Report of the Board of Directors

2018 in Brief

  • The Group’s net operating profit without unrealised fair value changes grew by 1.2% and amounted to EUR 189.6 million at the end of the financial year (2017: EUR 187.4 million). Taking fair value changes into account, net operating profit was EUR 190.0 million (2017: EUR 198.4 million).
  • The Group’s net interest income grew by 3.4% from the previous year and amounted to EUR 236.3 million (2017: EUR 228.5 million).
  • The balance sheet total grew by 2.7% and was EUR 35,677 million (2017: EUR 34,738 million) at the end of the year.
  • The Group’s capital adequacy continued to strengthen and CET1 capital ratio was 66.34% (2017: 53.01%). Tier 1 capital ratio and total capital ratio were 87.97% at the end of December (2017: 72.50%).
  • At the end of December, the Group’s leverage ratio amounted to 4.06% (2017: 3.84%).
  • New loans withdrawn in the January–December period totalled EUR 2,953 million (2017: EUR 2,439 million). The lending portfolio amounted to EUR 22,354 million (2017: EUR 21,219 million). Of this amount, EUR 1,143 million had been withdrawn at the end of December 2018 as green finance targeted for environment-friendly investments (2017: EUR 803 million).
  • The leasing portfolio increased 42.2% and amounted to EUR 614 million at the end of December (2017: EUR 432 million).
  • In January–December, EUR 7,436 million was acquired in long-term funding (2017: EUR 9,510 million). The total amount of acquired funding was EUR 30,856 million (2017: EUR 30,153 million).
  • At the end of December, total liquidity was EUR 8,722 million (2017: EUR 9,325 million).
  • Return on equity (ROE) decreased slightly to 10.76% (2017: 12.57%).
KEY FIGURES (GROUP)31 Dec 201831 Dec 2017
Net operating profit without unrealised changes in fair value (EUR million)189.6187.4
Net operating profit (EUR million)190.0198.4
Net interest income (EUR million)236.3228.5
New loans withdrawn (EUR million)2,9532,439
New funding acquisition (EUR million)7,4369,510
Balance sheet total (EUR million)35,67734,738
Common Equity Tier 1 (CET1) (EUR million)1,065946
Tier 1 capital (T1) (EUR million)1,4131,293
Total own funds (EUR million)1,4131,293
Common Equity Tier 1 (CET1) capital ratio, %66.3453.01
Tier 1 (T1) capital ratio, %87.9772.50
Total capital ratio, %87.9772.50
Leverage ratio, %4.063.84
Return on equity (ROE), %10.7612.57
Cost-to-income ratio0.210.18
Personnel151134
The formulas for calculating key figures can be found at the end of this document, under the heading "Calculation of Key Figures". Unless otherwise stated, the figures presented in this report are the figures of the Municipality Finance Group. Alternative key figures have been reported after the key figures.

Group Structure

Municipality Finance Group (hereinafter the Group) consists of Municipality Finance Plc (MuniFin or Company) and Financial Advice Services Inspira Oy (Inspira). MuniFin owns 100% of Inspira.

MuniFin is a credit institution by the Act on Credit Institutions and it’s owned by municipalities, Keva and the government of Finland, providing a wide range of financial services for the local ­government sector and the state-subsidised housing production. The core of the company’s strategy is to build a better future in cooperation with its customers. MuniFin is Finland’s only financier specialising in the local government sector and state-subsidised housing production. The ­company’s ­vision is to be the best financial expert for customers in a changing world.

Inspira is a company specialised in providing financial advisory services to municipalities and state-subsidised housing production. It provides financial advisory services in investment activities and in reorganising operations.

Operating Environment in 2018

In 2018, trends in the Finnish and global economies remained generally favourable, but the rate of growth slowed down in many areas. Forecasting market trends was complicated by, among ­other things, the growing tensions between the major world powers, the consequent restrictions on international trade, and, in Europe, particularly by the risks posed by Italy’s debt situation and the difficulties involved in the Brexit negotiations. However, these, and the ongoing uncertainties affecting global politics, did not have a major impact on the markets. In 2018, the European Central Bank ended net purchases under its purchase programme, but in spite of this plenty of liquidity was available in the market for most of the year, meaning that the availability of financing remained at a good level. However, towards the end of the year market liquidity weakened substantially compared with the beginning of the year.

Housing construction remained brisk in Finnish growth centres. Municipalities also stepped up their investments, and demand for financing grew towards the end of the year due to lower-than-anticipated municipal tax revenue. Changes in service needs ushered in investment pressures in growth centres with respect to municipal infrastructure, traffic arrangements, and schools and daycare centres. Also the property maintenance backlog was shortened around the country.

The regional government, health and social services reform did not progress as expected during the year. This uncertainty involves MuniFin’s customer base, but it does not appear to have had a significant impact on the appetite for investments.

Credit ratings

The credit ratings of Moody’s and Standard & Poor’s and their outlooks for MuniFin did not change in 2018. The credit rating of MuniFin is the same as the government’s credit rating: Standard & Poor’s rating is AA+ and Moody’s rating is Aa1. The ratings’ outlooks are stable.

RATING AGENCYLong-term fundingOutlookShort-term funding
Moody’s Investors ServiceAa1StableP-1
Standard & Poor’sAA+StableA-1+

Income Statement and Statement of Financial Position

Municipality Finance Group

The Group’s business operations remained strong during 2018. The Group’s net operating profit without unrealised fair value changes amounted to EUR 189.6 million (2017: EUR 187.4 million). This was affected particularly by the year-on-year improvement in net interest income, but also by higher costs. Taking unrealised fair value changes into account, net operating profit was EUR 190.0 million (2017: EUR 198.4 million).

Net interest income grew by 3.4% to EUR 236.3 million (2017: EUR 228.5 million) at the end of the financial year. Growth of net interest income was due to successful ­funding operations, volume growth and a favourable interest rate ­environment for MuniFin’s business operations. The Group’s net interest income does not recognise the interest expenses of the AT1 capital loan through profit or loss, as the capital loan is treated as an equity instrument in the consolidated accounts. The interest expenses of the capital loan are treated similarly to dividend distribution, that is, as a decrease in retained earnings under shareholders’ equity upon realisation of payment on an annual basis.

