21. Risk Management
The Group is subject to a variety of risks and uncertainties in the normal course of its business activities. The principal business risks and uncertainties include general macro-economic conditions. The precise impact or probability of these risks cannot be predicted with certainty and many of them lie outside the Group’s control. The Board has ultimate responsibility for the governance of all risk taking activity and has established a framework to manage risk throughout the Group.
In addition to general risks mentioned above, specific risks arise from the use of financial instruments. The principal risk categories identified and managed by the Group in its day-to-day business are credit risk, liquidity and funding risk, market risk and operational risk.
Asset and liability management
The management of NAMA’s assets and liabilities is achieved through the implementation of strategies which have been approved by the Board. Day-to-day management is carried out by the NAMA Treasury team with transactions executed on NAMA’s behalf by the NTMA.
As a result of acquiring loans and derivatives, NAMA is exposed to currency and interest rate risks. Foreign currency risk arises at the point of loan acquisition when euro-denominated securities are issued as consideration for loan assets in GBP or other currencies, thereby creating an asset/liability currency mismatch for NAMA. NAMA also faces ongoing currency risks after loan acquisition as non-euro facilities are drawn, repaid or rescheduled and assets are disposed. NAMA is also exposed to interest rate risk on acquired loans and derivatives. The current and expected performance of a loan or derivative is a key driver in the assessment of the interest rate risk to be managed.
The Risk Management Committee and the Board have adopted a prudential liquidity policy which incorporates ongoing liquidity stress-testing and the maintenance of a minimum liquidity buffer or cash reserve. This buffer is kept under review in line with overall asset and liability management strategy.
Risk Oversight and Governance
The Risk Management Committee, a subcommittee of the Board, oversees risk management and compliance throughout the Group. It reviews, on behalf of the Board, the key risks inherent in the business and ensures that an adequate risk management framework is in place to manage the Group’s risk profile and its material exposures.
The Audit Committee seeks to ensure compliance with financial reporting requirements. It reports to the Board on the effectiveness of control processes operating throughout the Group. It reports on the independence and integrity of the external and internal audit processes, the effectiveness of NAMA’s internal control system, the processes in place for monitoring the compliance of the loan service providers with their contractual obligations to NAMA and compliance with relevant legal, regulatory and taxation requirements by NAMA.
The Credit Committee is responsible for making credit decisions within its delegated authority from the Board. These include inter alia the approval of debtor asset management / debt reduction strategies, advancement of new money, approval of asset / loan disposals, the setting and approval of repayment terms, property management decisions and decisions to take enforcement action where necessary. The Credit Committee also makes recommendations to the Board in relation to specific credit requests where authority rests with the Board and provides an oversight role in terms of key credit decisions made below the delegated authority level of the Credit Committee. It is also responsible for evaluating the overall credit framework and sectoral policies for ultimate Board approval. Finally, the Credit Committee reviews management information prepared by the Asset Recovery, Asset Management and CFO functions in respect of the NAMA portfolio.
The Audit and Risk unit is part of the CFO division of NAMA and is responsible for the co-ordination and monitoring of internal and external audit and risk. The unit supports the NAMA CFO to ensure that NAMA operates within the Board approved risk limits and tolerances. Audit and Risk is also responsible for the design and implementation of the NAMA Risk Management Framework. The unit provides an independent assessment and challenge of the adequacy of the control environment, it coordinates the internal and external audit activities across NAMA, Participating Institutions and Primary and Master Servicer and monitors and reports to the Audit Committee and Board the progress in addressing actions highlighted in audit findings.
The Treasury unit has primary responsibility for managing market risk, liquidity and funding risk. Credit risk is dealt with in detail in Note 22.
The NTMA Risk unit provides market risk support to the Group. Furthermore the management of the Group’s counterparty credit risk on market related transactions (derivatives and cash deposits), in line with the Board’s policy, has also been delegated to the NTMA.
