Annual report 2020 KLP Kommunekreditt AS

The Company’s profit before tax was NOK 34.7 (25.1)¹ million and the total profit for the year was NOK 36.0 (19.6) million. This gave a return on equity of 4.5 (3.4) per cent before tax. The change in profits compared to last year is mainly due to increased lending volumes and slightly higher average lending margins through the year. Changes in the value of financial instruments are at about the same level as last year and have little effect on the change in profits. Operating expenses are approximately NOK 1 million lower than the previous year.

Net interest income increased by 15.2 per cent compared to last year. The change is mainly due to increased volumes and slightly higher average lending margins than the previous year. Margins varied significantly in 2020. From the start of the Covid-19 pandemic, a rapid reduction in lending rates led to low margins through the second quarter. In subsequent quarters, the Company’s financing costs also fell, and margins returned to roughly normal levels.

Net interest income from the loan and investment portfolios amounted to NOK 72.4 (62.9) million. Gross interest income on loans and liquid investments was lower than last year, because of falling interest rates.

The credit premiums in the securities market also varied widely in 2020, but the overall profit effect of the reduction in value of the Company’s securities investments was limited to realised and unrealised losses of NOK -0.1 (-1.8) million.

During the term of its borrowing agreements, the Company makes regular adjustments to reduce its liquidity risk and meet regulatory requirements with respect to liquidity indicators and capital adequacy (Basel III and CRD IV). Refinancing of the borrowing side then results in a need to buy back the Company’s own issuance. In 2020, the effect on profits due to repurchases of borrowings was NOK -19.1 (-16.3) million.

The total accounting effect of changes in value on financial instruments was negative for the year, at NOK -19.2 (-18.2) million. For further information, see Note 5.

The Company’s lending is managed by KLP Banken AS, and most of the operating expenses are regulated in a management agreement with the parent company. Under this agreement, KLP Kommunekreditt AS is charged for its share of the parent company’s costs for the management of public-sector loans, based on volume. Costs are settled monthly. Operating expenses in excess of this are mainly direct costs incurred by the Company in connection with external assistance, such as rating, auditing, etc. In 2020, the Company’s operating expenses decreased to NOK 18.5 (19.6) million. Increased efficiency in the parent company’s management of loans to public-sector borrowers contributed to lower costs in KLP Kommunekreditt AS.

KLP Kommunekreditt AS’s lending operations are primarily based on loans directly from the Company. Refinancing of loans in KLP has had little effect on the growth in lending in recent years.

Total lending amounted to NOK 17.7 (16.5) billion at the end of the year. 80 (83) per cent of the lending volume is at floating interest rates. The share of fixed-rate loans increased from 17 to 20 per cent in the financial year.

In 2020, the Company paid out new loans worth NOK 3.4 (1.6) billion. The loan portfolio consists of loans to Norwegian municipalities and county municipalities directly, or to enterprises working for the public sector and receiving unconditional guarantees from municipalities or county authorities. The risk in the loan portfolio is considered very low.

In Norway, the credit risk associated with loans to municipalities and county authorities is limited to deferred payments, not to any lapse in the obligation to pay. This follows from the Norwegian Local Government Act, and secures the lender against loss if a municipality cannot meet its payment obligations. In the event of deferred payment, the lender is also secured against the loss of accrued interest, interest on overdue payments and collection costs. KLP Kommunekreditt AS has not had any credit loss on loans to Norwegian municipalities or county authorities.

The Company had no non-performing loans more than 90 days past due at the end of 2020. No individual losses were recorded in the financial year. In the financial year, estimated loss provisions had an effect on profits of NOK -13 (2) thousand. Please refer to Note 16.

Loans to the public sector are provided by both KLP and KLP Kommunekreditt AS, and managed by KLP Banken AS.

KLP Kommunekreditt AS, together with KLP, has a good position in the market for long-term financing of municipalities, county authorities and enterprises working in the public sector. KLP increased its lending limits by NOK 5 billion when the pandemic struck in March 2020. KLP Banken AS was thus able to go on offering competitive conditions to public-sector borrowers who were concerned at finding greatly reduced opportunities for new loans and refinancing in the lending markets.

Total loans to public-sector borrowers amounted to NOK 81.6 (73.4) billion at the end of 2020, an increase of NOK 8.2 (5.7) billion, or 11.2 (8.5) per cent, in the financial year. For the local government sector as a whole, the estimated net debt growth is just under 8 per cent in 2020.

