Risk management in an ever changing environment
The Company has implemented a formal process in risk management in order to identify the most important factors. Management and employees of Landsvirkjun identify financial and non-financial risks for Landsvirkjun and evaluate their significance.
The results are recorded in the Company's risk register and used to decide on appropriate action and management, with respect to possible effects on image, financial position, health and safety, environment and compliance.
The treasury division is entrusted with analysing, managing and providing information regarding Landsvirkjun’s financial risks. The Company's financial risk is divided into market risk, liquidity risk and counterparty risk.
The Company’s market risk consists mainly of three risk categories:
- Aluminium price risk due to power agreements linked to the price of aluminium
- Interest rate risk due to the Company’s liabilities
- Foreign exchange risk due to liabilities and cash flow
Landsvirkjun has been focused on reducing market risk in recent years. For this purpose, the ratio of USD and fixed interests has been significantly increased. Efforts have been made to reduce the ratio of aluminium linked revenue in power sales and new sales agreements have not been linked to aluminium price.
In November 2019 a renewed power sales agreement will take effect where its link to aluminium price will be discontinued. As a result, market risk in revenues due to changes in aluminium prices will decrease.
Aluminum price risk
The Company is exposed to market risk due to changes in aluminium price as about a quarter of its income (before aluminium hedges) is linked to aluminium price.
Thus, the Company has entered into derivative agreements in order to secure its income base and reduce fluctuations. Such agreements consist in most cases of fixing the aluminium price at a certain level. Therefore, the Company can lose income if the aluminium price goes up, but at the same time guarantees higher income should the aluminium price go down.
About 67% of the estimated cash flow of 2019 and 25% of 2020 has been hedged. At year-end 2018, fair value of the hedges was positive by USD 8.4 million (2017: negative USD 16.1 million).
Interest rate risk
Landsvirkjun faces interest rate risk as the Company has interest bearing assets and liabilities.
The Company’s interest bearing assets and liabilities carry both fixed and floating interest rates and cross currency swaps with exchange of currency and interest are used to manage interest rate risk. No interest rate swaps were in effect at year end 2018 (2017: negative by USD 0.7 million). The Company’s risk consists of a possible increase in floating interest rates on debt which can lead to an increase in financial expenses.
At year-end 2018, the proportion of loans with fixed interest rates including swap agreements was 73% (2017: 68%). At year-end 2018, the estimated market value of the Company’s long-term liabilities was USD 145 million higher than their book value (2017: USD 173 million higher) discounted by the underlying currencies yield curve without spread.
The graph below shows the breakdown of interest bearing liabilities including cross currency swap agreements.
Foreign exchange risk
Foreign exchange risk is the risk of loss due to unfavourable changes in foreign exchange rates. Landsvirkjun’s foreign exchange risk is due to cash flows, assets and liabilities in addition to transactions in other currencies than the functional currency.
Landsvirkjun’s functional currency is the USD and therefore a foreign exchange risk arises from the cash flow and open balances in currencies other than the USD. The Company’s revenues are mainly in USD. Other revenues are mainly in ISK and NOK but foreign exchange risk due to those currencies is limited due to netting in the cash flow in ISK and income in NOK is relatively low.
Currency risk due to amortisation and interest payments for future years has been limited with the use of cross currency swaps. The fair value of cross currency swaps was negative by USD 3.7 million at the end of December 2018 (2017: positive by USD 18.2 million).
The Company’s reporting risk related to changes in exchange rate arises mainly due to its debt in EUR which is mainly long-term.
The graph below shows interest bearing long-term liabilities by currencies without swap agreements.
Liquidity risk consists of risk of losses should the Company not be able to meet its obligations at maturity date.
Landsvirkjun limits liquidity risk with effective liquidity management by ensuring that there is sufficient cash at all times to be able to meet obligations. In order to keep a balance between liabilities and expected revenues an emphasis is placed on a secure liquidity position in the form of cash and access to revolving credit facilities.
