From 2020, our financial reporting standard has changed from Dutch Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS). Triodos Bank's continued growth and increasing internationalisation, as well as wanting to align ourselves with reporting developments in the banking sector, were the key factors driving this decision.
IFRS-9 and the Expected Credit Loss Model
With the introduction of IFRS at the beginning of this financial year, Triodos Bank had to apply initial and subsequent measurement rules in line with the underlying IFRS framework. Consequently, Triodos Bank replaced the credit provisioning model under Dutch GAAP with the expected credit loss (ECL) model in line with IFRS-9 for all loans and debt securities. The ECL model calculates credit risk costs by anticipating potential credit losses in future periods for performing loans (stages 1 and 2) and loans in default (stage 3). The underlying calculation parameters in the model and the overall ECL provision are closely monitored and updated on a monthly basis. The calculation for ECL stages 1 and 2 for potential future credit losses (not yet incurred) are particularly sensitive to forward-looking macro-economic parameters, like gross domestic product, unemployment rate, house prices, etc., for the countries in which Triodos Bank is active.
In 2020, the economic outlook worsened as a result of the COVID-19 pandemic. The forward-looking macro-economic parameters adjusted accordingly. This resulted in higher ECL provisions, which reduced bank profitability. The build-up of the ECL provision in 2020 was mainly related to the influence of these forward-looking macro-economic parameters on our stage 1 and stage 2 ECL provisions. Additions, in 2020, to stage 1 and stage 2 provisions, i.e. expected losses, make up 57% of our total addition to the ECL provision, with just 43% relating to stage 3, incurred, losses. The risk profile of our portfolio also implies that any improvement in the forward-looking macro-economic parameters, perhaps because of better-than-expected post-COVID-19 economic conditions, might result in a reduction in Triodos Bank's overall ECL provision. Further details can be found in the following paragraphs on our financial results.
Consolidated financial results
At the start of 2020, Triodos Bank anticipated a year of stable development, building on the results of 2019. By the end of February it was apparent that this year would be different.
On 11 March 2020, the World Health Organization declared that the coronavirus outbreak was a global pandemic. The disruption to lives, livelihoods and our business has been unprecedented. As the scale of the global crisis became clear, economic outlooks worsened and financial markets became very volatile. Triodos Bank had to take some exceptional decisions:
On 18 March 2020, the Executive Board voted to suspend trading in Triodos Bank Depository Receipts (DRs). Trading resumed on 13 October 2020 with a new prospectus and restrictions in place, limiting the number of DRs investors can sell in one transaction.
Despite the mitigating measures we took, the patterns of buying and selling of Depository Receipts did not return to the balance we were expecting. The ongoing uncertainty around the corona crisis and its longer-term economic effects have not disappeared; on the contrary, further lockdown measures and other restrictions were seen globally in the last two months of 2020. The trading pattern we were experiencing put into question whether the balance in trade in Depository Receipts will be restored in the current economic context. It also poses the question of what measures we can take to achieve balanced trading, as we must now assume that previous trading patterns will likely not recover in the foreseeable future. DR trading was therefore suspended on Tuesday 5 January 2021.
On 1 April 2020, the Executive Board decided to withdraw the dividend proposal which was published in the Annual Report 2019. This was a direct response to the recommendation made by the European Central Bank and De Nederlandsche Bank on 27 March to all banks not to pay out dividends so as to prioritise supporting the real economy by lending to customers during the COVID-19 pandemic.
We focused first on the implications for customers of the global pandemic, especially our borrowing customers. We have been in close contact with most of our business customers to assess and address their short-term needs. We have contributed to initiatives with other banks, governments and regulators to advance measures to assist business, particularly in the SME sector. Triodos Bank has been doing its utmost to reinforce our customers' economic resilience during the crisis by facilitating repayment holidays and payment deferrals across countries. We have helped other companies and organisations to remain active with government-guaranteed loans and other special agreements.
In light of these developments, the consolidated financial results are summarised below.
Impact drives our ‘impact, risk, return’ model
In essence, Triodos Bank aims to maximise sustainability. It embraces the need to be profitable but only as a means to a sustainable end. Profit can be seen as a yardstick. It shows an organisation is working efficiently but says nothing about the content and the impact of what it is doing.
Triodos Bank uses a three-tier approach to making lending and investment decisions, which starts with evaluating the content of an activity and focuses on its sustainable impact. The first thing to consider is ‘How does this contribute to positive social, environmental and cultural change?’; Next, we ask ‘Is it viable?' And finally, 'Is the idea rooted in society – is it supported by those around the entrepreneur?' If the professional judgement is correct, financial and social profit should follow almost automatically.
In 2020, Triodos Bank’s income grew by 4% to EUR 305 million (2019: EUR 292 million). Triodos Investment Management contributed EUR 45 million to this figure (2019: EUR 51 million). The growth of Triodos Bank’s income was mainly driven by the growth in the loan portfolio. This was achieved in a low interest rate environment and despite the economic effect of the first, second and third waves of COVID-19. In 2020, net commission income amounted to 35% (2019: 36%) of total income, in line with expectations. Further, Triodos Bank participated in the TLTRO tender III.5 of the ECB for EUR 750 million. In 2020, this resulted in additional income of EUR 1.9 million.
