However, it is important for Nordea to keep this level as low as possible. Through risk management and assessment of credit status of the loan takers, Nordea can try and reduce bad loans, which is what is being done at the moment370.
the public have risen significantly from 2005 to 2009. As the financial crisis hit in fall 2007, loan losses were incurred. It is therefore a natural development that Nordea has tried to reduce loans to the public in order to reduce risk in 2008 and 2009. Furthermore, Nordea has increased its use of derivatives tremendously from 2007 to 2009 as the bank is trying to hedge risk and decrease the impact of the financial crisis.
The section will focus on the assets that mainly contribute to the value creation for Nordea. As it can be seen in Table 25, these value creating assets are loans, interest-bearing securities and derivatives, as they make up the largest percentage of assets. Furthermore, we look at the composition of RWA to determine Nordea‟s risk exposure. First, however, the key ratios used to analyze the assets will be broken down and elaborated on.
Choice of ratios
To illustrate Nordea‟s use of capital the following key figures have been chosen:
Loans
Impaired Loans
Interest-bearing Securities
Derivatives
RWA
The development in loans is relevant because loans make up the basis of Nordea‟s earnings.
Impaired loans express the amount of loans that have reduced interest rates. These loans are loans where the bank has found it necessary to reduce or entirely halt the interest rate calculations as it is not deemed realistic that the debt holder will be able to repay the loan according to the initial agreement. This key ratio is interesting as it shows the development in reduced payback on interest rates and indicates Nordea‟s expectations to future loan defaults.
Derivatives express the amount Nordea spends on hedging risk. This key ratio will show how much risk Nordea is trying to hedge and will indicate future expectations to the development in financial markets.
Risk weighted assets divides Nordea‟s operation into two different pillars, according to the Basel II agreement. Pillar 1 deals with maintenance of regulatory capital calculated for three major components of risk that Nordea faces: credit risk, market risk, and operational risk371. Pillar 2 deals with the regulatory response of the first pillar, giving regulators much improved tools compared to those in Basel I. Furthermore, Pillar 2 provides a framework for dealing with all the other risks Nordea may face, such as: systematic risk, pension risk, concentration risk, strategic risk, reputation risk, liquidity risk, and legal risk372. RWA will indicate how risky Nordea‟s assets are.
Loans
As loans are by far the largest asset on the balance sheet, an extensive analysis of this asset is appropriate. In order to analyze loans we will go through the yearly increase in loans, the dispersion of loans and the key figures on impaired loans.
Increase in loans
The yearly increase in loans represents Nordea‟s core business and revenue basis.
Table 26. Loans and receivables
Source: Nordea Annual Reports
As it can be seen from Table 26, the loan portfolio has steadily increased over the last 9 years.
This has mainly been driven by the loans and receivables to the public. The amount of loans to other credit institutions has been decreasing since 2005. Although this development is a positive indicator, the dispersion of the loans must also be analyzed in order to assess the exposure.
371 www.wikipedia.org – Basel II
372 www.wikipedia.org – Basel II
Loans EURm 2001 2002 2003 2004 2005 2006 2007 2008 2009
Loans and receivables to credit institutions 21,370 23,496 29,037 24,774 31,578 26,792 24,262 23,903 18,555 Loans and receivables to the public 137,570 145,740 145,644 161,060 188,460 213,985 244,682 265,100 282,411
Total allowances -2,259 -2,153 -1,936 -1,772 -1,481 -1,118 -957 -1,170 -2,156
Loans and receivables total 161,199 171,389 176,617 187,606 221,519 241,895 269,901 290,173 303,122
8%
52%
38%
2%
Credit institutions Corporate Household Public sector
Loan Dispersion 2008
6%
51%
41%
2%
Credit institutions Corporate Household Public sector
Loan Dispersion 2009 Loan Dispersion
Nordea‟s loan portfolio consists of loans to credit institutions and to the public. The loans to the credit institutions are mainly interbank deposits373. The loans to the public can be divided into loans to corporate customers, household customers and the public sector. Figure 14 illustrates the dispersion of the loans in 2008 and 2009. Both years exhibit similar exposures, the highest exposure being corporate and household loans.