CONSOLIDATED INCOME STATEMENT
(EUR million)
1–12/2018 *1–12/2017Change, %
Net operating profit without unrealised fair value changes189.6187.41.2
Net interest income236.3228.53.4
Unrealised fair value changes0.411-96.5
Other income1.91.85.6
Total income238.5241.3-1.1
Commission expenses-4.2-4.12.7
Personnel expenses-15.2-13.612.1
Other administrative expenses-12-8.837
Depreciation and impairment on tangible and intangible assets-2.3-218.2
Other operating expenses-15.4-14.56
Total expenses-49.1-42.914.5
Expected credit losses (ECL)0.6--
Net operating profit190198.4-4.2
Figures have been rounded, so the total of individual figures may differ from the total figure presented.

* The company has applied the IFRS 9 option to not restate prior periods, and thus the unrealised fair value changes for 2017 are not fully comparable due to reclassification.

Following the adoption of IFRS 9 at the beginning of 2018, MuniFin reclassified financial assets and liabilities. Due to reclassification, the unrealised fair value changes of financial instruments have increased the volatility of financial results during the year. At year-end, the impact of the unrealised fair value changes on profit totalled EUR 0.4 million (2017: EUR 11 million), of which net income from hedge accounting amounted to EUR 27.6 million (2017: EUR 2.7 million). Unrealised net income from securities transactions totalled EUR -27.3 million (2017: EUR 8.3 million). The company has applied the IFRS 9 option to not restate prior periods, and thus the unrealised fair value changes for the previous year are not fully comparable due to reclassification.

The Group’s expenses grew by 14.5% and amounted to EUR 49.1 million at the end of December (2017: EUR 42.9 million).

Commission expenses totalled EUR 4.2 million (2017: EUR 4.1 million) and primarily comprise paid guarantee fees, custody fees and funding programme update fees.

Administrative expenses were EUR 27.2 million (2017: EUR 22.3 million), of which personnel expenses comprised EUR 15.2 million (2017: EUR 13.6 million) and other administrative expenses EUR 12.0 million (2017: EUR 8.8 million). Administrative expenses were increased particularly by growth in the number of employees at the parent company. Due to increase in banking regulation, the company needs to develop its governance, risk management and processes. In addition, the company made substantial investments in developing customer service as well as service offerings and systems.  

Depreciation and impairment on tangible and intangible assets amounted to EUR 2.3 million at the end of the financial year (2017: EUR 2.0 million).

Other operating expenses grew to EUR 15.4 million (2017: EUR 14.5 million). Growth in other operating expenses was mainly due to financial supervision costs paid to the ECB and to the Finnish Financial Supervisory Authority (FIN-FSA), and the contributions paid to EU-level crisis resolution fund.

Impairments of financial assets have been calculated as from the beginning of 2018 in accordance with the requirements of IFRS 9. The amount of expected credit losses (ECL) calculated in accordance with IFRS 9 decreased during the financial year compared with the amount booked at the time of IFRS 9 transition on 1 January 2018 and the change recognised in profit or loss was EUR 0.6 million at the end of the year.

The Group’s comprehensive income includes unrealised fair value changes related to financial instruments due to the IFRS 9 transition that are not treated as fair value changes through profit or loss. During the financial year, the largest items affecting the comprehensive income were a fair value change of EUR 49.0 million due to changes in own credit risk on financial liabilities designated at fair value through profit or loss as well as a net change in cost-of-hedging totalling EUR 27.7 million. The changes in the fair value of items included in the comprehensive income reflect the temporary effects of market conditions on the valuation level of financial instruments at the reporting date. Deferred valuation changes may vary significantly over the reporting periods, ­causing more volatility in fair value equity reserves.

The consolidated balance sheet saw growth of 2.7% from the end of 2017 and at the end of December 2018 amounted to EUR 35,677 million (2017: EUR 34,738 million). The increase in balance sheet assets is primarily due to growth in the lending and leasing portfolio. The growth of liabilities is due to increased funding and is shown in liabilities to credit institutions, liabilities to the public and public sector entities, and debt securities issued. Equity at the end of the year totalled EUR 1,486 million (2017: EUR 1,339 million), including the AT1 capital loan of EUR 347.4 million. ­Equity increased due to profit for the period. However, the transition to IFRS 9 as from 1 January 2018 decreased equity by EUR 43 million. In addition, in the consolidated accounts interest expenses amounting to EUR 12.6 million net of deferred tax on the AT1 capital loan were deducted from the equity upon the realisation of the interest payment in April, and the dividends of EUR 6.3 million paid to MuniFin shareholders were likewise deducted.

CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(EUR million)
31 Dec 201831 Dec 2017Change, %
Total liabilities and equity35,67734,7382.7
Cash and balances with central banks3,5223,554-0.9
Loans and advances to credit institutions1,3811,25110.3
Loans and advances to the public and public sector entities22,96821,6516.1
Debt securities5,8636,494-9.7
Derivative contracts1,5391,4337.3
Other assets40535414.3
Total assets35,67734,7382.7
Liabilities to credit institutions8238022.5
Liabilities to the public and public sector entities3,8713,7473.3
Debt securities issued26,90226,3042.3
Derivative contracts2,2052,216-0.5
Other liabilities39033018.2
Total equity1,4861,33910.9

The Parent Company

At the end of 2018, MuniFin’s net interest income was EUR 220.1 million (2017: EUR 212.3 million), and the company’s net operating profit amounted to EUR 173.8 million (2017: EUR 181.9 million). The interest expenses of EUR 16.2 million for 2018 on the AT1 capital loan, which forms part of the Additional Tier 1 capital in capital adequacy calculation, have been deducted in full from the parent company’s net interest income (2017: EUR 16.2 million). In the parent company, the AT1 capital loan has been recorded under the balance sheet item Subordinated liabilities. The balance sheet of the parent company at the end of the year amounted to EUR 35,676 million (2017: EUR 34,738 million).

Inspira

The turnover of MuniFin’s subsidiary Inspira was EUR 2.5 million for 2018 (2017: EUR 2.7 million), while its net operating profit amounted to EUR 0.0 million (2017: EUR 0.2 million).