Loan applications totalling NOK 141.8 (83.2) billion were received in 2020. The increase came mainly in the first half of the year, particularly from March onwards, when the outbreak of the Covid-19 pandemic resulted in a tighter lending market for the municipalities. Less access to capital and higher prices in the securities market meant that a greater proportion of the municipalities’ new borrowings, and their refinancing arrangements, were sourced from KLP Banken.

The Company’s liquidity situation is satisfactory, as its financing more than covers the liquidity requirement from operations.

KLP Kommunekreditt AS is subject to strict rules with respect to the assets it may invest in. The portfolio of liquid investments comprises safe securities and deposits in other banks. The securities are certificates and bonds with excellent security, largely covered bonds with an Aaa rating.

Holdings of cash and cash equivalents have been used to pay out new loans or for redemptions and buybacks of borrowings.

As new borrowings occur when the terms for them are considered favourable, a need sometimes arises to invest surplus liquidity. This liquidity contributes to earnings and provides the flexibility to meet demand for new lending.

At the end of 2020, outstanding liquidity investments in the form of interest-bearing securities amounted to NOK 0.9 (1.4) billion. Securities are recognised at market value. At the same time, bank deposits amounted to NOK 0.4 (0.6) billion.

KLP Kommunekreditt AS has established a programme for issuing covered bonds.

At the end of 2020, loan-backed covered bonds issued in the Norwegian market amounted to NOK 17.9 (18.6) billion. New issues in 2020 totalled NOK 4.0 (6.0) billion. Buybacks of previous issues amounted to NOK 4.7 (5.5) billion. No bonds were issued outside Norway. KLP Kommunekreditt AS has achieved the best rating for its borrowing programme.

The bonds are backed by the Company’s lending activity. Loans to enterprises have to be guaranteed by municipalities or county authorities under the provisions of the Local Government Act, by the Norwegian government or by a bank. They must be unconditional and cover both repayments and interest.

The Company’s debt to credit institutions at the end of the year comprised internal financing from KLP Banken AS in the amount of NOK 0.7 (0.3) billion.

Total assets stood at NOK 19.0 (18.5) billion at the end of 2020. Of this, loans to public-sector borrowers amount to NOK 17.7 (16.5) billion and NOK 1.3 (2.0) billion are liquid investments.

The Company’s equity and subordinated loan capital, based on the Board of Directors’ proposal for allocation of the year’s profit, totalled NOK 744 (768) million at the end of 2020. Core capital is identical to equity and subordinated loan capital. This gives a capital adequacy and tier 1 capital ratio of 19.4 (20.7) per cent.

The current capital requirement, including capital buffers, is 11.0 per cent tier 1 capital ratio and 14.5 per cent capital adequacy. The unweighted tier 1 capital ratio was 3.9 (4.1) per cent, compared with the requirement of 3.0 per cent.

The risk-weighted balance came to NOK 3.7 (3.6) billion. Capital adequacy is considered good.

The financial statements for KLP Kommunekreditt AS for 2020 show a total profit of NOK 36.0 (19.6) million. The Board of Directors proposes that a group contribution of NOK 24.8 million be paid to KLP. NOK 19.3 million will be returned from KLP as a group contribution without any tax effect. Net profit and group contribution will be transferred to other equity. The group contribution only has an accounting effect from the date of the decision.

The Board of Directors believes that the financial statements provide a true and fair view of the Company’s assets and liabilities, financial position and profit. The conditions for continued operation are present, and this is assumed in the financial statements.

KLP Kommunekreditt AS prepares its financial statements in accordance with International Financial Reporting Standards (IFRS), as approved by the EU with associated interpretations. See Note 2 for more details.

The rating agencies’ assessments of the Company have a bearing on its borrowing terms. The Company uses Moody’s for credit rating of bonds. All covered bond issues have the best rating, Aaa.

KLP Kommunekreditt AS is subject to KLP Banken’s risk management framework, the purpose of which is to ensure that risks are identified, analysed and managed by means of policies, limits, procedures and instructions.

It has established its own guidelines for the most important individual risks liquidity, credit, market, operational and compliance risk) and an overall policy for risk management, which includes principles, organisation, limits, etc. for the Bank’s overall risk. The risk policies are adopted by the Board of Directors and are reviewed at least once a year. The policies are of an overarching nature and are complemented by procedures, rules, and instructions determined at the administrative level.

The Company aims to maintain a low level of operational risk, and to be characterised by a high level of professional competence, good procedures and efficient operations.