Figure 14. Loan Dispersion
Source: Nordea Annual Report 2008 and 2009
Corporate Loans
Figure 15 illustrates the largest exposures, which in 2008 and 2009, was shipping and offshore, retail trade, consumer staples, industrial commercial services, financial institutions and real-estate. Real-estate is by far the largest exposure in Nordea‟s corporate loan portfolio. In 2009, real-estate exposure amounted to 24% of the corporate loan portfolio and 12% of Nordea‟s total loan portfolio. Loans to corporate customers went up 1% from EUR 152bn in 2008 to EUR 154bn in 2009. This development was mainly driven by a 5% positive development in the real-estate sector, 57% in consumer durables and 21% in the construction sector374. Geographically, real-estate exposure is mainly related to the Nordic market. Overall, the corporate loan portfolio is fairly diversified. The distribution of loans by size shows that approximately 62% of the corporate loan volume is for loans up to EUR 50m per customer375.
373 Nordea Annual Report 2009
374 Annual Report 2009
375 Annual Report 2009
23%
10%
8%
9% 7%
11%
32% Real estate
Industrial commercial services Shipping and offshore Retail Trade Consumer Staples Financial Institutions Other
Corporate Loan Dispersion 2008
24%
10%
7%
8% 7%
11%
33% Real estate
Industrial commercial services Shipping and offshore Retail Trade Consumer Staples Financial Institutions Other
Corporate Loan Dispersion 2009
77%
23%
Household mortgage loans
Household consumer loans
Household Loan Dispersion 2008
78%
22%
Household mortgage loans
Household consumer loans
Household Loan Dispersion 2009
Source: Nordea Annual Report 2008 and 2009
Household Loans
Loans to household customers can be divided into household mortgage loans and household consumer loans as illustrated in Figure 16. Household mortgage loans make up by far the largest component of the total loan portfolio with 32% in 2009, up 3% from 2008, and 78% of the household customer loans. The household mortgage loans are mainly exposed to the Nordic market, with an exposure of EUR 2,903m.
Lending to household customers increased by 13% from EUR 109bn in 2008 to EUR 123bn in 2009376. This development was driven by a 15% increase in household mortgage loans and 8%
increase in household consumer loans.
Figure 16. Household Loan Dispersion
Source: Nordea Annual Reports 2008 and 2009
376 Nordea Annual Report 2009 Figure 15. Corporate Loan Dispersion
Overall, Nordea‟s largest exposure is towards the real-estate sector in the Nordic countries. With real-estate amounting to EUR 37,173m (12%) and household mortgage loans amounting to EUR 96,615m (32%) of the total loan portfolio in 2009, there is a 44% exposure to real-estate of the total loan portfolio. The Baltic country total real-estate exposure amounts to 1.4% of the total loan portfolio in 2009.
Impaired loans
The gross impaired loans in Table 27 can be analyzed relative to the entire loan portfolio in order to indicate how solid the portfolio is, this ratio is known as the impairment rate. This ratio has also been calculated by Nordea in the financial statements; however, the ratio calculations have been inconsistent over the 9 years. We have chosen to calculate the ratio as gross impaired loans/
total loans and receivables.
Table 27. Impaired loans
Source: Nordea Annual Reports
As seen in Table 27, the gross impaired loans have fallen prior to the financial crisis and have increased significantly during the last two years. The impairment rate was also declining prior to the financial crisis and has increased since. Nordea has as of end of December 2006 changed the principles for disclosure of impaired, but performing, loans, which increases the size of impaired loans. This change does not reflect increased risk, but since the size of allowances for impaired loans are unchanged, the ratio between allowances and impaired loans decreases. The 2005 and 2006 figures have been changed in accordance with this new principle.
The allowance for impaired loans gives an indicator of the banks expectations of loan defaults.
The allowance is a general reserve established to cushion all credit losses in Nordea‟s loan portfolio. It covers losses that are probable and can be estimated on the date of valuation. When the allowances are subtracted from the gross impaired loans, the result is net impaired loans.
Finally, the net impaired loans relative to the loan portfolio provides an indicator of the net losses on loans the given year.
Impaired Loans EURm 2001 2002 2003 2004 2005 2006 2007 2008 2009
Impaired loans (gross) 3,114 3,260 2,649 2,315 2,526 1,868 1,432 2,224 4,102
Impairment rate (gross) 1.93% 1.90% 1.50% 1.23% 1.14% 0.77% 0.53% 0.77% 1.35%
Table 28. Allowances
Source: Nordea Annual Reports
From Table 28, it is evident that the yearly total allowances have fallen steadily until the beginning of the financial crisis. After the crisis there has been an increase in total allowances, and this has also been the case for the net impaired loans as well as the net impairment rate.