Financing and other services for customers

MuniFin is the only credit institution in Finland which specialises in financing the local government sector and central government-subsidised housing production, and is by far the largest financier for its customer base. MuniFin’s customers consist of municipalities, municipal federations and municipality-controlled entities, as well as organisations and housing sites defined as not for profit by the Housing Finance and Development Centre of Finland (ARA). The company offers its customers versatile financing services, as well as comprehensive support for investment planning and financial management.

Demand for MuniFin’s financing saw year-on-year growth. Changes in service needs in growth centres call for new investments in municipal infrastructure, traffic arrangements and the development of the service network, and shortening of the maintenance backlog. Demand for financing grew towards the end of the year, partly due to lower-than-anticipated municipal tax revenue. Migration to growth centres maintained the need for the construction of affordable rental housing.

The total of new loans withdrawn, EUR 2,953 million, was more than the year before (2017: EUR 2,439 million).

MuniFin’s total customer financing year-on-year growth was 6.1% and amounted to EUR 22,968 million at year-end (2017: EUR 21,651 million). The long-term loan portfolio increased 5.3% and amounted to EUR 22,354 million at the end of the year (2017: EUR 21,219 million). Financial leasing portfolio increased 42.2% and amounted to EUR 614 million at year-end (2017: EUR 432 million). The largest share of portfolio growth is generated by property leasing agreements. Property leasing is typically used to finance school buildings, for instance.

Green finance, launched in 2016 to finance environmental investments, continued to attract interest, and the company has successfully increased awareness of the product among its customers. By the end of 2018, EUR 1,143 million in green finance had been withdrawn (2017: EUR 803 million). Whether or not a project fits in with the green finance framework is determined by an evaluation team comprising external experts.

The company’s year-end balance sheet included EUR 726 million in municipal papers and municipal commercial papers issued by municipalities and municipal companies (2017: EUR 749 million).

In 2018, MuniFin’s Apollo e-service for financial portfolio management was expanded to include features such as investment management. With pilot customers, it was deployed for use in wide-ranging economic modelling and forecasting. Customers are rapidly adopting the Apollo service. Its users include all of Finland’s largest cities.

Demand for the services provided by MuniFin’s subsidiary Inspira was brisk in 2018. Its assignments focused on the regional government, health and social services reform that is currently under preparation, participating in the competitive tendering processes of schools and daycare centre buildings, and M&A projects.

Funding and liquidity management

MuniFin’s funding strategy is to diversify its funding sources, which aims to ensure the continuity of its funding under all market conditions. MuniFin actively diversifies its funding across different currencies and maturities as well as geographical areas and investor groups. Active long-term cooperation with investors has increased name recognition of MuniFin in different markets.

Liquidity remained generally strong in the international capital markets during 2018, and MuniFin’s funding operations were very successful. Extensive diversification has also made funding efficient, which makes the funding terms for MuniFin’s customers competitive. MuniFin’s name is widely known in the international capital markets, where investors regard it as one of the most flexible, reliable and fast-reacting issuers.

MuniFin’s public benchmark issuances were in extremely high demand. In 2018, MuniFin organised four benchmark bonds: two in USD (both 1 billion), one in GBP (400 million) and one in EUR (750 million). The 15-year term of the EUR 500 million benchmark bond issued in January 2018 is the longest benchmark bond in the company’s history so far and the size of the bond was increased by EUR 250 million in October. These benchmark bonds are listed on the London Stock Exchange.

Long-term funding acquired during the year totalled EUR 7,436 million (2017: EUR 9,510 million). MuniFin’s short-term debt instruments under the Euro Commercial Paper (ECP) programme amounted to EUR 3,062 million at the end of the year (2017: EUR 3,833 million).

Total funding at the end of 2018 was EUR 30,856 million (2017: EUR 30,153 million). Of this amount, 24% was denominated in euros (2017: 23%) and 76% in foreign currencies (2017: 77%). In total, the company issued bonds denominated in 11 different currencies in 2018 (2017: 14 currencies).

MuniFin currently acquires all of its funding from the international capital market. In total, 260 long-term funding arrangements were made in 2018 (2017: 318).

Medium Term Note (MTN) programmeEUR 30,000 million
Euro Commercial Paper (ECP) programmeEUR 5,000 million
AUD debt programme (Kangaroo)AUD 2,000 million

MuniFin’s funding is guaranteed by the Municipal Guarantee Board, which has the same credit ratings from Moody’s and Standard & Poor’s as MuniFin and the Finnish government. The Municipal Guarantee Board is a public-law institution, whose members are all Finnish mainland municipalities. The members are responsible for the liabilities of Guarantee Board in proportion to their population. The Municipal Guarantee Board has granted guarantees for MuniFin’s debt programmes, as well as for funding arrangements outside the programmes. As a result, debt instruments issued by MuniFin are classified as zero-risk when calculating the capital adequacy of credit institutions and as Level 1 liquid assets in liquidity calculation in the EU.

The company’s liquidity remained excellent during 2018. MuniFin’s investment operations mostly comprise the management of acquired funding. The funds are invested in liquid and highly rated financial instruments, so as to ensure business continuity under all market conditions.

According to the company’s liquidity policy, its liquidity must be sufficient to cover the needs of continued undisturbed operations (including new net lending) for at least the following 12 months.

At the end of 2018, total liquidity was EUR 8,722 million (2017: EUR 9,325 million). Investments in debt securities totalled EUR 5,146 million (2017: EUR 5,755 million) and their average credit rating was AA (2017: AA). The average maturity of the portfolio stood at 2.1 years at year-end (2017: 2.5 years). In addition to this, the company had EUR 3,576 million in other investments (2017: EUR 3,570 million), of which EUR 3,554 million was in central bank deposits (2017: EUR 3,554 million) and EUR 22 million in money market deposits in credit institutions (2017: EUR 16 million). The company invests cash collateral received on the basis of derivative collateral agreements primarily in short-term money market investments.

As of 2015, MuniFin has also monitored the ESG performance (Environmental, Social and Governance) of its liquidity investments. At the end of 2018, MuniFin’s liquidity investments had an ESG average of 50.9 on a scale of 1–100 (2017: 49.1). The benchmark index is 50.8 (2017: 49.2).

