Risk Profile
Table of content
1. Commercial risks
1.1. Purchase and sales price fluctuations
The ongoing expansion of the fleet of owned vessels is associated with certain risks, particularly in relation to changes in the value of the vessels.
At the end of 2007, the Company held purchase options for 75 vessels (71 vessels). Risk is associated with the exercise of these options, in that the market value of the vessels may drop subsequent to acquisition. The risk is judged to be limited at the time being, however, as the majority of the options were entered into on favourable terms in lower freight markets. The Company’s newbuilding programme was also entered into on favourable terms.
1.2. Freight rate fluctuations
The Company manages commercial risk from fluctuations in freight rates and imbalances in the ratio of cargo-tocargo capacity (vessels) on a general level by employing some of its vessels on fixed-term COAs and timecharters.
One way of covering is to enter into COAs, which typically have a term of twelve months, although certain contracts have terms of several years. At the end of 2007, the value of future COAs corresponded to freight income of USD 1,012 million (USD 288 million). Most of the contracts covered 2008 and 2009, but a few of them ran to 2013.
NORDEN also uses FFAs to supplement the actual, longterm employment of the vessels. They typically run twelve months forward and are used when physical alternatives are more expensive or unattainable. At the end of 2007, the Company had bought FFAs with a contract value of approximately USD 93 million net (sold USD 27 million) up to and including 2008.
2. Financial risks
The overall financial risk management guidelines are set out in NORDEN’s finance policy, which has been approved by the Board of Directors. The finance policy determines the limits for the Group’s currency, investment, finance and credit risks in relation to financial counterparties. All financial positions are recognised on a ”market to market” basis.
2.1. Foreign exchange risks
The Group’s functional currency is USD. Accordingly, the Company records and reports amounts in USD.
The Company endeavours to match expenses against income and liabilities against assets in terms of currency. Furthermore, as many expenses and liabilities as possible are denominated in USD. The actual foreign exchange risk is thus limited to those cash flows that are not denominated in USD, primarily administrative expenses (DKK), certain commercial payments (JPY and EUR) and the payment of shareholder dividends (DKK).
A 10% rise in exchange rates in foreign currencies against USD at the end of 2007 would, all other things being equal, have the following effect before tax on equity and income statement in the mentioned currencies stated in USD’000:
|
Currency |
Income statement |
Equity |
||
|
|
2007 |
2006 |
2007 |
2006 |
|
DKK |
31,528 |
6,077 |
0 |
0 |
|
JPY |
109 |
3,598 |
8,397 |
3,403 |
|
EUR |
341 |
307 |
0 |
0 |
The financial instruments denominated in foreign currencies largely consist of receivables and payables, bank deposits and forward exchange transactions.
In connection with the Group’s payments relating to existing agreements to purchase 3 vessels in JPY, the foreign exchange risk has been hedged by means of forward buying of JPY. The payments amount to JPY 10,444, equalling the equivalent of USD 94 million. Exchange rate adjustments up to the payment dates are taken to equity and subsequently recognised together with the asset (vessel) to which the payment relates.
Receivables and payables in currencies other than USD represent a net liability of USD 4 million (USD 5 million), which has not been hedged.
In 2008, payments in DKK are expected to total the equivalent of approximately USD 75 million, excluding dividend. The Company hedges these payments for a period of between 6-24 months, depending on the development of the USD/DKK exchange rate.
2.2. Interest rate risk
As there seems to be no clear correlation between freight rates and vessel prices on the one hand and US interest rates on the other, it is Company policy to lock the interest rate for the entire loan portfolio for a period of between two and six years. The interest rate is normally locked for each vessel loan individually on the basis of the degree and term of financing, the loan repayment profile, the duration of the vessel’s fixed employment, anticipated sale, the interest rate level and the yield curve.
In recent years, the Company has chosen to purchase vessels for cash and only raise loans secured on vessels if it is able to obtain highly favourable financing terms. In 2007, the Group raised loans on vessels in a nominal amount of USD 20 million (USD 80 million) at highly attractive financing terms.
It is the Company’s general assessment that it is not attractive to mortgage vessels as an investment. This is due to the costs of mortgaging vessels and the risk/return ratio currently prevailing in the financial markets.
The Company’s interest rate risk on non-current debt has been fixed for a period of 3.6 years at an interest rate of 3.96% including the lenders’ margin.
At the end of 2007, the majority of the Group’s excess liquidity was placed in short-term, fixed-interest deposits. Based on the Group’s liquidity and debt at the end of 2007, a 1% interest rate drop would, all other things being equal, have an effect of USD -6 million (USD -3 million) on the Group’s financial performance before tax.
In 2008, the Company will continue to place excess liquidity in bank deposits and liquid interest-bearing instruments of short duration and low credit risk.
2.3. Liquidity risk
In order to ensure a sufficient cash reserve, it is the Company’s policy that cash should at all times at least equal the Company’s payment obligations one year ahead. The size of these obligations is continuously calculated and adjusted to ensure that the cash reserve is adequate.
Based on the expected activities for 2008, the Company estimates a positive cash flow from operations of USD 666 million.