21.1 Market risk
Market risk is the risk of a potential loss in the income or net worth of the Group arising from changes in interest rates, exchange rates or other market prices.
Market risks arise from open positions in interest rate and currency products, all of which are exposed to general and specific market movements, and changes in the level of volatility of market rates or prices such as interest rates, credit spreads and foreign exchange rates. The Group is exposed to market risk on its loans and receivables, senior debt and derivative positions. While the Group has in place a comprehensive set of risk management procedures to mitigate and control the impact of movements in interest rates, foreign exchange rates and other market risks to which it is exposed, it is difficult to predict accurately changes in economic or market conditions or to anticipate the precise effects that such changes could have on the Group.
The Group’s senior debt securities are denominated in euro, while certain of the Group’s acquired assets are denominated in GBP. As a consequence, the Group has made use of foreign currency derivatives to manage the currency profile of its assets and liabilities. Similarly, interest rate swaps are used to manage mismatches in the Group’s interest rate profile.
21.2 Market risk management
The Group has in place effective systems and methodologies for the identification and measurement of market risks in its statement of financial position. These risks are then managed within strict limits and in the context of a conservative risk appetite that is consistent with the NAMA legislation.
The management of market risk within the Group is governed by market risk policies approved by the Risk Management Committee and the Board. The Board approves overall market risk tolerance and delegates the lower level limit setting to the Risk Management Committee. The management of the Group’s key market risks (such as interest rate and foreign exchange risk) is centralised within the Group’s Treasury unit. NAMA’s Audit and Risk unit provides oversight and is responsible for the monitoring of the limit framework within the context of limits approved by the Risk Management Committee and Board. Market risk support is provided by the NTMA Risk unit.
Risk mitigation involves the matching of asset and liability risk positions to the maximum extent practicable, and the use of derivatives to manage cash flow timing mismatch and interest rate sensitivity within the approved limit structure. The Group’s Balance Sheet policies are designed to ensure a rigorous system of control is in place which includes prescribing a specific range of approved products and limits that cover all of the risk sensitivities associated with approved products.
The Group provides bi-monthly reporting to the Risk Management Committee with detailed analysis of all significant risk positions and compliance with risk limits. In addition to market risk position limits, stress testing is used to gauge the impact on the Group’s position of a range of extreme market scenarios. Scenario based stress tests and long run historic simulations (going back to the 1990s) on current positions are used to assess and manage market risk.
The Risk Management Committee reviews, approves and makes recommendations concerning the market risk profile and limits across the Group. In addition, a Market Risk Management Group, comprising senior managers from the NAMA CFO Division and the NTMA Risk unit meets regularly to review the market risk position and ensure compliance with the decisions of the Board and the Risk Management Committee. The weekly report produced by the NTMA Risk unit includes detailed analysis of all significant risk positions and compliance with risk limits.
21.3 Market risk measurement
The Group is exposed to interest rate risk through movements in interest rates to which it is exposed. Effective systems have been put in place to mitigate such exposure.
The Group acquired fixed and variable rate loans from the Participating Institutions, as well as derivatives that were used to convert (for debtors) variable rate loans to fixed rate loans. In addition, the Group has issued floating rate senior debt securities and has entered into derivative transactions to manage mismatches in its asset and liability profile. The Group employs risk sensitivities, risk factor stress testing and scenario analysis to monitor and manage interest rate risk. Risk sensitivities are calculated by measuring an upward parallel shift in the yield curve to assess the impact of interest rate movements.
Information provided by the sensitivity analysis does not necessarily represent the actual change in fair value that the Group would incur under normal market conditions because, due to practical limitations, all variables other than the specific market risk factors are held constant.
The following tables summarise the Group’s and the Agency’s time-bucketed (defined by the earlier of contractual re-pricing or maturity date) exposure to interest rate re-set risk. It sets out, by time bucket, the assets and liabilities which face interest rate re-setting.