Capital adequacy

Minimum capital requirements and capital buffers

MINIMUM CAPITAL REQUIREMENTS
AND CAPITAL BUFFERS, %

31 Dec 2018
Capital requirementCapital conservation buffer 1)Countercyclical buffer 2)O-SII 3)Total capital buffersTotalRealised
31 Dec 2018
Common Equity Tier 1 (CET1)4.50 %2.50 %0.45 %1.00 %3.95 %8.45 %66.34 %
Tier 1 Capital (T1)6.00 %2.50 %0.45 %1.00 %3.95 %9.95 %87.97 %
Total own funds8.00 %2.50 %0.45 %1.00 %3.95 %11.95 %87.97 %
MINIMUM CAPITAL REQUIREMENTS
AND CAPITAL BUFFERS, (EUR 1000)

31 Dec 2018
Capital requirementCapital conservation buffer 1)Countercyclical buffer 2)O-SII 3)Total capital buffersTotal
Common Equity Tier 1 (CET1)72,27840,1547,16816,06263,384135,662
Tier 1 Capital (T1)96,37040,1547,16816,06263,384159,754
Total own funds128,49440,1547,16816,06263,384191,878
MINIMUM CAPITAL REQUIREMENTS
AND CAPITAL BUFFERS, %

31 Dec 2017
Capital requirementCapital conservation buffer 1)Countercyclical buffer 2)O-SII 3)Total capital buffersTotalRealised
31 Dec 2017
Common Equity Tier 1 (CET1)4.50 %2.50 %0.34 %0.50 %3.34 %7.84 %53.01 %
Tier 1 Capital (T1)6.00 %2.50 %0.34 %0.50 %3.34 %9.34 %72.50 %
Total own funds8.00 %2.50 %0.34 %0.50 %3.34 %11.34 %72.50 %
MINIMUM CAPITAL REQUIREMENTS
AND CAPITAL BUFFERS (EUR 1,000)

31 Dec 2017
Capital requirementCapital conservation
buffer 1)
Countercyclical buffer 2)O-SII 3)Total capital buffersTotal
Common Equity Tier 1 (CET1)80,25844,5886,0178,91859,522139,780
Tier 1 Capital (T1)107,01044,5886,0178,91859,522166,532
Total own funds142,68044,5886,0178,91859,522202,202
1) Act on Credit Institutions (610/2014), Chapter 10, Section 3, and the EU capital requirements Regulation (575/2013; CRR) and Directive (2013/36/EU; CRD IV). Valid from 1 January 2015.

2) Act on Credit Institutions (610/2014) Sect 10:4-5 § and Capital Requirements Regulation and Directive (CRR/CRD4). On 20th December 2018 (21 December 2017), the Board of Financial Supervisory Authority (FIN-FSA) decided not to set countercyclical capital buffer requirement for credit exposures allocated to Finland. The institution-specific countercyclical capital buffer requirement is determined on the basis of the geographical distribution of the exposures. For MuniFin it is 0.45% on 31 December 2018 (31 December 2017: 0.34%).

3) Other Systemically Important Institutions additional capital requirements: Act on Credit Institutions (610/2014) Sect 10:8 § and Capital Requirements Regulation and Directive (CRR/CRD4). Additional capital requirement (O-SII) for MuniFin is 1%. The decision of the Board of FIN-FSA on 21 December 2017, effective on 1 July 2018 (31 December 2017: 0.5%).

The minimum capital adequacy is 8% and the minimum CET1 capital adequacy 4.5%. Under the Act on Credit Institutions, the capital conservation buffer is 2.5%.  In December 2017, the Financial Supervisory Authority (FIN-FSA) decided that the additional capital requirement for other systematically important institutions applied to MuniFin will be increased from 0.5% to 1.0%. This requirement became effective on 1 July 2018. The FIN-FSA decides on a countercyclical capital buffer requirement on a quarterly basis. In December 2018, it decided not to impose a countercyclical capital buffer. For MuniFin, the credit institution-specific countercyclical capital buffer requirement imposed based on the geographical distribution of exposures is 0.45%. Therefore, the minimum requirement for CET1 capital ratio is 8.45% and the minimum requirement for total capital ratio 11.95%.

In addition as part of the annual Supervisory Review and Evaluation Process (SREP), the European Central Bank has imposed an additional Pillar II capital requirement of 1.75% (P2R) on MuniFin, effective from 1 January 2018. The minimum level of CET1 capital ratio is 10.20% when taking account of the P2R additional capital requirement, and the minimum level of total capital ratio is 13.70% at the end of 2018.

In February 2019, the European Central Bank has updated MuniFin’s additional Pillar II capital requirement (P2R) as part of SREP and the new requirement is 2.25% effective from 1 March 2019. In June 2018, the FIN-FSA took a decision on the additional capital requirement for other systematically important institutions and reduced the requirement applied to MuniFin back to 0.5%. This change came into force on 1 January 2019. In the same context, the FIN-FSA made a macro-prudential decision on structural additional capital requirements and decided to impose a systemic risk buffer on credit institutions. For MuniFin, the additional capital requirement imposed based on the systemic risk buffer is 1.5%. The systemic risk buffer and the O-SII additional capital requirement are parallel buffers, of which the greater is applied. The systemic risk buffer requirement will come into force on 1 July 2019.

Groups own funds and capital adequacy

Key figures for capital adequacy

At the end of 2018, the Municipality Finance Group’s total capital ratio was 87.97% (2017: 72.50%), and its CET1 capital ratio was 66.34% (2017: 53.01%). The capital ratio saw year-on-year growth of 15.47 percentage points, largely due to growth in own funds and the decline in total risk. The Group’s capital adequacy has remained strong and clearly above the statutory requirements and the minimum capital adequacy requirements set by the authorities. MuniFin’s own funds exceed the minimum requirement set in legislation by EUR 1,221 million (2017: EUR 1,091 million), taking valid capital buffers into account.

Common Equity Tier 1 capital (CET1) at the end of the year totalled EUR 1,065 million (2017: EUR 946 million), and Tier 1 capital (T1) amounted to EUR 1,413 million (2017: EUR 1,293 million). There was no Tier 2 capital, and the company’s own funds totalled EUR 1,413 million (2017: EUR 1,293 million).

