Credit risk loan book
Credit risk is the risk that a counterparty doesn’t fulfil its financial obligations. Triodos Bank manages its Credit Risk at a client and at portfolio level. It operates within a pre-defined set of criteria for accepting credits. Credits are extended within the target markets and lending strategy in accordance with Triodos Bank’s mission and expertise. Before accepting a credit facility, Triodos Bank makes an assessment of the customer’s risk profile, cash flows, available collateral and the requested transaction, including an assessment of the integrity and reputation of the borrowers or counterparty. Compliance analysis with Triodos Lending Criteria is an integral part of each credit proposal.
In order to manage credit risk Triodos Bank developed an internal rating-based system, resulting in a probability of default. Furthermore, Triodos Bank has developed a loss given default model, allowing us to model the expected loss and the economic capital.
An obligor is a single legal entity that commits to the terms and conditions of a loan agreement. The obligor is thoroughly analysed on meeting Triodos Bank’s lending criteria and its capacity to repay a loan. The risk related to the obligor is that it fails to meet its contractual obligations. Obligors are rated through an internal rating methodology.
A thorough assessment of each obligor and the structure of their loan is made before any loan is provided. A review of approved credit is made once a year, as a minimum, to assess the evolution of the client’s capacity to meet its obligations. The high quality of securities (collateral) against outstanding loans reduces credit risk. Examples of principal collateral: mortgage registrations for business or private properties, securities from public authorities, companies or private individuals, and rights of lien on movables, such as office equipment, inventories, receivables and/or contracts for projects.
Triodos Bank aims to finance specific projects and assets that are in line with its mission. When financing a project, the bank has a pledge on the underlying contracts. For the financing of objects, Triodos Bank will take a pledge or mortgage on the specific object. It applies haircuts, in all cases, on the market value. The level of this haircut will depend on the marketability of the asset in a negative scenario. This allows Triodos Bank to make a proper assessment of the overall risk of the loan and the value of the asset in case of a downturn. The value of the collateral is reviewed on a yearly basis. An external valuation by an expert is requested, at a minimum every three years, for large loans with a mortgage.
Triodos Bank has an early warning system that helps identify problem loans early, to allow for more available options and remedial measures. Once a loan is identified as being in default (unlikeliness to pay or overdue payments beyond 90 days), it is managed under a dedicated remedial process, with a focus on full recovery.
The risk related to a Group is that if one obligor fails to meet its contractual obligations, so will the remaining obligors within the Group. A group is defined as two or more obligors that are interrelated in such a way that they are considered as a single risk.
Each obligor of the Group, and the Group as a whole, are analysed on all aspects, from meeting Triodos Bank’s lending criteria to their capacity to repay the loan.
Concentration risk loan book
Loans are provided to businesses and projects that contribute to achieving Triodos Bank’s mission. Given that this involves a small number of sustainable sectors, a certain level of sector concentration is inherent to the loan portfolio. Concentration in the existing sectors is acceptable as Triodos Bank has considerable expertise in these sectors and actively invests in further increasing its knowledge.
Triodos Bank focus primarily on the quality and diversification of its loan portfolio. We put extra effort into identifying loans to front-runners in their fields; the entrepreneurs developing the sustainable industries of the future.
A diversified credit risk portfolio is the result of assets spread over many debtors, sectors and geographies that are not interrelated. In order to manage concentration risks and face an economic downturn with confidence, Triodos Bank maintains a set of limits. It measures and limits the following concentration risks in its lending activities: obligor exposures, group exposures, top 20 exposures (excluding central and lower government exposures), government exposures, exposures at sector per country, mortgage exposures and country exposures.
Besides lending activities, Triodos Bank has established limits related to the investment portfolio concerning central banks, governments, supranational institutions and banks and financial institutions. These limits are derived from the risk appetite framework and aim to keep concentration risk at an acceptable level.
From a regulatory perspective, exposures to a client or a group of connected clients may never exceed 25% of the Actual Own Funds. Loans in excess of 10% of the Actual Own Funds require special reporting to the supervisory authority.
