Financial liabilities, financial costs and managing the financial risks of liabilities
5.3 Financial liabilities, financial costs and managing the financial risks of liabilities
The company takes advantage of the opportunities offered by its credit ratings at any given time on the international and domestic debt capital and money markets. Market-based and diversified financing is sought from several sources aiming at a balanced maturity profile.Fingrid’s existing loan agreements, debt or commercial paper programmes are unsecured and do not include any financial covenants based on financial ratios. In 2016, the company issued bonds totalling EUR 80 million (EUR 50 million with a four-year maturity and EUR 30 million with a six-year maturity) to refinance current borrowings.
Borrowings are as follows:
|14. BORROWINGS, €1,000|
|Loans from financial institutions||163,895||151,203||186,408||172,866||Level 2|
|955,843||842,866||76 %||1,015,483||907,232||79 %|
|Loans from financial institutions||23,246||21,662||22,195||20,710||Level 2|
|Other loans/Commercial papers (international and domestic)||120,059||120,128||75,022||75,003||Level 2|
|269,190||264,865||24 %||241,501||236,217||21 %|
|Total||1,225,033||1,107,730||100 %||1,256,984||1,143,448||100 %|
The fair values of borrowings are based on the present values of cash flows. Loans raised in various currencies are measured at the present value on the basis of the yield curve of each currency. The discount rate includes the company-specific and loan-specific risk premium. Borrowings denominated in foreign currencies are translated into euros at the mid-rate quoted by the ECB at the closing date.
|15. BONDS INCLUDED IN BORROWINGS, €1,000|
|SEK||500,000||18.10.2016||interest rate structure||54,385|
|SEK||1,000,000||19.11.2018||interest rate structure||104,685||108,820|
|Bonds, long-term total||691,663||734,366|
|Bonds, short-term total||123,074||140,504|
The company operates in the debt capital, commercial paper and loan markets:
- For long-term financing, the company has a Medium Term Note Programme (“EMTN Programme”), totalling EUR 1.5 billion.
- Fingrid has a Euro Commercial Paper Programme (“ECP Programme”) totalling EUR 600 million.
- Fingrid has a domestic commercial paper programme totalling EUR 150 million.
- Furthermore, Fingrid has bilateral long-term loan agreements with both the European Investment Bank (EIB) and the Nordic Investment Bank (NIB).
The graph below illustrates Fingrid’s various sources of debt financing. Fingrid sources debt financing mainly from the international debt capital markets.
The company defines net debt as the difference between cash in hand, and the financial assets recognized in the income statement at fair value and borrowings as shown in the balance sheet. The development of net debt is actively monitored.
|16. RECONCILIATION OF DEBT, €1,000|
|Debt on 1 Jan 2015||263,033||962,324||1,225,358|
|Cash flow from financing activities||-185,181||107,424||-77,757|
|Exchange rate adjustments||-3,573||2,350||-1,223|
|Accrual of effective interest rates||1,051||12,873||13,925|
|Other changes not involving a payment transaction||161,937||-164,867||-2,930|
|Debt on 31 Dec 2015||237,268||920,105||1,157,373|
|Cash flow from financing activities||-119,917||80,000||-39,917|
|Exchange rate adjustments||-1,192||5,243||4,051|
|Accrual of effective interest rates||355||1,472||1,827|
|Other changes not involving a payment transaction||149,757||-149,608||149|
|Debt on 31 Dec 2016||266,271||857,211||1,123,482|
|Financial assets recognised in the income statement at fair value are liquid investments traded on active markets.|
|Reconciliation of net debt, € 1,000||2016||2015|
|Cash in hand and cash equivalents||21,939||23,099|
|Financial assets recognised in the income statement at fair value||57,790||93,451|
|Borrowings - repayable within one year||264,865||236,217|
|Borrowings - repayable after one year||842,866||907,232|
|Net debt is the difference between the company's debt and its cash in hand and cash equivalents|
Interest income and costs on loans and other receivables are as follows:
|17. INTEREST INCOME AND EXPENSES FROM LOANS AND OTHER RECEIVABLES, €1,000|
|Interest income on held-for-trading financial assets||500||449|
|Interest income on cash, cash equivalents and bank deposits||189||174|
|Net foreign exchange gains and losses||0||77|
|Interest expenses on borrowings||-27,017||-29,650|
|Net interest expenses on interest rate and foreign exchange derivatives||7,261||8,250|
|Gains from measuring derivative contracts at fair value||6,016||3,749|
|Losses from measuring derivative contracts at fair value||-6,358||-17,025|
|Net foreign exchange gains and losses||-67||0|
|Other finance costs||-1,236||-1,416|
|Capitalised finance costs, borrowing costs;|
|at a capitalisation rate of 2 % (note 11)||2,016||1,690|
Managing the market risks of debt
Fingrid’s debts are based on both fixed and floating interest rates and issued in several currencies. They thus expose Fingrid’s cash flow to interest rate and exchange rate risks. Fingrid uses derivative contracts to hedge against interest rate risks on cash flow and exchange rate risks on borrowings. Fingrid generally retains issued bonds until the maturity date and thus does not value its bonds in the balance sheet at fair value or hedge against the fair value interest rate risk. The permitted hedging instruments are defined in the Treasury policy and are chosen in order to achieve the most effective hedging possible for the risks in question.