Common Equity Tier 1 capital includes the profit for the financial year, as the result for the financial year has been subject to a financial review by the auditors and can, therefore, be included in CET1 capital based on the permission granted by the ECB in accordance with the Capital Requirements Regulation.

The Group’s risk-weighted assets decreased by 10% since the end of 2017 and amounted to EUR 1,606 million at year-end (2017: EUR 1,784 million). The overall credit and counterparty risk decreased from the year-end 2017 figure of EUR 1,108 million to EUR 977 million at the end of the financial year. This was particularly affected by the decrease in the size of liquidity portfolio. The credit valuation adjustment risk (CVA VaR) declined to EUR 247 million (2017: EUR 341 million). This was mainly due to the lower amount of derivatives exposure and shortening average maturity of the derivatives. The currency position was less than 2% of own funds and therefore, based on Article 351 of the Capital Requirements Regulation (CRR), the own funds requirement for market risk has not been calculated. The exposure for operational risk grew by EUR 48 million to EUR 383 million (2017: EUR 335 million) due to an increase in the relevant indicator.

CONSOLIDATED OWN FUNDS
(EUR 1,000)
31 Dec 201831 Dec 2017
TOTAL OWN FUNDS1,412,9091,292,973
Common Equity Tier 1 before adjustments1,118,171976,260
Adjustments to Common Equity Tier 1-52,715-30,741
COMMON EQUITY TIER 1 (CET1)1,065,455945,519
Additional Tier 1 capital before adjustments347,454347,454
Adjustments to Additional Tier 1 capital--
ADDITIONAL TIER 1 CAPITAL (AT1)347,454347,454
TIER 1 CAPITAL (T1)1,412,9091,292,973
Tier 2 capital before adjustments--
Adjustments to Tier 2 capital--
TIER 2 CAPITAL (T2)--
TOTAL RISK EXPOSURE
(EUR MILLION)
31 Dec 201831 Dec 2017
Total1,6061,784
Credit and counterparty credit risk9771,108
Market risk00
Credit valuation adjustment risk247341
Operational risk383335

MuniFin has updated the capital adequacy figures for the 2017 comparison year, accounting for a technical correction to the calculation of CVA VaR and the fact that guarantees are not taken into consideration as means of mitigating risk with respect to derivative counterparties in the calculation of CVA VaR. These changes increased the CVA VaR. In the same context, MuniFin refined the treatment of given cash collateral under derivatives netting agreements, which reduced the amount of credit and counterparty risk. In the comparison year, also the currency risk amounted to less than 2% of own funds.

The capital adequacy management principles applied and key figures are described in Notes to this Report of the Board of Directors: in Note 2 capital adequacy management principles, in Note 3 the Group’s capital adequacy position and in Note 4 the parent company’s capital adequacy. In addition to the Report of the Board of Directors and the Financial Statements, MuniFin publishes a separate Pillar III Disclosure Report on capital adequacy and risk management, which is available in English on the company’s website.

Leverage ratio and liquidity coverage ratio

The leverage ratio of MuniFin at the end of the year was 4.06% (2017: 3.84%), calculated using currently valid calculation principles. According to the draft legislation, the minimum leverage ratio is 3%. A proposal concerning the leverage ratio is currently under consideration at the EU level and the leverage ratio with its calculation principles is expected to come into effect no earlier than in 2021.

At the end of the year, the liquidity coverage ratio (LCR) was 177% (2017: 173%). As from the beginning of 2018, LCR must be at least 100%.

MuniFin is also preparing for the Net Stable Funding Ratio (NSFR), which is being made ready at EU level and will, according to the current estimate, not take effect until sometime in 2021.

Liabilities under the Act on the Resolution of Credit Institutions and Investment Firms

MuniFin’s crisis resolution authority is the EU’s Single Resolution Board (SRB). The Single Resolution Board decided against setting a minimum requirement for own funds and eligible liabilities (MREL) for the company in year 2018.

Risk management

MuniFin’s operations require sufficient risk management mechanisms to ensure that the company’s risk position remains within the limits confirmed by the Board of Directors. MuniFin applies very conservative principles in its risk management. The aim is to keep the overall risk status at such a low level that the company’s strong credit rating is not compromised.

The significant risks associated with the Group’s operations are credit and counterparty risk, market risk and liquidity risk. All operations also involve strategic risks and operational risks, including compliance risk.

The Group’s risks are described in greater detail in Note 2 to the consolidated Financial Statements. In addition to the Report of the Board of Directors and the Financial Statements, MuniFin publishes a separate Pillar III Disclosure Report on capital adequacy and risk management, which is available in English on the company’s website.

Group’s risk position

There were no material changes in the company’s risk appetite in 2018. The company’s Board of Directors assures that the risk management arrangements in place are adequate with respect to the Group’s risk profile and strategy. Risks remained within the set limits during the financial year and, according to the company’s assessment, risk management met the requirements set for it. The IFRS 9 standard adopted at the beginning of 2018 has increased volatility of the financial results through unrealised fair value changes of financial instruments. In the adoption, MuniFin reclassified financial assets and liabilities, and the profit and loss volatility of financial liabilities in particular has grown. The company continuously monitors and analyses the volatility arising from valuations and prepares for any impacts it may have on profit and capital adequacy.

Credit risks comprise a key aspect of MuniFin’s business. Due to the nature of the risks, it is impossible to entirely eliminate them from operations. MuniFin’s credit risks primarily emerge from customer financing and the receivables of the liquidity portfolio and the derivatives portfolio. Derivatives are only used for hedging against market risks. MuniFin calculates expected credit losses in accordance with IFRS 9. On the transition date, 1 January 2018, a provision for expected credit losses of EUR -0.9 million was recorded in equity. The amount of expected credit losses declined during the year and a EUR 0.6 million change in credit losses on financial assets was recognised through profit or loss at the end of the financial year. MuniFin’s credit risk position remained stable during the year, with a low risk level.

