Risk Profile
Latest updated in accordance with NORDEN's Annual Report for 2010
Table of content
- Commercial and financial risks
- Commercial risks
- Financial risks
- Liquidity risks
- Capital management risks
- Other operational risks (commercial)
1. Commercial and financial risks
NORDEN’s activities expose the Company to a number of risk factors, the most significant of which are assessed to be:
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freight rate volatility, affecting vessel values and the vessels’ earning capacity;
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credit risk on customers in relation to COAs and T/C contracts;
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credit risk on banks and shipyards in relation to deposits and prepayments on newbuildings, respectively.
As the first two of these risk factors relate to future earnings and therefore do not have any direct impact on the Company’s financial position at year-end 2010, these risks are discussed below in the section “Commercial risks”. Risk factors relating to items already included in the financial position at year-end 2010 are discussed in the section ”Financial risks”.
2. Commercial risks
2.1. Freight rate risks (commercial)
Purchasing and chartering vessels imply a risk as the Company assumes a financial liability in expectation of an inflow of income which is dependent on the freight market. To limit the uncertainty relating to earnings, the future open ship days are covered by COAs, T/C contracts and financial instruments.
Coverage in 2011 constituted, at the end of 2010, a total value of USD 666 million for Dry Cargo and Tankers, corresponding to 85% and 36% coverage of capacity, respectively. Earnings on the remaining 15% and 64% of capacity in Dry Cargo and Tankers, respectively, are directly exposed to the future level of freight rates. A 10% drop in freight rates at the end of 2010 would, all other things being equal, result in a drop in expected future earnings for 2011 of USD 19 million (a drop of USD 22 million).
For further information, see the section on capacity and coverage in the management’s review.
2.2. Vessel price risks (commercial)
One of NORDEN’s most material risks relates to fluctuations in freight rates and vessel prices and the resulting changes in the value of the Company’s owned vessels and charter parties with purchase options. At the end of 2010, the Company had 51 owned vessels and newbuildings and 58 charter parties with purchase options. The change in the value of owned vessels will directly affect the Company’s estimated Net Asset Value (NAV), while a change in the value of charter parties with purchase options will only affect the Company’s theoretical NAV.
Based on the portfolio of owned vessels and charter parties with purchase options as well as market prices at the end of 2010, a simultaneous 10% decline in vessel prices and the freight rate curve would cause the Company’s theoretical NAV to drop by USD 359 million (USD 341 million). On the contrary, a 10% rise in prices and freight rates would cause the theoretical NAV to increase by USD 364 million (USD 328 million).
The value of the purchase options and the assumptions applied in the calculations are set out in the sections “Fleet development” and “Fleet values” in the management’s review.
2.3. Credit risks (commercial)
NORDEN mitigates its credit risks through systematic credit assessment of counterparties and through regular monitoring of counterparties’ creditworthiness.
The Company’s Credit Risk Desk (CRD) monitors counterparties in close collaboration with the commercial departments.
The CRD uses information from external credit rating agencies, publicly available information and its own analyses. All counterparties are given an internal rating, which is used in determining whether the Company wishes to do business with the counterparty and, if so, the allowed scope of the commitment. Ratings range from A to D, A being the best category, which typically comprises counterparties with strong and transparent financial positions, available financial information and good reputations. Conversely, the Company does not enter into contracts with counterparties rated D. The creditworthiness of counterparties is assessed on an ongoing basis, and ratings are updated accordingly. The Company’s internal ratings are not identical to the ratings issued by the international credit rating agencies.
The Company’s largest commercial credit exposure is with counterparties in COAs and T/C contracts and totalled USD 1,637 million (USD 1,367 million) at the end of 2010. In 2011, coverage of known ship days in Dry Cargo involves 167 counterparties of which the 5 largest accounted for 41% of the covered revenue in the segment at the beginning of 2011. In Tankers, coverage is allocated on 43 counterparties, and the 5 largest counterparties represent 74% of the covered revenue.
3. Financial risks
The table on page 66 provides an overview of financial credit and market risks, including market risks associated with fluctuations in foreign exchange rates and interest rates.
4. Liquidity risks
In order to ensure sufficient cash reserves, it is the Company’s policy that cash should at least equal the Company’s payment obligations 1 year ahead. The size of these obligations is calculated on an ongoing basis and adjusted according to the profit forecast for the year and profit projections for future years, market outlook, the availability of attractive investment opportunities and the Company’s future liabilities on and off the statement of financial position. See also the section on capital management below.
5. Capital management risks
The Company’s formal external capital adequacy requirement is limited to the subordinated loan capital of the parent company and the subsidiaries, which is significantly lower than the Group’s equity.
The Group’s equity ratio (excluding minority interests) was 89% (89%) at the end of 2010. This significant equity ratio should be considered relative to the Company’s future payment obligations in the form of operating lease liabilities (T/C contracts) and payments for newbuildings not recognised in the statement of financial position.
As part of the management of NORDEN’s capital structure, the Company’s gearing, defined as net commitments relative to equity, is monitored on a monthly basis. The Board of Directors sets out a limit for this ratio, and in 2010, the ratio was not to exceed 1.5. At year-end 2010, the ratio of net commitments to equity was 0.2 (0.4). Please see the statement on page 7 in the management’s review.
Net commitments are measured as the difference between the present value of total future T/C liabilities, payments to shipyards, instalments on loans less expected future contractual freight and T/C payments received and cash and cash equivalents.
6. Other operational risks (commercial)
The operation of vessels is exposed to a number of risks. In terms of value, the most material events covered by insurance are oil spills and total loss (lost value of owned vessels, value of purchase options and charter parties). The Company covers these risks by taking out insurances with recognised international insurance companies. The Company further minimises these risks by operating a modern fleet and by investing in the maintenance of the vessels and in staff awareness of both external and internal
environments.
6.1. IT
The IT Department has established a technical emergency capacity with an IT environment distributed on 2 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 and supporting the IT Department in setting up emergency operations as soon as possible after a disaster.