Triodos Bank has no loans to a group of connected clients exceeding 10% of the Actual Own Funds in its loan book. Limits of the investment portfolio are described in the relevant chapters.
Triodos Bank is active in well-defined sectors where it has extensive expertise, and which are in line with its mission. It has set limits on sectors, based on Actual Own Funds, at group and banking entity level. Sector studies have shown relatively low correlations of risk drivers in sectors that Triodos Bank finances in multiple countries. A specification of the lending by sector can be found from page 142 onwards.
At group level, Triodos Bank divides the sector concentration limits in different levels. Specific limits for each sector per country are set by the Executive Board within these levels, taking into account the specific risks of each sector and country.
Larger sectors are strategic for Triodos Bank. These are well distributed across banking entities (and countries) and have an overall low risk profile that justifies a higher consolidated concentration. Sector analyses are performed on an annual basis and are presented to the Central Credit Committee to be able to respond swiftly to developments that may affect the risk profile of the portfolio. Central Credit Risk can request sector updates at shorter intervals if there is a change to a sector risk profile.
Sector limits are approved on the basis of thorough annual sector analyses demonstrating an in-depth knowledge of the sector and Triodos Bank’s track record.
Triodos Bank is a European bank, acting under the European Banking Directive since 1993, with banking entities in four countries (The Netherlands, Belgium, Spain and Germany), with a subsidiary in the United Kingdom and with additional exposures amongst others in France and Ireland.
Triodos Bank does not set any country limits for the countries it operates in as long as these countries have a credit rating of AA- or better. Specific limits are defined for countries with a credit rating of A+ or lower.
Credit risk investment portfolio
Liquidity not invested in loans to customers is invested in deposits with banks (including Central Banks) or bonds. Triodos Bank’s policy is to invest the liquidity in the countries where it has banking entities. The bond portfolio of Triodos Bank comprises of (local) government bonds (from countries where Triodos Bank has a banking entities) and investment grade bonds issued by European supranational organisations (e.g. European Investment Bank), Financial Institutions and corporates.
There are no regulatory restrictions to exposures on governments. Triodos Bank sets limits based on the country risk.
There are also no regulatory restrictions to exposures on multilateral development banks as far as an institution has a credit risk weight of 0% for regulatory capital requirements. Triodos Bank has set limits to avoid concentration risk in these exposures.
Credit risk banks
Banks are selected on the basis of their creditworthiness and screened on their sustainability performance. Exceptions can occur, when the capacity of selected banks in a country is considered not sufficient to place Triodos Bank’s liquidities using a certain maximum concentration per individual bank. In such cases, deposit maturity periods will not exceed three months. All counterparty limits for banks are set by either the Executive Board or the Central Credit Committee. Banking entities place excess liquidity with the country’s central banks (minimum reserve requirements and deposit facility). There are no regulatory restrictions on exposures to Central Banks.
The Capital Requirements Regulation Large Exposures Regime limits the maximum exposure to a bank at 25% of its Tier 1 capital plus (if available) Tier 2 with a maximum of one third of Tier 1 capital. To avoid the interbank exposure exceeding the regulatory maximum, Triodos Bank applies a maximum exposure below the limit based on the Large Exposures Regime. The limits are furthermore adapted to the external rating of the counterparty and also deposits on banks are limited to a maximum maturity of one year.
Credit risk related to derivatives
Triodos Bank has exposure to credit risk resulting from outstanding Foreign Exchange (FX) contracts (spot, forward and swap transactions) with Financial Institutions and with funds managed by Triodos Investment Management. Triodos Bank services these funds by providing hedges for the foreign exchange risk of these funds’ investments.
Triodos Bank has limited exposure to credit risk resulting from outstanding Interest Rate Swaps (IRS). The IRS are all centrally cleared with the LCH Clearnet. The daily margining minimises the (potential) credit risks.
A limit is set per counterparty based on the expected amount of outstanding FX transactions and the corresponding expected exposure. This limit is subject to the overall counterparty limit Triodos Bank has per counterparty.