Market risks comprise IRRBB, FX exchange, share price and other price risks. MuniFin manages the interest rate risk arising from business operations by means of derivatives. Interest rate risk mainly arises from the differences in the Euribor interest rates applicable to the receivables and liabilities in the balance sheet. Interest rate risk is actively monitored and hedged.  The company hedges against exchange rate risks by using derivative contracts to swap all foreign currency denominated funding and investments into euros. The company is not in practice exposed to FX risk in its operations. However, a small temporary FX risk may arise due to collateral management in the clearing of derivatives by central counterparties. FX risk is actively monitored and hedged. Derivatives are also used to hedge against other market risks. Derivative contracts may only be concluded for hedging purposes as MuniFin does not have a trading book. The Group’s market risk has remained stable, even though the profit and loss volatility of unrealised valuations of financial instruments has increased during the financial year due to the adoption of IFRS 9.

MuniFin manages the refinancing risk by limiting the average maturity between financial assets and liabilities. In addition, the company manages the liquidity risk by setting a limit for the minimum adequacy of the available short- and long-term liquidity.  At the end of 2018, the company had EUR 8,688 million (2017: EUR 9,313 million) in assets for managing liquidity that, irrespective of their contractual maturity dates, can be sold in order to manage liquidity. MuniFin’s liquidity is good and the availability of financing has remained solid during the financial year.

Operational risks are estimated to be at a moderate level. No material losses were incurred as a result of operational risks in 2018.

Governance

In addition to corporate legislation, MuniFin complies with the governance requirements of the Finnish Act on Credit Institutions. The company’s governance policy is described in more detail on the company’s website. Upon the publication of the Annual Report, MuniFin publishes a Corporate Governance Statement on its website, pursuant to Chapter 7, Section 7 of the Finnish Securities Market Act. The statement is separate from the Report of the Board of Directors and includes a description of the main features of the internal audit and risk management systems pertaining to the financial reporting process. The statement also includes the governance descriptions required by the Act on Credit Institutions and information on how the company complies with the Finnish Corporate Governance Code for listed companies published by the Finnish Securities Market Association. Since MuniFin is exclusively an issuer of listed bonds, and since its shares are not subject to public trading, it is not appropriate to directly apply this Code with respect to MuniFin. However, the company has used the Corporate Governance Code as the basis for preparing its own internal Corporate Governance Policy.

Annual General Meeting

The Annual General Meeting (AGM) of MuniFin was held on 28 March 2018. The AGM confirmed the Financial Statements for 2017 and discharged the members of the Board of Directors and the President and CEO from liability for the financial year 2017. In addition, in accordance with the proposal of the Board of Directors, the AGM decided that a dividend of EUR 0.16 per share will be paid, amounting to a total of EUR 6,250,207.68, and the remaining part of distributable funds (EUR 89,206,444.47) will be retained in equity.

Based on the proposal of the Shareholders’ Nomination Committee, the AGM appointed the Board of Directors for the 2018–2019 term of office (from the 2018 AGM to the end of the 2019 AGM). The AGM also adopted the proposal of the Shareholders’ Nomination Committee on the remuneration of Board members.

The meeting also elected KPMG Oy Ab as the auditor of the company, with Marcus Tötterman, APA, as the principal auditor. Marcus Tötterman was also the principal auditor in the previous financial year.

Board of Directors

At the AGM of 28 March 2018, the Shareholders’ Nomination Committee made a proposal to the meeting regarding the Board members to be elected for the term that began at the end of the 2018 AGM and concludes at the end of the following AGM. The AGM elected the following members to the Board of Directors: Helena Walldén (Chair of the Board), Tuula Saxholm (Vice Chair of the Board), Fredrik Forssell, Minna Helppi, Markku Koponen, Jari Koskinen, Kari Laukkanen and Vivi Marttila.

In order to organise its work as efficiently as possible, the Board of MuniFin has established Audit, Risk and Remuneration Committees for the assistance and preparation of matters.

The members of the Audit Committee are Markku Koponen (Chair of the Committee), Kari Laukkanen, and Vivi Marttila. The members of the Risk Committee are Fredrik Forssell (Chair of the Committee), Minna Helppi, and Kari Laukkanen. The members of the Remuneration Committee are Helena Walldén (Chair of the Committee), Tuula Saxholm, Markku Koponen, and Jari Koskinen.

From the 2017 AGM to the 2018 AGM, the members of the Board of Directors were: Helena Walldén (Chair of the Board), Tapani Hellstén (Vice Chair of the Board), Fredrik Forssell, Minna Helppi, Teppo Koivisto, Jari Koskinen, Vivi Marttila, and Tuula Saxholm.

The operations of the Board of Directors and its committees are described in more detail on the company’s website.

Personnel

At the end of December 2018, Municipality Finance Group had 151 employees (2017: 134), of whom 141 were staff of the parent company (2017: 119). The significant increase in the number of employees is due to changes in the operating environment and customer needs, as well as the need created by banking regulations to develop the company’s governance, risk management and processes. New employees have been hired for almost all of the company’s functions, including customer service, business development, administrative services, IT, finance and risk management. Wages and salaries paid to the personnel totalled EUR 12.5 million in the Group (2017: EUR 11.0 million).

The President and CEO of MuniFin is Esa Kallio. He was appointed CEO on 28 February 2018.  Before he served as interim CEO since 22 August 2017. Mari Tyster, Executive Vice President, has served as deputy to the CEO as from 1 March 2018. In addition, the Executive Management Team of MuniFin includes Executive Vice Presidents Toni Heikkilä, Jukka Helminen, Rainer Holm, Joakim Holmström, and Marjo Tomminen.

Salaries and remuneration

The remuneration paid to the management and employees of MuniFin consists of fixed remuneration (base salary and fringe benefits) and a variable element based on the conditions of the remuneration scheme. The principles for the remuneration scheme are confirmed by the Board of Directors, and they are reviewed on an annual basis. The Remuneration Committee advises the Board of Directors on remuneration-related matters. For more information on salaries and remuneration, please refer to Note 31 Salaries and Remuneration, and to the Remuneration Report for 2018, which is published as a separate document from the Report of the Board of Directors and the Financial Statements, and is available on the company’s website.

Internal audit

Internal audit is tasked with monitoring the reliability and accuracy of MuniFin’s financial and other management information. Other tasks include ensuring that the company has sufficient and appropriately organised manual and IT systems for its operations, and that the risks associated with the operations are adequately managed.