Financial instruments are shown at nominal amounts. These tables take account of hedging instruments which have the effect of significantly reducing interest rate sensitivity.
| Interest rate risk Group 2014 |
0-6 months €’000 |
Greater than 6 months €’000 |
Non-interest bearing €’000 |
Total €’000 |
|---|---|---|---|---|
| Financial assets | ||||
| Cash and cash equivalents | 1,158,692 | - | - | 1,158,692 |
| Cash placed as collateral with the NTMA | 690,000 | - | - | 690,000 |
| Loans and receivables | 13,360,034 | - | - | 13,360,034 |
| Amounts due from Participating Institutions | - | - | 84,810 | 84,810 |
| Investments in equity instruments | - | - | 36,181 | 36,181 |
| Other assets | - | - | 12,164 | 12,164 |
| Total financial assets exposed to interest rate re-set | 15,208,726 | - | 133,155 | 15,341,881 |
Liabilities |
||||
| Amounts due to Participating Institutions | - | - | 20,428 | 20,428 |
| Senior debt securities in issue | 13,590,000 | - | - | 13,590,000 |
| Derivative financial instruments | (11,500,000) | (1,250,000) | - | (12,750,000) |
| Other liabilities | - | - | 126,114 | 126,114 |
| Tax payable | - | - | 1,769 | 1,769 |
| Total financial liabilities exposed to interest rate re-set | 2,090,000 | (1,250,000) | 148,311 | 988,311 |
| Interest rate risk Group 2013 |
0-6 months €’000 |
Greater than 6 months €’000 |
Non-interest bearing €’000 |
Total €’000 |
|---|---|---|---|---|
| Financial assets | ||||
| Cash and cash equivalents | 3,453,236 | - | - | 3,453,236 |
| Cash placed as collateral with the NTMA | 802,000 | - | - | 802,000 |
| Financial assets available for sale | 145,138 | - | - | 145,138 |
| Loans and receivables | 31,313,699 | - | - | 31,313,699 |
| Amounts due from Participating Institutions | - | - | 78,447 | 78,447 |
| Investments in equity instruments | - | - | 6,373 | 6,373 |
| Other assets | - | - | 23,755 | 23,755 |
| Total financial assets exposed to interest rate re-set | 35,714,073 | - | 108,575 | 35,822,648 |
Liabilities |
- | - | ||
| Amounts due to Participating Institutions | 24,676 | - | - | 24,676 |
| Senior debt securities in issue | 34,618,000 | - | - | 34,618,000 |
| Derivative financial instruments | (14,350,000) | (8,680,000) | - | (23,030,000) |
| Other liabilities | - | - | 172,594 | 172,594 |
| Tax payable | - | - | 407 | 407 |
| Total financial liabilities exposed to interest rate re-set | 20,292,676 | (8,680,000) | 173,001 | 11,785,677 |
| Interest rate risk Agency 2014 |
0-6 months €’000 |
Non-interest bearing €’000 |
Total €’000 |
|---|---|---|---|
| Financial assets | |||
| Cash and cash equivalents | 101 | - | 101 |
| Other assets | - | 168,161 | 168,161 |
| Total financial assets exposed to interest rate re-set | 101 | 168,161 | 168,262 |
Liabilities |
|||
| Interest bearing loans and borrowings | 53,699 | - | 53,699 |
| Other liabilities | - | 3,892 | 3,892 |
| Total financial liabilities exposed to interest rate re-set | 53,699 | 3,892 | 57,591 |
| Interest rate risk Agency 2013 |
0-6 months €’000 |
Non-interest bearing €’000 |
Total €’000 |
|---|---|---|---|
| Financial assets | |||
| Cash and cash equivalents | 1,152 | - | 1,152 |
| Other assets | - | 5,961 | 5,961 |
| Total financial assets exposed to interest rate re-set | 1,152 | 5,961 | 7,113 |
Liabilities |
|||
| Interest bearing loans and borrowings | 53,513 | - | 53,513 |
| Other liabilities | - | 7,178 | 7,178 |
| Total financial liabilities exposed to interest rate re-set | 53,513 | 7,178 | 60,691 |
The following table represents the interest rate sensitivity arising from a 50 basis point (bp) increase or decrease in interest rates across the curve, subject to a minimum interest rate of 0%. This risk is measured as the net present value impact, on the statement of financial position, of that change in interest rates. This analysis shifts all interest rates for each currency and each maturity simultaneously by the same amount.