The Company is included in the KLP Banken Group’s process for assessing and quantifying material risks and calculating its capital requirement (ICAAP). The capital requirement assessment is forward-looking and, in addition to calculating needs based on current exposure (and, if appropriate, limits), an assessment is made of future needs in light of planned growth, determined strategic changes, etc. The Company’s Board of Directors takes an active part in these assessments and, in addition to the capital requirement assessment, determines a desired level for total capital (capital target).

The boards of directors of KLP Banken AS, KLP Kommunekreditt AS and KLP Boligkreditt AS have appointed a joint risk committee. Based on the total assets, this is not required by law. The risk committee deals with matters specifically related to risk and has an advisory function to the Board of KLP Kommunekreditt AS.

The Company’s articles of association and applicable legislation provide guidelines for corporate governance, corporate management and define a clear division of roles between governing bodies and corporate management.

The Board of Directors sets the policies for the Company’s activities. The Board of Directors held eight board meetings in 2020. The Board comprised two women and two men at the end of 2020.

The Managing Director is in charge of the day-to-day management of the Company in accordance with instructions issued by the Board of Directors.

An account of KLP Banken’s corporate governance is available on the KLP website

There are no direct employees in KLP Kommunekreditt AS. The Company’s governance and management are handled by people employed by KLP Banken AS.

A management agreement has been entered into with KLP Banken AS, covering administration, IT support, finance and risk management, as well as borrowing and liquidity management.

Through its social responsibility strategy, KLP has pledged to maintain good procedures for the measurement and reduction of the companies’ environmental impact. Like the rest of the KLP Group, KLP Kommunekreditt AS takes its environmental impact seriously. As an office-based company, it has greatest control over energy consumption, transport, waste management and procurement. The parent company, KLP Banken AS, is environmentally certified.

As part of the KLP Group, KLP Kommunekreditt AS aims to contribute to sustainable investments and responsible business operations. Social responsibility is of strategic importance for KLP. This is manifested through actions linked to the Group’s business. KLP is a signatory to the UN Global Compact, and is thereby committed to working for human rights, workers’ rights and the environment, and against corruption. A more detailed descriptions of targets, measures and results can be found on the KLP website

KLP Banken AS signed the UN Principles for Sustainable Banking in the autumn of 2019 and has committed to implementing these principles in its operations. The Principles for Sustainable Banking mean that banks are transparent about how their products and services create value for customers and investors, as well as for society as a whole. The Principles are intended to guide banks in their work on sustainability, and support society’s overall goals in line with the UN Sustainable Development Goals and the Paris Agreement.

KLP Kommunekreditt AS is the only credit company in Norway that issues bonds secured by loans to the public sector. The presence of KLP Kommunekreditt AS together with KLP in the market for public loans contributes to competition and so provides the public sector with access to long-term financing on favourable terms. Overall growth in recent years shows that the market position has been strengthened.

High credit quality in the loan portfolio will help KLP Kommunekreditt AS to achieve favourable borrowing terms. Government regulation of banks and financial institutions means that a number of regulatory requirements for capital and liquidity have to be met. This requires constant earnings that make it possible to meet such requirements.

The market for loans to the local government sector is still growing, and a large part of the borrowing is financed from the securities market rather than financial institutions. KLP Kommunekreditt AS is well capitalised and has an advantage as a stable and long-term lender in a market characterised by low risk. General developments in the financial markets will determine the extent to which KLP Kommunekreditt AS can finance its lending activities on terms that provide sufficient profitability for further growth.

Norwegian municipalities have developed a good and comprehensive range of services to the public. Increased life expectancy, demographics, income growth and climate risk give grounds to expect a sustained high level of investment in the public sector over the next few years. In particular, we may expect further growth in demand for loans for projects that contribute to climate change adaptation.

The Board of Directors expects that there will also be a need for significant long-term and stable financing beyond what the securities market can offer to public-sector borrowers. KLP Banken’s expertise in municipal financing, regardless of the size of its own balance sheet, can be used in its stewardship role for KLP. KLP Kommunekreditt AS and KLP as a whole will be a key player providing loans for public investment purposes.

We hereby declare that, to the best of our knowledge, the annual financial statements for the period from 1 January to 31 December 2020 have been prepared in accordance with applicable accounting standards, and that the information in the financial statements gives a true and fair view of the Company’s assets, liabilities, financial position and overall profit or loss.

We also declare that the Directors’ report provides a true and fair overview of the development, profit or loss and the financial position of the Company, together with a description of the most significant risk and uncertainty factors the Company faces.