The internal audit function has been outsourced to Deloitte Ltd, which reported directly to the Board of Directors and its Audit Committee. In the 2018 financial year, the company’s Board of Directors decided that the auditing function will be handled internally instead of by an external third party. At the beginning of September 2018, MuniFin appointed a Senior Vice President responsible for the internal auditing function, who reports directly to the Audit Committee and Board of Directors.

Share capital and shareholders

At the end of the 2018 financial year, MuniFin had paid share capital registered in the Trade Register to the amount of EUR 43,008,044.20 million, and the number of shares was 39,063,798. The company has two series of shares (A and B), with equal voting and dividend rights. Each share confers one vote at the Annual General Meeting.

At the end of 2018, MuniFin had 278 shareholders (31 December 2017: 278).

10 LARGEST SHAREHOLDERS 31 DEC 2018No. of sharesPer cent
1. Keva11,975,55030.66 %
2. Republic of Finland6,250,00016.00 %
3. City of Helsinki4,066,52510.41 %
4. City of Espoo1,547,8843.96 %
5. VAV Asunnot Oy (City of Vantaa)963,0482,47%
6. City of Tampere919,0272.35 %
7. City of Oulu903,1252.31 %
8. City of Turku615,6811.58 %
9. City of Kuopio592,0281.52 %
10. City of Lahti537,9261.38 %
The amounts of shares presented in the above table do not include any shares owned by the Group companies of the listed shareholders.

According to the company, there has been no material changes in the shares owned by the largest shareholders.

Events after the reporting period

The Board of the company is not aware of any events having taken place after the end of the reporting period that would have a material effect on the company’s financial situation.

Outlook for 2019

Developments in the global economy and capital markets seem fairly stable, but the financial markets are filled with uncertainties. The international financial markets are characterised particularly by the slowdown in the global economy, the financial system-level risks related to Italy’s debt situation and the hard-to-predict impacts of the UK’s potential exit from the EU. The company is prepared for Brexit, and it is not expected to result in material changes in the company’s operations.

From the perspective of Finnish local government finances, the outlook for 2019 is still stable. The regional government, health and social services reform is still under preparation; evaluating its overall effects on MuniFin’s customer base and the company’s own operations is challenging. The reform is not currently expected to have a fundamental impact on MuniFin’s operating volumes in 2019.

In 2019, MuniFin will continue to put major effort into developing the service offering and systems in order to further enhance its efficiency and operations, as well as on the digitisation of services. MuniFin expects that expenses will be higher than in 2018 due to personnel increases, the development of IT systems and higher fees collected by authorities. Considering the above-mentioned outlook in the operational environment and assuming that there are no major changes in the development of interest rates and credit risk premiums when compared to market expectations, MuniFin expects its net operating profit without unrealised fair value changes to remain in the same level than in 2018 or decrease. The developments in financial markets and the IFRS 9 standard adopted at the beginning of 2018 might increase the volatility of financial results through the unrealised fair value changes of financial instruments.

The estimates presented herein are based on current views on the development of the operating environment and operations.

Proposal from the Board of Directors concerning profit for the financial year 2018

Municipality Finance Plc has distributable funds of EUR 133,868,022.38, of which the profit for the financial year totalled EUR 21,831,739.09.

The Board of Directors proposes to the Annual General Meeting that

  • EUR 0.16 per share be paid in dividends, totalling
    EUR 6,250,207.68, and that
  • the distributable funds of EUR 127,617,814.70 be
    retained in equity.

The result for the financial year is good, and the Board of Directors considers the payment of a moderate dividend to be a strongly grounded decision. In recent years, the company has been preparing for the anticipated banking regulation’s capital requirements, in particular leverage ratio’s entry into force. Own funds have been strengthened with retained earnings and the issue of an AT1 loan. At the end of 2018, the company’s leverage ratio was 4.06%. The effective date for the leverage ratio requirement has not yet been finalised, but the company currently fulfils the anticipated leverage ratio requirement of 3%. The Board of Directors estimates that the moderate distribution of dividends will not place the fulfilment of the capital requirements or the company’s liquidity in jeopardy. MuniFin clearly fulfils all the prudential requirements set for it. 

Dividends will be paid to shareholders who are recorded in the company’s list of shareholders on 4 April 2019. The Board of Directors proposes that the dividends be paid on 9 April 2019.

No events have taken place since the end of the financial year that would have a material effect on the company’s financial position. The company’s liquidity is solid and, in the Board’s opinion, the proposed distribution of profits does not put the company’s liquidity in jeopardy.

THE GROUP'S DEVELOPMENT31 Dec 201831 Dec 201731 Dec 201631 Dec 201531 Dec 2014
Turnover (EUR million)*714204.1183.7204.1222
Net interest income (EUR million)236.3228.5206.1172.2160
% of turnover33.1112112.284.472.1
Net operating profit (EUR million)190198.4174.2151.8144.2
% of turnover26.697.294.874.464.9
Cost-to-income ratio0.210.180.170.160.15
Lending portfolio (EUR million)22,35421,21920,91020,08819,205
Total funding acquired (EUR million)30,85630,15328,66228,41926,616
Total balance sheet (EUR million)35,67734,73834,05233,88930,009
Return on Equity (ROE), %10.7612.5712.5114.8421.66
Return on Assets, (ROA), %0.430.460.410.380.41
Equity ratio, %4.173.863.483.081.98
CET1 capital (EUR million)1,065946777686556
Tier 1 capital (EUR million)1,4131,2931,1241,034557
Total own funds (EUR million)1,4131,2931,1241,069623
CET1 capital ratio, %66.3453.0146.2141.4929.94
Tier 1 capital ratio, %87.9772.566.8962.4929.98
Total capital ratio, %87.9772.566.8964.6133.53
Leverage ratio, % 4.063.843.543.151.8
Personnel1511341069590
*) Based on IFRS 9 standard, effective from 1 January 2018, the amount of derivatives that are measured at fair value through profit or loss have increased and are presented in gross figures in interest income and expenses. This has increased the turnover as interest income increased. The company has applied the IFRS 9 option not to restate prior periods. More detailed information on the distribution of interest income and expenses can be found in consolidated Financial Statement Note 32.
OTHER ALTERNATIVE PERFORMANCE MEASURES31 Dec 201831 Dec 2017
Net interest income including interest expenses on AT1 capital loan (EUR million)220.1212.3
Expenses (EUR million)49.142.9
Income (EUR million)238.5241.3
Unrealised fair value changes (EUR million)0.411
Cost-to-income ratio without unrealised fair value changes0.210.19
Net operating profit without unrealised fair value changes (EUR million)189.6187.4
Return on Equity (ROE) at fair value, %14.7913.32