The interest rates for each currency are set as at 31 December 2014. The figures take account of the effect of hedging instruments, loans and receivables and securities issued.
| 2014 | 2013 | |||
|---|---|---|---|---|
| Group | +50bp €’000 |
-50bp €’000 |
+50bp €’000 |
-50bp €’000 |
| EUR | 82,994 | (84,382) | 217,934 | (223,403) |
| GBP | 3,220 | (3,236) | (1,218) | 1,623 |
| USD | (24) | 24 | (146) | 146 |
| Other | (102) | 102 | (104) | 104 |
21.3.2 Foreign exchange risk
As part of the acquisition of loans and derivatives from the Participating Institutions, the Group acquired a number of loans and receivables denominated in foreign currency, principally in GBP. As a result, the Group is exposed to the effects of fluctuations in foreign currency exchange rates, on its financial position and cash flows. The Group monitors on a regular basis the level of exposure by currency and has entered into hedges to mitigate these risks.
The following table summarises the Group’s exposure to foreign currency risk at 31 December 2014. Included in the table are the Group’s assets and liabilities at carrying amounts, categorised by currency. These tables take account of hedging instruments which have the effect of significantly reducing currency risk.
| Group 2014 |
USD €’000 |
GBP €’000 |
Other €’000 |
Total €’000 |
|---|---|---|---|---|
| Assets | ||||
| Cash and cash equivalents | 8,047 | 193,868 | 958 | 202,873 |
| Loans and receivables | 23,818 | 2,688,466 | 97,862 | 2,810,146 |
| Derivative financial instruments | (30,887) | (2,906,103) | (96,217) | (3,033,207) |
| Total assets exposed to currency risk | 978 | (23,769) | 2,603 | (20,188) |
| Group 2013 |
USD €’000 |
GBP €’000 |
Other €’000 |
Total €’000 |
|---|---|---|---|---|
| Assets | ||||
| Cash and cash equivalents | 9,288 | 45,590 | 2,937 | 57,815 |
| Loans and receivables | 138,265 | 5,655,355 | 99,422 | 5,893,042 |
| Derivative financial instruments | (145,022) | (5,475,686) | (101,698) | (5,722,406) |
| Total assets exposed to currency risk | 2,531 | 225,259 | 661 | 228,451 |
All the Agency’s assets and liabilities are stated in euro. Therefore the Agency has no exposure to foreign currency risk.
A 10% strengthening of the euro against the following currencies at 31 December 2014 would have increased equity and profit before taxation by the amounts set out below. This analysis assumes that all other variables, in particular interest rates, remain constant. A 10% weakening of the euro against the same currencies would have had the equal but opposite effect, on the basis that all other variables remain constant.
| Group | 2014 €’000 |
2013 €’000 |
|---|---|---|
| GBP | 2,161 | (20,484) |
| USD | (89) | (226) |
| Other | (237) | (53) |
21.3.3 Other price risk
The Group is exposed to equity price risk arising from equity instruments. The fair value of equity instruments is measured based on the net asset value of the investment entity at the reporting date.
The sensitivity analysis below has been determined based on the exposure to equity price risks at the end of the reporting period.
If equity prices had been 10% higher / lower, profit before taxation for the year ended 31 December 2014 would increase / decrease by €3.6m as a result of the changes in fair value of NAMA’s equity instruments, which are classified as fair value through profit or loss, in accordance with accounting policy 2.6.