KLP Kommunekreditt AS was founded on 25 August 2009. The Company is a credit enterprise whose object is to provide and acquire public sector loans that are guaranteed by the Norwegian state, Norwegian county administrations or Norwegian municipalities. Borrowers provide ordinary surety covering both repayments and interest.

The business is mainly financed by issuing covered bonds with collateral in government guaranteed loans. Some of these are listed on Oslo Børs (The Norwegian Stock Exchange).

KLP Kommunekreditt AS is registered and domiciled in Norway. KLP Kommunekreditt AS has its head office at Beddingen 8 in Trondheim and the company has a branch office in Oslo.

The Company is a wholly-owned subsidiary of KLP Banken AS, which is in turn wholly owned by Kommunal Landspensjonskasse (KLP). KLP is a mutual insurance company.

The annual financial statement is available at www.klp.no.

Below is a description of the most important accounting principles used in the preparation of the financial statements for KLP Kommunekreditt AS. These principles are applied in the same way in all periods presented unless otherwise indicated.

The company/group prepares estimates and assumptions about future situations. These are constantly evaluated and are based on historical data and expectations concerning probable future events considered on the basis of data available at the time of presentation of the financial statements. The estimates may be expected to differ from the final outcome.

The Company’s balance sheet principally comprises loans to local government and enterprises with local government guarantee, as well as covered bonds issued. These items are valued in the accounts at amortized cost, with the exception of borrowing and lending with fixed interest rates which are valued at fair value in accordance with the rules on fair value hedging. This means that the accounting value of the hedging object (fixed interest borrowing and lending) is changed when the market interest rate changes. The credit spread is locked at the commencement date, so the market's pricing of credit is not reflected in book value. This is because the credit element is not hedged.

Financial instruments are assessed for impairment for expected losses. The method for measuring impairment for expected loss depends on whether the credit risk has increased significantly since initial recognition. Upon initial recognition, and when the credit risk has not increased significantly after initial recognition, provisions are based on 12 months’ expected loss (step 1). If the credit risk has increased significantly since initial recognition, but there is no objective evidence of impairment, write-downs are based on expected loss over the lifetime (step 2). If the credit risk has increased significantly and there is objective evidence of impairment, a provision should be raised for the expected loss over its lifetime (step 3).

In the company, the assessment of what is considered to be a significant change in credit risk for home mortgage loans is based on a combination of quantitative and qualitative indicators and ‘backstops”. The most important driver for a significant change in credit risk for home mortgage loans in the group is a change in the probability of default (PD) from initial recognition up to the reporting date. A relative change in PD of more than 2.5 is considered to be a significant change in credit risk. The change in PD must also be at least 0.6 percentage points for the change to be considered significant.

For the products where the company/group has not developed its own PD and LGD (loss given default) models, the simplified loss ratio method is used. Here a change in risk rating of at least one grade from initial recognition to the reporting date is considered to be a significant increase in credit risk. For more information about the company's calculation of losses, refer to Note 16.

KLP Kommunekreditt AS has no division of its income by products or services. The Company has only the public sector market segment and offers only loans to its customers. The Company has only Norwegian customers. The Company has no external customers representing more than 10 per cent of the Company's total operating income.

Fair value should be a representative price based on what a corresponding asset or liability would have been traded for at normal market terms and conditions. A financial instrument is considered as listed in an active market if listed prices are simply and regularly available from a stock market, dealer, broker, industry group, price-setting service or regulatory authority, and these prices represent actual and regularly occurring transactions at arm’s length. If the market for the security is not active, or the security is not listed on a stock market or similar, the Group uses valuation techniques to set fair value. These are based for example on information on recently completed transactions carried out on business terms and conditions, reference to trading in similar instruments and pricing using externally collected yield curves and yield spread curves. As far as possible the estimates are based on externally observable market data and rarely on company-specific information.

Fair value shall be a representative price based on what a corresponding asset or liability would have been traded for at normal market terms and conditions. Highest quality in regard to fair value is based on listed prices in an active market. A financial instrument is considered as listed in an active market if listed prices are simply and regularly available from a stock market, dealer, broker, industry group, price-setting service or regulatory authority, and these prices represent actual and regularly occurring transactions at arm's length.

Effective interest is calculated as a yield-to-maturity, i.e. it is the constant interest rate level at which one may discount all the future cash flows from the securities to obtain the securities’ total market value.

Interest rate agreements are used to correct for imbalances between the Company's lending and borrowing in regard to interest rate exposure. All the agreements entered into are hedging transactions. The value change from the effective part of the hedging instrument is compared with the value change for the hedged risk of the hedged objects.

