1.1 GENERAL INFORMATION
Sparebanken Møre, which is the Parent company of the Group, is a savings bank registered in Norway. The bank’s Equity Certificates (ECs) are listed on the Oslo Stock Exchange.

The Group consists of Sparebanken Møre (the Parent Bank) and its subsidiaries Møre Boligkreditt AS, Møre Eiendomsmegling AS and Sparebankeiendom AS.

The Sparebanken Møre Group provides banking services for retail and corporate customers and real estate brokerage through a large network of branches within Møre og Romsdal, this region being defined as the bank’s geographic home market.

The company’s Head Office is located at Keiser Wilhelmsgt. 29/33, P.O.Box 121 Sentrum, 6001 Ålesund, Norway.

The preliminary annual accounts were approved for publication by the Board of Directors on 23 January 2019. The final annual accounts were presented by the Board of Directors on 20 February 2019.

The Group’s operations are described in note 17.

1.2 ACCOUNTING PRINCIPLES
The Group’s annual accounts have been prepared in accordance with the International Financial Reporting Standards (IFRS), which have been stipulated by the International Accounting Standards Board, and implemented by the EU as at 31 December 2018.  

How to read the Group`s accounting principles:
Sparebanken Møre describes the accounting principles in conjunction with each note. See the table below for an overview the various principles and the notes in which they are described, as well as reference to relevant and important IFRS standards.

Consolidation principles
The consolidated financial statements comprise Sparebanken Møre and all companies in which Sparebanken Møre has control through ownership. An entity is controlled when the owner is exposed to or has rights to returns from the entity and has the opportunity to influence these returns through its influence over the entity. This applies to subsidiaries mentioned in note 16.   

Companies which are bought or sold during the year are included in the Group accounts from the time at which control is obtained and until control ceases.

The Group accounts are prepared as if the Group is one financial unit.

All transactions between companies in the Group, have been eliminated in the consolidated financial statements. Uniform accounting principles have been applied for all companies in the Group. In the Parent Bank’s accounts, investments in subsidiaries are valued at cost. The acquisition method is applied when recognising acquired units/entities. The acquisition cost relating to an acquisition is assessed as the fair value of the items involved, such as assets, equity instruments issued and liabilities taken over. Identifiable assets bought, liabilities taken over and debt obligations are assessed at fair value at the time of the acquisition. Any acquisition cost in excess of fair value of the Group’s equity stake of identifiable net assets is, according to IFRS 3, incorporated as goodwill. Transaction costs related to acquisitions are recognised in the income statement as incurred.   

Temporary acquired shares in connection with securing commitments are not consolidated, but are treated as equity investment valued at fair value.

Changes in accounting principles and presentation (classifications)
There are no material changes in accounting policies for 2018.    

New or amended standards
The Group has  implemented  one new  standard in 2018, IFRS 9 Financial instruments, replacing IAS 39 from 1 January 2018. See following notes for additional information:    

• Changes in equity: implementation effect on equity by transition to IFRS 9

• Note 6 Losses on loans and guarantees: information and specifications related to the effect of the implementation on expected credit losses

• Note 13 Classification of financial instruments: the effect on classification and assessment
  
  
• Note 10.3 Financial derivatives: changed principles for hedge accounting

The implementation of IFRS 9 had no impact on primary capital of the Group or the Parent Bank, as expected losses according to the capital adequacy requirements already exceeded losses according to IFRS 9. Sparebanken Møre therefore had no need to apply the transitional rule.

In addition, IFRS 15 was implemented in 2018, but this standard has not resulted in changes in the Group’s recognition of income.

Future standards
Standards and interpretations which are issued up to the date of issuance of the consolidated financial statements, but not yet effective, are disclosed below. The Group’s intention is to adopt the relevant new and amended standards and interpretations when they become effective, provided that the EU approves the changes prior to issuing the consolidated financial statements.

The following new standard with future effective date will not have  significant relevance for the Sparebanken Møre Group:

• IFRS 16 Leases

This standard replaces existing standard, IAS 17 Leases. IFRS 16 sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract, ie the customer (“lessee”) and the supplier (“lessor”). The new leases standard requires lessees to recognise assets and liabilities for most leases, which is a significant change from current requirements. Accounting requirements for lessor is unchanged. The new standard is effective for fiscal years beginning 1 January 2019 or later. Early adoption is permitted. Sparebanken Møre has not used the possibility of early adoption.  The new standard will affect the Group's  accounting for lease of property This will affect the Group’s balance sheet by the implementation on 1 January 2019, by recognizing assets related to rights of use with NOK 90 million and corresponding liabilities related to lease obligations are recognised at NOK 90 million. For the Parent Bank, the corresponding figures will be NOK 202 million. The implementation will not have any impact on the Group’s equity. Annual depreciation and interest cost according to IFRS 16 will not materially deviate from the current rental cost in accordance with IAS 17.

