves as a central unit for independent liquidity analysis. Internal Audit is responsible for inspecting the Group’s liquidity control tools.
- Continuous monitoring: The Group uses short and long-term liquidity forecasts to monitor the liquidity position and reduce liquidity risk. These forecasts are presented to management and the Board.
- Stress testing: The Group conducts stress tests of the liquidity situation. These tests vary in nature to demonstrate the risk from multiple angles and to preclude negative results due to defects in stress test methodology.
- Interest-rate adjustment: The size of deposits from the public can be managed by adjusting quoted interest rates.
- Well-diversified deposit portfolio with no concentration risks: The highest savings deposit is limited to SEK 950,000. The risk of large outflows is further reduced through the coverage of 99 per cent of deposits by the national deposit insurance.
- Liquidity portfolio: Liquidity investments are made in low-risk, high-liquidity interest-bearing securities, which allows for rapid cash conversion if needed.
As a credit institution, Hoist Finance is subject to laws and regulations covering liquidity requirements. Hoist Finance’s short-term liquidity coverage ratio (LCR) was 1,130 per cent (755) at year-end, compared with its regulatory ratio of 100 per cent. The Net Stable Funding Ratio (NSFR) was 119 per cent (124) at year-end. Pursuant to CRR2, the regulatory requirement of 100 per cent NSFR will take effect as from 28 June 2021. Hoist Finance is well prepared to meet this requirement.
As per 31 December 2020, Hoist Finance’s liquidity reserve amounted to 27 per cent (24) of total assets. The liquidity portfolio is largely made up of Swedish government and municipal bonds, German government bonds, covered bonds, and also includes short-term lending to other banks.
|Liquidity reserve, SEK m||31 Dec 2020||31 Dec 2019|
|Cash and holdings in central banks||0||0|
|Deposits in other banks available overnight||2,160||2,526|
|Securities issued or guaranteed by sovereigns, central banks or multilateral development banks||1,354||2,207|
|Securies issued or guaranteed by municipalities or other public sector entities||1,056||522|
|Securities issued by non-financial corporates||-||-|
|Securities issued by financial corporates||-||-|
The Group’s Treasury Policy specifies a limit and a target level for the amount of available liquidity. Available liquidity was within target level as per 31 December 2020 and totalled SEK 8,652m (8,024).
Hoist Finance has a liquidity contingency plan for managing liquidity risk. This identifies specific events that may trigger the contingency plan and require actions to be taken. These events may include:
An outflow from savings deposits of more than 10 per cent of total deposits over a 30-day period.
A lowering or removal of Hoist Finance’s credit rating by an official rating institute.
Internal capital and liquidity adequacy assessment processes
The internal capital and liquidity adequacy assessment processes (ICAAP and ILAAP) are ongoing processes carried out by the Executive Management Team, which reviews, evaluates and quantifies risks to which the Group is exposed in carrying out its business operations. This risk analysis forms the basis for ensuring that the Group has sufficient capital and liquidity to cover the regulatory requirements and to ensure a comfortable financial margin vis-à-vis the regulatory requirements.
The capital and liquidity assessment process is developed and reviewed at least once per year. The annual review focuses on ensuring that the process is always relevant to the current risk profile and to the Group’s operations. The Board decides on any changes to the process, and Internal Audit verifies that the process is carried out pursuant to the Board’s instructions.
The processes start with the management’s business plan and budget for the coming three years. These are formalised into a forecast. The ICAAP and ILAAP use these forecasts as a starting point and, as a first step, evaluate the risks inherent in the forecasts.
ICAAP is Hoist Finance’s internal evaluation to ensure that it has sufficient capital to meet the risks in both normal and stressed scenarios.
Credit and market risks are rigorously stress-tested to determine the extent of the losses that Hoist Finance is capable of withstanding under extremely adverse circumstances. This loss figure is then compared to the statutory capital requirement calculated according to Pillar 1. If the simulated losses exceed this amount, the excess is covered by additional Pillar 2 capital.
Operational risks are evaluated based on the company’s reported incidents statistics. Once the operational risks have been quantified, the next step is calculation of the amount of capital required to cover all potential unexpected losses related to the operational risks. The company must be able to withstand even extremely serious operational incidents. Here as well, the calculated capital requirement is compared to the statutory Pillar 1 capital requirement and any excess loss risk is covered by additional Pillar 2 provisions.
Hoist Finance conducts stress tests and sensitivity analyses of the business plan, under ICAAP and on an ongoing basis in the operations, to ensure that the Group maintains a strong financial position in relation to regulatory capital requirements under extremely adverse internal and external market conditions.
The capital requirement produced by ICAAP is used by management as a decision-making tool when making future plans for the Group. ICAAP thus adds a further dimension to the Group’s decision-making above and beyond strategic and daily planning. Before being implemented, strategic plans, forecasts and immediate management decisions are always reviewed against the background of capital requirements.
The conclusions from this year’s ICAAP are that Hoist Finance has sufficient capacity to withstand unexpected events without risking its solvency.
ILAAP is Hoist Finance’s internal evaluation to ensure that the Group maintains sufficient levels of liquidity buffers and sufficient funding in light of the liquidity risks that exist. The process identifies, verifies, plans and stress-tests Hoist Finance’s future funding and liquidity requirements.
Hoist Finance uses ILAAP to define the size of the liquidity buffer that the Group needs to maintain, to prevent identified liquidity risks from affecting the Group’s capacity to achieve its business plan and to meet regulatory requirements (LCR/NSFR) and the limits set by the Board of Directors.
Results from this year’s ILAAP show that Hoist Finance has sufficient capacity to meet unexpected liquidity risks without risking refinancing problems, and that Hoist Finance maintains a liquidity reserve sufficient to maintain continued growth.