Triodos Bank’s balance sheet total grew by 15% to EUR 13.9 billion (2019: 12.1 billion) caused by a significant growth of funds entrusted and lending during the year in all banking entities. This compares with expected growth of between 5% and 10%. Triodos Bank’s funds under management grew by 12% to EUR 6.4 billion (2019: 5.7 billion).
Continuing growth in loans, deposits and equity, although hampered by the three waves of COVID-19 and despite low interest rates and returns, shows that Triodos Bank’s commitment to values-based banking remains relevant for people and businesses who choose to make a more conscious choice about their bank and the sustainable contribution their money makes to the economy.
The total number of Triodos Bank customers increased by 1% to 728,000 during the year (2019: 721,000). Surplus liquidity led to a reduced marketing spend in 2020; our main focus was on assisting borrowing customers through the COVID-19 crisis and on data quality. These priorities likely reduced the rate of customer growth during the year.
In 2020, our operational cost base increased by 5% to EUR 245.4 million (2019: EUR 234.4 million). Technology and efficiency improvements further optimised our cost base, but these cost reductions were more than offset by external factors over which Triodos Bank has little direct influence. Increased regulatory requirements, the deposit guarantee scheme (DGS), and managing know your customer/customer due diligence (KYC/CDD) and anti-money laundering (AML) processes all imposed additional costs during the year. Furthermore, the new way of working, which is a combination of working from home and working from the office, triggered an impairment of the office building in Zeist. This resulted in a non-recurring cost of EUR 5 million.
Regulatory expenses increased by EUR 2.2 million to EUR 16.6 million at the end of the year 2020. This was mainly driven by higher DGS costs as a result of the significant growth of our funds entrusted. Compliance costs also increased, with additional co-workers being assigned to CDD and AML improvements and related IT investments.
Operating profit before tax decreased in 2020 to EUR 35.5 million (2019: EUR 54.1 million).
In 2020, our ratio of operating expenses against income remained stable at 80% (2019: 80%). This is an exceptional achievement in a year in which our income ambitions could not be fully realised, with the coronavirus crisis dampening the pace of our loan volume development. We managed to compensate for unavoidable cost increases with cost-containment measures and efficiency gains. Consequently, we were able to achieve a stable cost/income ratio in 2020.
Improving our efficiency continues to be a key focus area for the bank. Given the challenges faced in this context we are pleased to have achieved a reasonable return on equity during the year, despite the consequences of COVID-19.
The current economic environment has, as a result of the COVID-19 pandemic, affected the credit risk of financial instruments. These changes in credit risk resulted in changes in expected credit losses (ECL). We have applied the ECL model in line with IFRS-9 based on underlying forward-looking macro-economic parameters. We have updated these parameters to factor in the consequences of COVID-19. This affected GDP growth and unemployment rates, which are key sensitivities for the stage 1 and 2 provisions in the ECL model.
Several judgements and estimations are made in order to calculate ECL. The accounting policies and ECL model are consistent with the 2019 pro forma IFRS consolidated financial statements. Nevertheless, the COVID-19 pandemic has had an impact on the judgements and estimations used in the ECL model. Triodos Bank has incorporated the current economic environment in its forward-looking macro-economic scenarios. This is done by using external market information and adding internal, specific information. GDP growth is a key driver of credit risk. The section Critical judgements and estimates in the annual accounts section presents the future outlooks implied by the different scenarios defined by Triodos Bank.
Triodos Bank uses the three-stage model to classify the ECL for financial instruments. Stage 1 includes the financial instruments that have maintained similar credit risk status since origination. The ECL for this category is determined by looking forward 12 months. Stage 2 includes financial instruments where there has been a significant increase in credit risk since origination. Stage 2 ECL is assessed by looking over the entire lifetimes of the financial instruments. The ECLs for stages 1 and 2 are determined by a model that includes various metrics, some are client-specific others are based on macro-economic scenarios.
Stage 3 includes financial instruments which are in default. The ECL for this stage is also determined over the entire lifetime but calculated individually considering default-specific scenarios.
In the macro-economic scenarios, Triodos Bank has taken into account that some sectors are expected to be more affected by the COVID-19 pandemic than others. Consequently, Triodos Bank has placed some sectors fully into stage 2 in the course of 2020.
In 2020, the provision for ECL was materially impacted by the effects of COVID-19. The ECL provision was recalculated in line with the subsequent measurement rules under IFRS-9 by considering forward-looking macro-economic parameters, such as GDP growth and unemployment numbers in Europe. The balance sheet provision for expected credit losses increased by EUR 18.7 million in 2020 to EUR 53.3 million. Fifty-seven percent of this provision increase was related to ECL stages 1 and 2, anticipating potential credit losses in future periods rather than actual, incurred losses. The calibration of this provision is carried out continuously, considering the changed forward-looking macro-economic parameters, as well as changes to support measures taken by governments and regulators and the creditworthiness of our clients in our loan portfolio.