Annual improvements
Minor changes have been made in a number of standards during IASB`s annual improvement projects. None of these changes are considered to have significant impact on the financial position or performance of the Sparebanken Møre Group.

1.3 FOREIGN EXCHANGE
The Group presents its accounts in Norwegian kroner (NOK). The functional currency for the Parent Bank and its subsidiaries is NOK. All monetary items in foreign currencies have been recalculated into the bank’s functional currency (NOK) according to foreign exchange rates provided by Norges Bank as at 31.12.2018.

Current income and costs have been translated into NOK at the foreign exchange rates ruling at the time of the transactions, and the effects of changes in foreign exchange rates have been included in the income statement on an ongoing basis during the accounting period.

1.4 JUDGMENTS IN APPLYING ACCOUNTING PRINCIPLES
Financial assets and liabilities are allocated to the different categories in IFRS 9, which subsequently determine the measurement in the statement of financial position. The bank has clear procedures for the categorisation, and the process normally requires only limited use of judgment.

1.5 USE OF ESTIMATES AND JUDGMENT IN THE PREPARATION OF THE ANNUAL FINANCIAL STATEMENTS
Preparation of the annual accounts in accordance with certain IFRS accounting standards means that in certain cases management has to use best estimates and assumptions. The assessments are based on historical experience and assumptions deemed to be reasonable and sensible by management. The estimates and assumptions on which the abovementioned preparation is based, affect the reported amounts of assets, liabilities and off-balance sheet items, as well as income and costs in the submitted annual accounts. There is a risk that actual results may later, to a certain extent, deviate from the estimates and assumptions on which the abovementioned preparation is based.

Certain accounting principles are regarded as particularly important in order to illustrate the Group’s financial position, due to the fact that management is required to make difficult or subjective assessments, applying estimates which mainly relate to matters which are initially uncertain.

The executive management team makes assessments when choosing and applying accounting policies. The company's financial assets and liabilities are allocated to different categories in accordance with IFRS 9. Little discretionary judgment is normally exercised in this context. Please refer to note 13 for the measurement policies.

In the opinion of the management, the most important areas which involve critical estimates and assumptions are as follows:

Impairment on loans and guarantees   
Measurement of ECL (Expected Credit Loss) according to IFRS 9 requires an assessment when it comes to significant increase in credit risk and determining the level of impairment, particularly with regard to estimates of amounts and timing of future cash flows and colleteral. These estimates are driven by a number of  factors, where changes can result in different levels of provisions.

Sparebanken Møre has developed an ECL-model based on IRB parameters in the Group.. ECL-calculations are output from complex models with several underlying  prerequisites related to the choice  of variable inputs and the dependency ratio.

Elements of  the ECL-model containing assessments and estimates include:

• The internal credit model, which specifies PDs (PD = Probability of Default)
  
  
• The crieria assessing whether there’s been a significant increase in credit risk, so that lifetime ECL (ECL = Expected Credit Loss) is calculated
  
  
• The development of the ECL-model, including variours formulas and choice of inputs
  
  
• Choice of connection between macroeconomic scenarios and economic inputs, such as unemployment level and value of collateral, and the effect on PD, EAD (Exposure at Default) and LGD (Loss Given Default)
  
  
• Choice of future-oriented macroeconomic scenarios and weighting of probability

Fair value of financial instruments – including derivatives
For financial instruments which are not traded in active markets, various evaluation methods are applied in order to ascertain fair value. Further information and a description of the techniques used may be found in note 15. Reference is also made to notes 9-14, dealing with financial instruments.

Pension liabilities
The present value of pension liabilities depends on several factors that are determined using a number of actuarial assumptions. Any change in these assumptions would affect the amount of the pension liabilities shown in the balance sheet. The rate of interest to be applied when discounting is decided at the end of the year. This is the rate of interest which is applied in order to calculate the present value of future necessary payments to cover the pension liabilities. The discount rate is based on the Norwegian market for covered bonds, and swap rates in the interbank market for the extrapolation of the curvature over 10 years, enabling us to arrive at an approximately similar maturity as that which applies to the pension liability. Other basic assumptions for the pension liabilities are partly based on actual market conditions. Mortality and death trend assumptions are based on standardized assumptions and other demographic factors. Please refer to note 22 for additional information.       