The functional currency of the company is euro. Generally, currency risks and the foreign exchange interest rate risk are fully hedged. A risk that amounts to less than EUR 5 million when realised can be unhedged for reasons of cost-effectiveness.
The company issues bonds in the international and domestic money and debt capital markets. The company’s loan portfolio is spread across euro and non-euro currencies, and the total debt portfolio and the related interest rate flows are hedged against the currency risk. The currency risk for each bond is fully hedged in conjunction with its issuance. The company uses interest rate and cross currency swaps to hedge the exchange rate and interest risk of bonds.
Business-related currency risks are small and they are mainly hedged. During the financial year, the company used foreign exchange forwards to hedge business transaction risks. A summary of the derivatives is presented in Note 23.
The sensitivity analysis of changes in the foreign exchange rate is measured as a 10 per cent change between the euro and the currency in question. The most important foreign currency for the Group is the Swedish krona (SEK). If the rate of SEK on 31 December 2016 had been 10% lower/higher than the euro, with all other variables remaining unchanged, the profit after taxes would have been EUR 1,000 higher/EUR 1,000 lower (2015: EUR 32,000/EUR 36,000). The main impact on the net profit is caused by the change in the fair value of derivatives. Starting in 2016, the impact of the SEK-denominated forward curve is also taken into account in the sensitivity analysis. In 2016, loans amounting to SEK 1,100 million and their corresponding derivatives matured, which accounts for the reduced impact of the exchange rate changes.
Interest rate risk
The company is only exposed to the interest rate risk in euros from its business operations, assets and borrowings. The company’s borrowings are, both in terms of principal and interest payments, fully hedged against exchange rate risks, and cash and cash equivalents and financial assets recognised in the income statement at fair value are denominated in euros.
Interest rate risk management will include optimisation of the future interest rate risk of business operations (risk-free interest in the WACC model described in the next infobox) together with the company’s net debt interest rate risk through a regulatory model specified by the Energy Authority.
The interest rate risk from business operations can in part or in its entirety be hedged in terms of the adjusted capital committed to grid operations. The Board of Directors always makes a separate decision on the hedging of operational interest rate risks. The interest rate risk included in business operations was not hedged in 2016. The interest rate risk inherent in Fingrid’s business operations is caused by changes in the risk-free interest in the WACC model. If the risk-free interest rate rises/falls by one percentage unit, the post-tax WACC rises/falls by 0.9%.
The objective of managing the interest rate risk on the loan portfolio is to minimise interest costs in the long term. The basic principle is to keep the interest rate exposure of the company’s loan portfolio linked to a floating rate of interest, targeting at most an average interest refixing period of 12 months.The loan portfolio’s interest rate risk arises from market interest rate volatility, which decreases or increases the annual interest expenses on the company’s floating-rate loans. When the interest rates increase (decrease) on the market, the interest expenses of the floating-rate loans also increase (decrease). The company hedges this so-called cash flow risk with derivatives. The exposure of the loan portfolio to interest rate risk is measured by using a Cash Flow at Risk (CFaR) type of model, more specifically the Autoregressive Integrated Moving Average (ARIMA) model. The key parameters of the model are the 3-month and 6-month Euribor rates, the historical development of which serve as a basis for a forward-looking simulation of the probable future interest expenses for Fingrid’s loan portfolio. The exposure on which the sensitivity analysis is calculated includes all of the Group’s interest-bearing borrowings, the loan portfolio’s derivatives and interest-rate options purchased to hedge against unexpected changes in interest rates. According to the model, there is a 95% (99%) probability that Fingrid’s interest expenditure will amount to no more than EUR 20 (20) million during the next 12 months.
Determination of the reasonable rate of return in regulation and operational interest rate risk
The reasonable rate of return on adjusted capital committed to grid operations is determined by using the weighted average cost of capital model (WACC). The WACC model illustrates the average cost of the capital used by the company, where the weights are the relative values of equity and debt. The weighted average of the costs of equity and interest-bearing debt are used to calculate the total cost of capital, i.e. the reasonable rate of return per the regulation. The reasonable return is calculated by multiplying the adjusted capital invested in network operations by the WACC.
WACC post-tax = reasonable rate of return after corporate tax
CE = reasonable cost of equity
CD = reasonable cost of interest-bearing debt
E = adjusted equity invested in network operations
D = adjusted interest-bearing debt invested in network operations
ctr = current rate of corporate tax
CD = Rr + DP
Rr = risk-free interest rate
DP = risk premium of debt
CE = Rr + βlevered × (Rm – Rr ) + LP
Rr = risk-free interest rate
β levered = levered beta
Rm = average market return
Rm – Rr = market risk premium
LP = liquidity premium
The above-mentioned reasonable rate of return after taxes is then adjusted with the current rate of corporate tax. This calculation gives the reasonable pre-tax rate of return.