The Company’s cash and cash equivalents amounted to USD 116 million at year end 2018 (2017: USD 127 million) but taking into account undrawn credit facilities (USD 250 million and ISK 12,000 million) Landsvirkjun has access to a total of USD 469 million (2017: USD 548 million). Cash flow from operations, a well distributed maturity profile in addition to strong liquidity and access to credit facilities secure the Company’s liquidity at least throughout the year 2020.
Counterparty risk is the risk that a counterparty to an agreement does not comply with provisions of the agreement.
Landsvirkjun’s counterparty risk arises first and foremost due to the Company’s power agreements, derivative contracts and cash and cash equivalents.
Though the amounts involved can be considerably high, the risk is limited by the Company´s requirements for take or pay clauses in power agreements and also through requirements for counterparty guarantees. Landsvirkjun requires that counterparties have an investment grade credit rating when it comes to keeping cash and cash equivalents and entering into derivative contracts.
Landsvirkjun places emphasis on securing access to capital and having diverse sources of funding.
Thus, the Company has been able to access capital through the issuance of bonds in the domestic and foreign capital markets, with borrowing from the European Investment Bank (EIB) and the Nordic Investment Bank (NIB) and through project financing in Europe and Japan. In addition, the Company has access to credit facilities from its relationship banks.
In 2018, Landsvirkjun issued for the first time a Green Bond for a total amount of USD 200 million through a US private placement (USPP) and was the first issuer in Iceland to issue a bond in a Green Bond format. Landsnet drew on a loan from the Nordic Investment Bank (NIB) amounting to USD 40 million. Total borrowings in 2018 amounted to USD 267 million (2017: USD 209 million). Total amortisation of debt was USD 405 million (2017: USD 228 million) but Landsvirkjun prepaid loans and bonds amounting to USD 95 million in the year.
Landsvirkjun´s interest-bearing debt amounted to USD 2.001 million at year-end 2018 (2017: USD 2.169 million). The risk associated with refinancing is reduced by the equal distribution of amortisations and by the suitable lifetime of outstanding debt. The weighted average lifetime of interest-bearing debt is 5.1 years (2017: 5.3 years) and the ratio of interest-bearing debt with maturity within a 12-month period is 9.6% (2017: 13%).
In recent years, Landsvirkjun has placed an emphasis on changing its loan portfolio and no longer takes on debt with a state guarantee. In addition, the Company has worked systematically to remove state guarantees of outstanding debt where possible. The principal of state guarantee debt is decreasing and the last debt enjoying a state guarantee is due in 2026. At year-end 2018, 40% of Landsvirkjun's debt was state guaranteed. Landsvirkjun pays a guarantee fee to the Icelandic state for the Company´s debt which has a state guarantee.
The first Icelandic company to issue a Green Bond
In connection with the United Nations´ Sustainable Development Goals, Landsvirkjun issued a USPP in Green Bond format of USD 200 million in March 2018.
The orderbook was just over USD 700 million, representing about 7x oversubscription from the launch size of USD 100 million.
This was the company´s first Green Bond and Landsvirkjun was the first Icelandic company to issue a Green Bond. The bond was issued under Landsvirkjun´s Green Bond Framework and the proceeds of the transaction have been fully allocated to the build-up of Theistareykir Power Station and the expansion of Burfell Power Station. Both projects are in compliance with the Green Bond Framework´s eligibility criteria and restrictions on CO2 emission.
Annual reporting under the Green Bond Framework and further information can be found on Landsvirkjun´s website: Landsvirkjun’s website.
Signý Sif Sigurðardóttir, Treasurer, Ólafía Harðardóttir, Head of Cash Management, Rafnar Lárusson, CFO and Jóhann Þór Jóhannsson, Assistant Treasurer. Photo by Haraldur Guðjónsson, photographer at Viðskiptablaðið.
You can download the Financial Statements for 2018 in electronic form here. The documents contain the financial statements as a whole in Acrobat (pdf) document and the key figures in an Excel (xls) document.