In the profit and loss account, the increased ECL provision is reflected in higher impairments for the financial instruments. These increased sharply to EUR 24.2 million from EUR 3.7 million in 2019. The impairments represent 0.27% of the average loan book (2019: 0.05%). This relatively high impairment ratio is primarily caused by increased stage 1 and stage 2 provisions as a result of the downward revision in macro-economic parameters caused by the COVID-19 pandemic. The resulting increase in ECL impairments has had a significant influence on year-on-year profit levels. Furthermore, the new way of working, which is a combination of working from home and working from the office, triggered an impairment of the office building in Zeist. This resulted in a non-recurring cost of EUR 5 million.
Despite the impact of COVID-19 on our loan book, income and impairments, Triodos Bank was able to achieve a net profit of EUR 27.2 million, down by 30% (2019: EUR 39.0 million), primarily caused by the EUR 24.2m (2019: EUR 3.7 million) impairments for the financial instruments in 2020 driven by the worsened macro-economic parameters that drive the ECL calculation model. These parameters worsened as a result of the COVID-19 pandemic and the economic consequences related to that crisis. This resulted in a positive return on equity of 2.3% in 2020 (2019: 3.4%).
Triodos Bank considers a return on equity of 3-5% as a realistic medium-term objective for the type of banking activity that Triodos Bank engages in. This has not been modified in light of the recent development.
Triodos Bank will continue to work on improving its profitability while maintaining a solid equity base, capital ratio and a substantial liquidity surplus. The bank recognises that this risk-averse strategy imposes constraints on its return on equity.
Earnings per share, calculated using the average number of outstanding shares during the financial year, were EUR 1.91 (2019: EUR 2.80), a 32% decrease. Triodos Bank proposes a dividend of EUR 0.65 per share, subject to policy recommendations and guidelines of the ECB and/or DNB. The remaining profit will be attributed to the retained earnings of the bank, which is part of the net asset value of the bank, the basis for the value of the Depository Receipts.
The number of individual Depository Receipt holders decreased overall in 2020. The number of Depository Receipt holders decreased from 44.401 to 43,614, despite a closed DR market for a significant period of time during 2020.
The price of the Depository Receipts for Triodos Bank shares (the issue price) is based on a financial model that derives the calculated net asset value (NAV) of Triodos Bank divided by the number of Depository Receipts (NAV per DR). As of 1 January 2020, the NAV of Triodos Bank is calculated in accordance with IFRS.
The Issue Price under Dutch GAAP, corrected for the estimated IFRS impact, was set on 3 July 2019 at EUR 82, in line with the new prospectus. This was EUR 1.00 lower than when trading was suspended on 4 June 2019. At the end of 2019, the net asset value for each Depository Receipt was EUR 83, based on the NAV including the estimated IFRS impact. In our pro forma IFRS consolidated Financial Statements 2019, as published on 3 July 2020, the net asset value on 31 December 2018 has been adjusted from EUR 84 to EUR 82 in line with the new IFRS accounting principles.
Triodos Bank increased its equity by 1%, or EUR 7 million, from EUR 1.201 million to EUR 1.208 million. This increase includes net new capital by DR growth and retained net profit.
The growth in equity, in combination with the implementation of capital requirements regulation measures and the strong capital base of Triodos Bank, ensured sufficient capital to meet the capital requirements set by the regulator.
At the end of 2020 the total capital ratio was 18.8% (2019: 17.9%) and the common equity tier-1 ratio was 18.7% (2019: 17.9%). In December 2020, Triodos Bank issued tier-2 capital in the amount of EUR 6.4 million. Triodos Bank aims for a common equity tier-1 ratio of at least 15.5% in the current regulatory context.
The Executive Board decided on 1 April 2020 to withdraw the dividend proposal which was published in the Annual Report 2019. Initially, the proposal was to distribute 50% of the profit for 2019 as a dividend. Given the uncertainty of the wider impact of COVID-19 on society and the economy at large, the regulatory authorities (ECB and DNB) strongly advised banks to provide a clear signal to the public that they would make maximum efforts to ensure the continuity of lending and to retain prior year profits until the extent of the crisis was known. Triodos Bank, which is embedded in the Dutch and European financial sector, felt it could not ignore such a request. We remain committed to our dividend policy, which under normal conditions aims to distribute to depository receipt holders a fair share of the profits realised.
For 2020, Triodos Bank proposes a dividend of EUR 0.65 per share (2019: EUR 0.00), equivalent to a maximum of 15% pay-out ratio (the percentage of total profit distributed as dividends) for the 2019 to 2020 two-year period, in compliance with the latest DNB guidelines following the instruction of the ECB.
In due course, as the economy recovers from the COVID-19 pandemic, Triodos Bank expects the ECB to end its restrictive regulations on dividend payments. We plan then to return to our long-term policy of maintaining a 70% pay-out ratio.