WACC pre-tax = reasonable rate of return before corporate tax
A fixed capital structure is applied to the TSO, whereby the weight of debt capital is 50% and the weight of equity capital is 50%. The pre-tax reasonable rate of return is calculated as follows
Rk, pre-tax = pre-tax reasonable return, EUR
WACC pre-tax = reasonable rate of return, %
E = adjusted equity invested in network operations, EUR
D = adjusted interest-bearing debt invested in network operations, EUR
E + D = adjusted capital invested in network operations, EUR
Liquidity risk and refinancing risk
Fingrid is exposed to liquidity and refinancing risks arising from the redemption of loans, payments and fluctuations in cash flow from operating activities.The liquidity of the company must be arranged so that 110% of the refinancing needs for the next 12 months can be covered by liquid assets (cash and cash equivalents, and financial assets recognised in the income statement at fair value) and available long-term committed credit lines.
The company has a revolving credit facility agreement of EUR 300 million signed on 11 December 2015. The maturity of the facility is five years. In addition to this, the company has two one-year extension options, one of which has been used. This extended the maturity of the revolving credit facility until 11 December 2021. The facility is committed and has not been drawn. The company additionally has uncommitted overdraft facilities totaling EUR 50 million.
The refinancing risk is managed by building an even maturity profile such that the share of long-term loans in a single year constitutes less than 30 per cent of the total debt and the average maturity of the company’s loan portfolio is at least three years. To secure refinancing, the company makes wide use of diverse sources of financing. The high credit rating and good bank and investor relations enable ready access to the debt capital market and thus minimises the company’s debt refinancing risks and financing costs.
The counterparty risks of financing activities are caused by counterparties related to investing (e.g. money market funds), derivatives counterparties and bank counterparties. The company minimises any counterparty risks. As a rule, credit rating categories are the decisive factor in specifying the counterparty limit.
Contractual repayments and interest costs on borrowings are presented in the next table. The interest rates on floating-rate loans are defined using the zero coupon curve. The repayments and interest amounts are undiscounted values. Finance costs arising from interest rate swaps are often paid in net amounts depending on the nature of the swap. In the following table, they are presented in gross amounts.
|18. DEBT REPAYMENTS, INTEREST PAYMENTS AND PAYMENTS AND RECEIVABLES UNDER DERIVATIVE CONTRACTS IN CASH, €1,000|
|31 Dec 2016||2017||2018||2019||2020||2021||2022-||Total|
|Loans from financial institutions||- repayments||21,662||21,662||21,662||17,662||17,662||72,554||172,866|
|Commercial papers||- repayments||120,000||0||0||0||0||0||120,000|
|Currency swaps||- payments||53,453||107,833||23,967||87||118||13,342||198,800|
|Interest rate swaps||- payments||2,287||2,204||845||269||370||2,204||8,180|
|Forward contracts||- payments||2,214||0||0||0||0||0||2,214|
|Currency swaps||- receivables||49,434||110,878||22,394||449||449||12,209||195,812|
|Interest rate swaps||- receivables||4,933||4,015||3,859||3,662||3,371||8,381||28,221|
|Forward contracts||- receivables||2,271||0||0||0||0||0||2,271|
|31 Dec 2015||2016||2017||2018||2019||2020||2021-||Total|
|Loans from financial institutions||- repayments||20,710||21,662||21,662||21,662||17,662||90,216||193,576|
|Commercial papers||- repayments||75,000||0||0||0||0||0||75,000|
|Currency swaps||- payments||146,373||53,753||108,408||24,160||170||13,889||346,753|
|Interest rate swaps||- payments||3,632||2,102||1,991||1,029||534||3,715||13,003|
|Forward contracts||- payments||2,266||1,914||0||0||0||0||4,181|
|Currency swaps||- receivables||148,587||49,939||111,766||22,394||449||12,658||345,792|
|Interest rate swaps||- receivables||4,656||4,733||3,751||3,339||2,813||8,863||28,156|
|Forward contracts||- receivables||2,222||1,871||0||0||0||0||4,093|
Borrowings are initially recognised at fair value net of the transaction costs incurred. Transaction costs consist of bond prices above or below par value, arrangement fees, commissions and administrative fees that are directly related to loan. Borrowings are subsequently measured at amortised cost; any difference between the loan amount and the amount to be repaid is recognised in the income statement over the loan period using the effective interest rate method. Borrowings are derecognised when they mature and are repaid.
Commitment fees to be paid on credit facilities are entered as transaction costs related to the loan insofar as partial or full utilisation of the facility is likely. In such cases, the fee is capitalized in the balance sheet until the facility is utilised. If there is no proof that loans included in a facility are likely to be drawn in part or in full, the fee will be recognised as an upfront payment for liquidity services and amortized over the maturity of the facility in question.