Strategy
Sparebanken Møre’s long-term strategic development and target achievement are supported by high quality risk- and capital management. The overall purpose of risk management and -control is to ensure that goals are achieved, to ensure effective operations and the handling of risks which can prevent the achievement of business related goals, to ensure internal and external reporting of high quality, and to make sure that the Group operates in accordance with relevant laws, rules, regulations and internal guidelines. Risk-taking is a fundamental aspect of banking operations, which is why risk management is a central area in the day-to-day operations and in the Board of Directors’ ongoing focus.

Sparebanken Møre’s Board of Directors has agreed overall guidelines for management and control throughout the Group. The Group shall have a low to moderate risk profile and revenue generation shall be a product of customer-related activities, not financial risk taking. In addition, the bank has introduced separate policies for each significant risk area: credit risk, counterpart risk, market risk, funding risk and operational risk. The risk strategies are agreed by the Board of Directors and revised at least once a year, or when special circumstances should warrant it. The Group has established a follow-up and control structure, which shall ensure that the overall framework of the strategic plan is adhered to at all times.

Corporate culture, organisation and responsibility
The risk management process is based on the bank’s and Group’s corporate culture. This includes management philosophy, management style and the people in the organisation. Staff’s integrity, value basis and ethical attitudes represent fundamental elements in a well-functioning corporate culture. Well-developed control and management measures cannot compensate for poor corporate culture. Against this background, Sparebanken Møre has established clear ethical guidelines and a clear value basis, which have been made well known throughout the organisation.

Sparebanken Møre attaches a great deal of importance to independence in the risk management. The responsibility for, and execution of risk management and control is therefore shared between the Board of Directors, management and operative units.

The Board of Directors of Sparebanken Møre bears the overall responsibility for ensuring the bank and the Group having adequate primary capital based on the desired levels of risk and the Group's activities, and for ensuring that Sparebanken Møre is adequately capitalized based on regulatory requirements. The Board shall also ensure that risk management and internal control is adequate and systematic, and that this is established in compliance with laws and regulations, articles of association, instructions, and external and internal guidelines. The Board also sets out the principles and guidelines for risk management and internal control for the various levels of activity, and regularly revises and adopts, at least once a year, various strategies and guidelines for risk management.

The Audit and Risk Committee is elected by and amongst the members of the Board of Directors. The committee is a sub-committee of the Board. Its purpose is to carry out more thorough assessments of designated areas and report the results to the Board. The Audit and Risk Committee shall ensure that the institution has independent and effective external and internal auditors, and satisfactory financial statement reporting and risk management routines, which comply with all pertinent laws and regulations.

The CEO is responsible for ensuring the establishment of appropriate risk management and internal control on the basis of assessments, agreed principles and guidelines introduced by the Board. The CEO is responsible for ensuring that good control environments are established in all levels of the bank and shall continuously monitor changes to the bank's risks and ensure that these are properly addressed in accordance with the Board's guidelines. The CEO shall ensure that the bank's risk management and internal control is documented according to current laws, rules, regulations and statutes, and shall, at least once a year, prepare an overall assessment of the risk situation, which shall be presented to the Board for their consideration.

The Risk Management Department is responsible for preparing and designing systems, guidelines and procedures for identifying, measuring, reporting and following up the bank’s most important inherent risks. The department is responsible for ensuring that the total risk exposure of Sparebanken Møre, including results of conducted stress tests, is reported to the CEO and the Board of Directors. Further, the department bears primary responsibility for the IRB process in the Group. It is also a key setter of conditions and adviser in the strategy process concerning risk assessments, risk tolerance and operationalisation of the bank's overall goals with regard to risks. The department also has responsibility for supervising the annual ICAAP work. The department forms part of the Risk management and Compliance, reporting directly to the CEO.

Pursuant to the requirements in the Financial Undertakings Act, Sparebanken Møre has an own compliance function. Each year, the Board of Directors of Sparebanken Møre approves compliance instructions, and an annual work- and action plan is prepared for the function. The department is responsible for coordinating annual internal control confirmations from the operational managers. The head of Compliance reports to Sparebanken Møre's CEO, but is organizationally subordinate to the EVP of the Risk management and Compliance Division.

Finance and Accounting is responsible for the Group's total financial management/reporting and accounting, and is part of the unit Finance and Facilities Management.