Any collateral needed for FX transactions is calculated and managed daily. In the liquidity stress tests, the amount of collateral needed for FX transactions is stressed in order to calculate the potential impact on Triodos Bank’s liquidity position.
Triodos Bank entered into FX deals with Triodos Investment Funds and these deals are hedged by deals with a few banks. Wrong-way risk is the risk that the exposure to a counterparty is adversely correlated with the credit quality of that counterparty. The FX deals with the Triodos Investment Funds do not cause wrong-way risk as these FX deals hedge the FX risk of the underlying assets of the Investment Funds. At the end of 2017 Triodos Bank stopped entering into new FX deals with Triodos Investment Funds because of new regulation. In addition, the wrong-way risk of transactions with banks is mitigated by only using banks with a sufficient credit rating and by having collateral agreements in place.
Additional disclosure related to the credit quality of assets
Business loans in the portfolio are periodically reviewed on an individual basis. Their frequency depends on the debtor’s creditworthiness, the degree of market exposure and the market in which the debtor operates. Small business and private loans are reviewed at portfolio level, and on individual basis if appropriate. The credit committee of a banking entity discusses and, if necessary, takes action with respect to overdue payments from debtors. If there is any doubt regarding the continuity of the debtor’s core operations and/or a debtor fails to settle agreed interest and repayment instalments for a prolonged period, this debtor falls under the category of doubtful debtors and will be managed intensively.
The net allocation (addition minus release) to the specific provision for doubtful debts have remained very low in 2019 and amounted to EUR 3.6 million. This is mainly due to a strong economy in the different European countries Triodos Bank is active in. The effects of the economy lead to lower amounts in defaults, more clients that can be cured from their default status and when in default, the collateral value used for recovery of the loan will often generate a higher value than in an economic downturn scenario. The loan portfolio has grown by 13% in 2019 and at the same time total provisions have been reduced by 14% compared to 2018, total provisions as percentage of the loan portfolio has reduced from 0.5% ultimo 2018 to 0.4% ultimo 2019 and the defaulted portfolio as percentage of the total portfolio reduced from 1.9% to 1.6%. Although the outlook is somewhat uncertain (Brexit, trade wars) with a possible slowdown of the economy in 2020, the effect on the Triodos Bank portfolio will be relatively limited as we predominantly support local production for a local need. This largely limits the negative effects of global markets and (limited) cross border trade.
Provisions for loan losses are taken for doubtful debtors at an individual level based on the difference between the total amount of the debtor’s outstanding liability to Triodos Bank and the future expected cash flows, discounted at the original effective interest rate of the contract. These individual provisions include provisions for concessions or refinancing given to debtors who face financial difficulties. They are only granted to the debtor in question in order to overcome their difficulties in these exceptional circumstances. These are described as forbearance measures.
A collective credit provision has been taken for Incurred But Not Reported bad debts (the IBNR) to cover the time lag between the event that prompts the debt to qualify as doubtful and the moment that fact is known to Triodos Bank. This is a collective credit provision and is based on statistics. The IBNR is calculated by multiplying the exposure at default with the probability of default, the loss given default and the loss incubation period. Since 2016, in view of the growing mortgage portfolio, Triodos Bank has added an IBNR provision for mortgages. Triodos Bank portfolio has no specific provisions of any relevance in its mortgage loan portfolio and has therefore chosen to use market statistics to define this additional provision.
In 2019, the net additions to the provision for doubtful debts, as a percentage of the average loan portfolio, was 0.05% (2018: 0.05%). The total of provisions related to the outstanding credits is 0.4% (2018: 0.5%) as at the end of the year.
The credit risk in the loan portfolio is reported each month to the Central Credit Committee, and quarterly to the Audit and Risk Committee as part of the ERM report.
Qualitative disclosure requirements on institutions' use of external credit ratings under the standardised approach for credit risk
In addition to our own opinion, external credit ratings – if available – are used to determine the credit worthiness of the counterparties of our investment portfolio and banks, and for a few corporates. External ratings are also used for calculating the minimum capital requirement for credit risk under the standardised approach. For this purpose, we use the ratings of Fitch and Moody’s.