Interest-bearing securities
The interest-bearing securities have steadily increased over the last nine years. The numbers specified have not been deducted financial instruments pledged as collateral and are thus gross numbers. As portrayed in Table 29, there is a slight decrease in 2004; however, this is due to changes in accounting standards, thus overall, the development has been an increase in the securities issued by other borrowers than the public.
Table 29. Interest-bearing securities
Source: Nordea Annual Reports
Table 30 shows that the ratio between interest-bearing securities and loans has been on a level between 11% and 19%.
Table 30. Interest-bearing securities/Loan ratio
Source: Nordea Annual Reports
Treasury bills and interest-bearing securities give an indicator of credit risk exposure towards exposure in securities financing. The securities financing has increased steadily during the last nine years. Furthermore, there has been a larger relative exposure towards securities financing.
Allowances EURm 2001 2002 2003 2004 2005 2006 2007 2008 2009
Total allowances (reserves) -2,259 -2,153 -1,936 -1,772 -1,481 -1,118 -957 -1,170 -2,156 Impaired loans (net) 855 1,107 713 543 1,045 750 475 1,054 1,946
Impairment rate (net) 0.53% 0.65% 0.40% 0.29% 0.47% 0.31% 0.18% 0.36% 0.64%
Securities EURm 2001 2002 2003 2004 2005 2006 2007 2008 2009
Issued by public bodies 5,608 9,746 16,034 10,061 4,752 5,863 2,945 3,120 8,349 Issued by other borrowers 19,779 18,420 15,983 17,124 31,369 33,699 40,354 49,626 58,915 Interest-bearing securities including pledged 25,387 28,166 32,017 27,185 36,121 39,562 43,299 52,746 67,264
Security/Loan ratio EURm 2001 2002 2003 2004 2005 2006 2007 2008 2009
Loans and receivables total 161,199 171,389 176,617 187,606 221,519 241,895 269,901 290,173 303,122 Interest-bearing securities 25,387 28,166 32,017 27,185 24,632 29,066 38,782 44,830 56,155
Security/Loan ratio 15.75% 16.43% 18.13% 14.49% 11.12% 12.02% 14.37% 15.45% 18.53%
Derivatives
Table 31 shows the development of Nordea‟s derivatives. Nordea mainly uses derivatives in order to meet customer needs as well as for proprietary trading purposes and to reduce interest rate currency risk in the regular banking activities377. The total credit risk exposure consists partly of current exposure and partly of potential future exposure378.
Table 31. Derivatives
Source: Nordea Annual Reports
It is evident that Nordea has increased its exposure to derivatives. This is as expected, as the financial crisis will presumably have banks and its customers seeking for a way to reduce risk.
Some of Nordea‟s risk has therefore been reduced through derivatives.
RWA
Table 32 shows the development in Nordea‟s risk weighted assets. With the implementation of the Basel II accord in 2007, the segmentation of RWA changed and operational risk and additional capital requirements had to be included as a risk.
Table 32. Risk Weighted Assets
Source: Nordea Annual Reports
It is evident that Nordea‟s risk has increased, especially with the implementation of Basel II.
However, in 2009, Nordea has been able to control its risk and reduce the amount of RWA. It is a positive development that Nordea‟s management has been able to control risk in 2009 as this leads to a safer bank. With regards to the future and Basel III, the new requirements might require that additional assets are classified as risk and that Nordea has to meet these new requirements by
377 Nordea Annual Report 2008
378 Nordea Annual Report 2008
Derivatives EURm 2001 2002 2003 2004 2005 2006 2007 2008 2009
Derivatives n/a 21,629 19,791 26,366 28,876 24,207 31,498 86,838 75,422
Risk Weighted Assets (RWA) EURm 2001 2002 2003 2004 2005 2006 2007 2008 2009
Basel Agreement I I I I I I II II II
Credit Risk 129,498 125,881 124,658 132,935 153,483 176,329 156,952 150,746 153,123 Market Risk 6,523 8,789 9,738 12,070 15,545 9,069 3,554 5,930 5,386 Operation Risk - - - - - - 10,976 11,896 13,215 RWA Basel II (Pilar 1) before transition rules 136,021 134,670 134,396 145,005 169,028 185,398 171,482 168,572 171,724 Additional Capital Requirements - - - - - - 33,103 44,709 20,134 RWA with Transition Rules 136,021 134,670 134,396 145,005 169,028 185,398 204,585 213,281 191,858
reducing, for example, credit risk. Nordea has, however, increased their Tier 1 capital ratio in 2009 through stock issues and this has, to some extent, prepared Nordea for the future and the regulations that will come with Basel III.