Sparebanken Møre`s operative managers of important business areas shall actively involve themselves in the process surrounding the assessment of whether or not the established risk management and internal control is being conducted as assumed. It is assumed that all managers at every level of the organisation are monitoring the approved control measures within their area of responsibility.

Sparebanken Møre`s Credit Committee deals with larger commitments and matters of a special nature, and shall provide an independent proposal to the person holding the power of attorney. The Credit Committee attaches special importance to the identification of risk in connection with each credit application, and makes its own assessment regarding credit risk. In addition, consideration is made whether commitments are in accordance with the Group’s credit risk strategy, credit policy, credit-granting rules and regulations, and credit handling routines.

The internal auditing is a monitoring function which, independent of the rest of the bank’s administration, deals with systematic risk assessments, control and examination of the Group’s internal control in order to ascertain whether it works according to its purpose and in a reassuring manner. The bank`s Board approves the resources and annual plans of the internal auditing. The internal auditor should also discuss the plan and scope of the audit work with the Audit and Risk Committee. The internal audit in Sparebanken Møre is outsourced to EY.

Reporting
Sparebanken Møre focuses on correct, complete and timely reporting of the risk and capital situation. Based on this, a number of different types of periodic reporting have been established, which are intended for the Group's management and Board, as well as reporting intended for the individual segments and departments, including customer account managers. The most important reports during the year are as follows:

ICAAP is carried out and reported at least once a year. The Board actively participates in the review and establishes ownership of the process, including through ICAAP's key role in the long-term strategic planning. Specific guidelines have been prepared for ICAAP in Sparebanken Møre. ICAAP is reviewed by the bank's management team, the Audit and Risk Committee and the Board of Directors.

A balanced scorecard report (BMS) is prepared every month. This illustrates the status and performance of the most important factors for Sparebanken Møre's target attainment. The report is being submitted to bank managers and the bank`s management team, and it is an integral part of the financial reporting to the Board of Directors.

A risk report is prepared every month. This is a key element of Sparebanken Møre's continuous monitoring of its risk situation. At the end of the quarter the risk report will also be expanded with supplementary comments from various disciplines within the Group. The report is dealt with by the bank`s management team, Audit and Risk Committee and Board of Directors.

Internal control reports are prepared annually. In this, an assessment is made of whether or not the internal control is adequate in relation to the risk tolerance. This includes an assessment of and comments on their own work on internal control, a review of all important risk areas, an assessment of their own compliance with external and internal regulations, and suggestions for and planned improvement measures. The internal control reports are dealt with by the bank`s management team, Audit and Risk Committee and the Board of Directors.

Compliance reports are prepared regularly and contain elements linked to an assessment of compliance risk and control, testing of compliance and the results of these tests, reassessments and plans for implementing guidelines, the follow-up of observations from external and internal auditors, the follow-up of observations from the FSA, deviation management in internal control, etc. The compliance reports are dealt with by the bank`s management team, Audit and Risk Committee and the Board of Directors.

Reports from external and internal auditors are dealt with by the bank`s management team, the Audit and Risk Committee and the Board of Directors. Both internal and external auditors have regular meetings with the Audit and Risk Committee.

Reports on mortgages are prepared quarterly for the bank`s Board of Directors.

A reporting portal has been established in Sparebanken Møre, in which each member of staff with customer responsibility has access to reports which show the position and development of credit risk in his or her portfolio. The portal has a hierarchical structure, allowing managers in Sparebanken Møre to monitor performance within their area of responsibility. The reports are also used to analyse customers, portfolios and different industries. The portal provides customer account managers with an overview of the customers' positions and limits in relation to exposure to financial instruments.

Finance and accounting reports are prepared monthly, and include monthly calculations of impairments. The reports are dealt with by the bank`s management team, Audit and Risk Committee and the Board of Directors.

Capital structure
Sparebanken Møre’s equity and related capital is composed with regard to several considerations. The most important considerations are the Group’s size, Møre og Romsdal’s internationally orientated industry and commerce, and a stable market for long-term funding whenever external funding is required. Furthermore, the Group’s long-term strategic plan is a significant provider of conditions with regard to which capital structure Sparebanken Møre should adopt.

Assessments of risk profile, capital requirements and profitability are always based on the Group's long-term strategic plan. The Group's capital requirements are calculated, at least, in the annual ICAAP. The Group's total capital shall comply with the Group`s accepted risk tolerance. The ICAAP clarifies all the alternatives the Group can implement if the Group's capital adequacy is subject to stress. The alternatives are listed in a prioritized order, with description of measures, and indication of planned implementation if necessary.