Interest rate swaps are agreements on exchange of interest rate terms in a future period. They do not cover exchange of principal.

All lending comprises loans to, or loans guaranteed by, Norwegian municipalities and county administrations, including loans to local government enterprises and intermunicipal companies (public sector loans). Guarantees are of the ordinary guarantor type covering both repayments and interest.

Credit risk is defined as the risk of loss associated with loan customers, derivative counterparties, issuers of securities and other counterparties being unable or unwilling to settle at the agreed time and in accordance with written contracts, where the collateral established does not cover the outstanding claim.

KLP Kommunekreditt AS provides loans to Norwegian municipalities and county administrations, local government enterprises, intermunicipal companies and loans to companies where the loan is guaranteed by a Norwegian municipality or county administration. Guarantees are payable on demand.

Market risk is here understood to mean the risk of a reduction in the fair value of the -Company’s owners’ equity as a result of fluctuations in market prices for the Company’s assets and liabilities. Changes in credit margins are excluded as they fall under credit risk.

KLP Kommunekreditt AS is exposed to market risk as a result of the Company's borrowing and lending activity and management of its liquidity.

The exposure is however limited to interest rate risk. Interest rate risk arises from differences in timing of interest rate adjustments for the Company’s assets and liabilities. The risk associated with such imbalances is reduced by using derivative contracts. All of the Company’s borrowing is in NOK, and the whole of the lending portfolio comprises loans in NOK.

Liquidity risk is the risk that the Company may not be able to meet its obligations and/or finance increases in its assets without substantial additional costs arising in the form of price falls on assets which must be realised, or in the form of more costly financing.

IFRS 9 was introduced 01.01.2018, and changed the methodology for provisions for losses on financial instruments in the accounts. For KLP Kommunekreditt AS, the exception in the rules for very low credit risk in public-sector lending has been used, and there will be no estimated future losses on the basis of substantially increased credit risk since initial recognition. All loans are classed in stage 1, which corresponds to unchanged credit risk since initial recognition. For KLP Kommunekreditt AS, a simplified loss rate method has been chosen to calculate the expected credit loss (ECL), where the bank uses a very low loss rate to calculate its losses, corresponding to 0.001 per cent of total lending.

A part of the assessment of future losses is the assessment of how the future will look with regard to the future in terms of macroeconomic conditions affecting the bank's credit losses, e.g. interest rates, house prices, unemployment, etc. The expected credit loss (ECL) should be probability-weighted based on several scenarios defined by the bank, but since we use an exception for very low credit risk the bank only use the expected scenario as a basis for the calculation of expected credit loss.. KLP Banken’s risk forum reviews the changes in macroeconomic conditions or other factors that could affect the impairments in KLP Kommunekreditt AS.

The KLP Board of Directors has laid down principles and guidelines for remuneration that apply for the entire Group and set up a remuneration committee as a subcommittee of the Board. The committee reports on and carries out checks that the remuneration schemes in the Group are in line with the Board's principles and guidelines.

Managing director is a contracted-in function from the parent company, KLP Banken AS, and the individual receives no benefits directly from KLP Kommunekreditt AS for the appointment. KLP Kommunekreditt AS refunds that part of the benefits associated with the role as managing director. The Managing Director has no agreement on performance pay (bonus) or guaranteed salary on termination. He is pensionable aged 70.

There are no obligations to provide the Chair of the Board of Directors special consideration or other benefits on termination or change in employment contract or appointment.

Directors’ fees are set by the General Assembly. Board members employed in the KLP Group, not having been elected by and from the employees, do not receive a fee for the Board appointment. Benefits in addition to Directors’ fees for Board members employed in the KLP Group are stated only if they are included in the senior management group employed in the KLP Group. This also applies to any loans they may have with the Group.

All benefits are shown without the addition of social security costs.

The KLP Group offers loans for various pruposes. There are separate loan terms for employees, and no senior employees hav loan terms that deviate from these.

Loans to external directors are only granted under ordinary loand terms. The interest rebate that accrues to employees is refunded to the lending company.

Attention is drawn otherwise to the description of the main principles on determination of remuneration in the KLP Group that may be found at klp.no.

Section 11-7 of the Regulations on Financial Institutions lays down a requirement for over-collateralisation by at least 2 per cent of the value of the outstanding covered bonds.

The purpose of this note is to show the potential effect of netting agreements on KLP Kommunekreditt AS. The note shows the derivative positions in the financial position statement.