2.4. Credit risk
The Company’s credit risk primarily comprises freight receivables, prepayments to shipyards on newbuildings, cash deposits in bank accounts, forward sales of foreign currencies, bunker hedging contracts and forward freight agreements.
These items are included in the balance sheet at amounts corresponding to the maximum credit risk as of the balance sheet date and amount to USD 1,047 million (USD 491 million).
The Company’s credit risks are limited. Financial instruments and commodity instruments are only entered into with major, recognised banks with a high credit rating and with large, wellknown, reputable partners with an adequate credit rating and a good equity ratio.
The risk on customers is limited by such measures as systematic assessment of customers’ credit rating and reputation and limits as to the size and duration of the Company’s engagements with new, unknown customers.
The Company’s cash deposits are placed exclusively with large, recognised banks with a credit rating of at least A+ (Moody’s) or the equivalent and meeting the solvency requirements of the Danish Financial Supervisory Authority.
2.5. Other price risks
FFAs (forward freight agreements)
The Company uses the FFA market to cover future physical positions.
At the end of 2007, the Company had bought FFAs with a contractual value of USD 84 million (sold USD 35 million).
All other things being equal, a 10% decrease in the market price of the FFAs entered into by the Group at the end of 2007 for the purpose of covering physical positions would affect the Company’s financial performance negatively by USD 8 million before tax.
In addition to this coverage activity, the Company sees a potential in using its knowledge of the market to take more controlled positions in the FFA market, independently of the Company’s portfolio of vessels.
This activity is handled by the company NORDEN Derivatives A/S, which is a wholly owned subsidiary of the Company.
The activity is controlled within clearly defined limits which, among other things, mean that:
-
Contracts may only be entered into in the Panamax and Handymax segments.
-
Individual contracts may not exceed 6 months’ duration.
-
The expiry date of the contracts must be within the coming twelve months.
-
The maximum net risk may not exceed 36 months.
-
The maximum net risk with individual counterparties may not exceed 24 months.
-
The company has introduced a stop/loss strategy.
At the end of 2007, NORDEN Derivatives A/S had bought FFAs with a contract value of approximately USD 9 million net (USD 8 million) up to and including 2008.
Bunker hedging contracts
The Company hedges its expected future bunker (fuel for the vessels) requirements to eliminate the risk of future oil price fluctuations. The Company uses so-called bunker hedging contracts, which lock in the price of the part of the bunker requirement related to loading contracts for a fixed period. At the end of 2007, NORDEN had purchased bunker hedging contracts for USD 168 million covering the period 2008-2012 (USD 66 million).
All other things being equal, a 10% decrease in bunker hedging contracts entered into at the end of 2007 would affect the Company’s financial performance negatively by USD 20 million before tax.
2.6. Capital management risks
The Group’s equity ratio (excluding minority interests) was 81% at the end of 2007 (74%) of total assets. This significant equity ratio should be seen in light of the Company’s future payment obligations in the form of operating lease payments and payments for newbuildings on order.
Central to the Group’s efforts to manage capital structure and gearing is NORDEN’s risk model, which ensures that the Group’s net liabilities do not exceed the ceiling fixed by the Board of Directors relative to equity.
This is measured by regularly calculating the present value of total net liabilities. Net liabilities are defined as the present value of future payments in respect of, among other things, timecharters excluding daily operating costs, lenders and shipyards, less expected known freight payments received excluding daily operating costs and cash and cash equivalents.
|
Net present values |
|
|
|
At 31 December in USD mill. |
2007 |
2006 |
|
Future payments |
-3,673 |
-1,917 |
|
Expected known payments received |
3,099 |
986 |
|
Net liabilities |
-574 |
-981 |
The calculation of net liabilities and their relation to equity is an integral part of the current reporting to the Board of Directors.
The Board regularly assesses the Group’s net liabilities and defines upper limits based on market outlook. The limit for 2007 was that the present value of total net liabilities was at no time to be more than double the equity. At the end of 2007, net liabilities equalled 0.4 times equity (1.4 times).
3. Other risks
3.1. Insurance
If an incident involving a vessel causes a spill of environmentally hazardous material, the Company may incur considerable liabilities. The Company minimises this risk by operating a modern fleet and by investing large amounts in the maintenance of the vessels and in the staff’s awareness of both external and internal environments. The Company’s fleet is insured by recognised international insurance companies at competitive premiums and the vessels are always insured for an amount higher than their market values.
3.2. IT
The IT Department has established a technical emergency capacity with an IT environment distributed on two locations with twinned critical systems. This emergency capacity is consistent with the management’s chosen alert level, which is to be able to ensure emergency operation within 4, 24 or 168 hours, depending on the system.
Also, the Company has established an IT Disaster Recovery Plan involving the entire organisation, which supports the IT Department in setting up emergency operations as soon as possible after a disaster.
3.3. Human Resources
Through a number of activities, NORDEN has increased the visibility and branding of the Group in order to attract necessary resources, among other things. Through a comprehensive development programme, NORDEN develops the qualifications of the employees on an ongoing basis, combined with a remuneration policy in order to maintain key employees.
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