Calculation of Key Figures

Turnover

Interest and similar income + commission income + net income from securities and foreign exchange transactions + net income on financial assets at fair value through fair value reserve + net income from hedge accounting + other operating income

Net interest income including interest expenses on AT1 capital loan

Interest and similar income – interest and similar expenses – AT1 capital loan interest in the parent company

Cost-to-income ratio

Commission expenses + administrative expenses + depreciation + other operating expenses /
Net interest income + commission income + net income from securities and foreign exchange transactions + net income on financial assets at fair value through fair value reserve + net income from hedge accounting + other operating income

Unrealised fair value changes

Net income from securities and foreign exchange transactions, unrealised fair value changes + net income from hedge accounting

Cost-to-income ratio without unrealised fair value changes

Commission expenses + administrative expenses + depreciation + other operating expenses /
Net interest income + commission income + net income from securities and foreign exchange transactions + net income on financial assets at fair value through fair value reserve + net income from hedge accounting + other operating income – unrealised fair value changes

* 100

Lending portfolio

Loans and advances to the public and public sector entities – lease receivables

Total funding acquired

Liabilities to credit institutions + liabilities to the public and public sector entities + debt securities issued – CSA collateral (received)

Return on equity (ROE), %

Net operating profit – taxes /
Equity and non-controlling interest (average of beginning and end of financial year)

* 100

Return on Equity (ROE) at fair value, %

Total comprehensive income for the period /
Equity and non-controlling interest (average of beginning and end of financial year)

* 100

Return on Assets (ROA), %

Net operating profit – taxes /
Average balance sheet total (average of beginning and end of financial year)

* 100

Equity ratio, %

Equity and non-controlling interest /
Balance sheet total

* 100

Common Equity Tier 1 (CET1) capital ratio, %

Common Equity Tier 1 (CET1) capital /
Risk exposure amount

* 100

Tier 1 (T1) capital ratio, %

Tier 1 capital /
Risk exposure amount

* 100

Total capital ratio, %

Total own funds /
Risk exposure amount

* 100

Leverage ratio, %

Tier 1 capital /
Total exposure

* 100

Liquidity coverage ratio (LCR), %

Liquid assets /
Liquidity outflows – liquidity inflows in a stress situation

* 100

Alternative Performance Measures

The alternative performance measures required by the European Securities and Markets Authority (ESMA) are presented to illustrate the financial performance of business operations and to improve comparability between reporting periods.

(EUR million)1 Jan–31 Dec 20181 Jan–31 Dec 2017
Interest and similar income (incl. lease assets)711.7191.4
Commission income2.43.2
Net income from securities and foreign exchange transactions-27.96.2
Net income from available-for-sale financial assets-0.5
Net income on financial assets at fair value through fair value reserve 0-
Net income from hedge accounting27.62.7
Other operating income0.10.1
Turnover714204.1
Interest and similar income (incl. lease assets)711.7191.4
Interest and similar expenses-475.437.2
AT1 capital loan interest in the parent company-16.2-16.2
Net interest income with interest expenses on AT1 capital loan220.1212.3
Commission expenses4.24.1
Administrative expenses27.222.3
Depreciation and impairment on tangible and intangible assets2.32
Other operating expenses15.414.5
Costs49.142.9
Net interest income236.3228.5
Commission income2.43.2
Net income from securities and foreign exchange transactions-27.96.2
Net income from available-for-sale financial assets-0.5
Net income on financial assets at fair value through fair value reserve 0-
Net income from hedge accounting27.62.7
Other operating income0.10.1
Income238.5241.3
Net income from securities and foreign exchange transactions, unrealised fair value changes-27.38.3
Net income from hedge accounting27.62.7
Unrealised fair value changes0.411
Costs49.142.9
Income238.5241.3
Cost-to-income ratio0.210.18
Costs49.142.9
Income238.5241.3
Net income from securities and foreign exchange transactions, unrealised fair value changes-27.38.3
Net income from hedge accounting27.62.7
Income without unrealised fair value changes238.1230.3
Cost-to-income ratio without unrealised fair value changes0.210.19
Net operating profit190198.4
Net income from securities and foreign exchange transactions, unrealised fair value changes-27.38.3
Net income from hedge accounting27.62.7
Net operating profit without unrealised fair value changes189.6187.4
Liabilities to credit institutions823802
Liabilities to the public and public sector entities3,8713,747
Debt securities issued26,90226,304
Total31,59530,853
- CSA-collateral (received)-739-700
Total funding acquired30,85630,153
Net operating profit190198.4
Taxes-38-39.7
Equity and non-controlling interest (average of beginning and end of financial year)1,412.701,261.90
Return on Equity (ROE), %10.76 %12.57 %
Total comprehensive income for the period209168.1
Equity and non-controlling interest (average of beginning and end of financial year)1,412.701,261.90
Return on Equity (ROE) at fair value, %14.79 %13.32 %
Net operating profit190198.4
Taxes-38-39.7
Average balance sheet total (average of beginning and end of financial year)35,207.4034,395.20
Return on Assets (ROA), %0.43 %0.46 %
Equity1,486.101,339.40
Non-controlling interest--
Balance sheet total35,676.7034,738.10
Equity ratio, %4.17 %3.86 %
Common Equity Tier 1 (CET1) capital1,065.50945.5
Risk exposure amount1,606.201,783.50
Common Equity Tier 1 (CET1) capital ratio, %66.34 %53.01 %
Tier 1 (T1) capital1,412.901,293.00
Risk exposure amount1,606.201,783.50
Tier 1 capital ratio, %87.97 %72.50 %
Total own funds1,412.901,293.00
Risk exposure amount1,606.201,783.50
Total capital ratio, %87.97 %72.50 %
Tier 1 capital1,412.901,293.00
Total exposure34,832.4033,669.40
Leverage ratio, %4.06 %3.84 %