Sparebanken Møre's aim is to achieve financial results which provide a good and stable return on equity. The results shall ensure that all equity owners receive a competitive long-term return in the form of dividends and capital appreciation on the equity. The equity owners' share of the annual profits set aside as dividend funds, shall be adjusted to the equity situation. Sparebanken Møre's allocation of earnings shall ensure that all equity owners are guaranteed equal treatment.

Capital adequacy rules and regulations
The capital adequacy regulations aim to strengthen the stability in the financial system through more risk-sensitive capital requirements, better risk management and control, more stringent supervision and more information provided for the market.

The capital adequacy directive is based on three pillars:

• Pillar I – Minimum requirement for equity and related capital

• Pillar II – Assessment of aggregate capital requirements and regulatory follow-up (ICAAP)

• Pillar III – Publication of information

Sparebanken Møre`s capital adequacy is calculated according to the IRB Foundation Approach for credit risk. Calculations related to market risk are based on the Standard Approach and operational risk on the Basis Approach. Sparebanken Møre’s Board of Directors insists that the Group must be well capitalised, both during economic downturns and periods of strong economic expansion. Capital assessments (ICAAP) are conducted every year, and the Group’s capital strategy is based on the risk in the Group’s operations, different stress scenarios having been taken into consideration.

Reference is made to note 28 concerning "Capital adequacy" for further descriptions, as well as comments related to changes in the regulations.

Risk exposure and strategic risk management
Sparebanken Møre is exposed to several different types of risk. The most important risk groups are:  

• Credit risk: This is the Group’s biggest area of risk. Credit risk is defined as the risk of loss due to customers or other counterparties being unable to meet their obligations at the agreed time, and in accordance with written agreements, and due to the collateral security held not covering the outstanding claims. Counterparty risk and concentration risk are also included in this area of risk.

• Market risk: The risk of loss involving market values relating to portfolios of financial instruments as a result of fluctuations in share prices, foreign exchange rates and interest rates.

• Funding risk: The risk of the Group being unable to meet its obligations and/or fund increases in assets without incurring significant extra costs in the form of fall in prices of assets which have to be sold, or in the form of particularly expensive funding. The level of the institution`s capital is a key condition to attract necessary funding at any time.

Operational risk: The risk of loss due to insufficient or failing internal processes and systems, or due to human error or external events.

Sparebanken Møre tries to take account of the interaction between the various risk areas when setting desired levels of exposure. Overall it is the internal conditions, general conditions, customer base, etc. within the Group which form the basis for setting the desired overall risk exposure.

Based on an evaluation of the risk profile, management and control, Sparebanken Møre has set the following overall levels of risk exposure for the various risk areas:

  • Credit risk: A moderate to significant level of risk is accepted

  • Market risk: A low level of risk is accepted

  • Funding risk: A moderate level of risk is accepted

  • Operational risk: A low level of risk is accepted

The Group’s risk is quantified partly through calculations of expected loss and the requirement for capital in order to be able to cover unexpected losses. Expected losses and financial capital are calculated for all main groups of risks, and for different business areas within the Group. Expected loss describes the amount which in statistical context the bank must expect to lose during a 12-month period. Financial capital describes the amount of capital the Group deems to be required in order to cover the actual risk which has been incurred by the Group. Statistical methods for the computation of financial capital have been used as a basis. Please also refer to note 28 regarding capital adequacy for further comments concerning financial capital.

Credit risk
Credit risk represents Sparebanken Møre’s biggest risk area. Included in this risk area are counterparty risk and concentration risk. The Group is exposed to this type of risk through its lending products for the retail market and corporate customers, and through the activities of Sparebanken Møre's Treasury and Markets Division.

The credit risk strategy is revised and agreed each year by the Board of Directors. The strategy focuses on risk sensitive limits, which have been designed in such a way that they manage the Group’s risk profile within the credit area in the most appropriate and effective manner. Furthermore, limits, guidelines, and power of attorney-related rules and regulations have been established, which underpin and support Sparebanken Møre’s credit risk strategy and long-term strategic plan.

The core values of Sparebanken Møre are “Dedicated, Close and Solid”. These values are to be reflected in all contact with the market, create added value for the customers and help create a positive view of Sparebanken Møre. The credit policy is intended to promote a credit culture in which creditworthiness is viewed in a long-term perspective, where general and industry economic fluctuations are taken into account. Sparebanken Møre shall conduct itself in accordance with high ethical standards, and shall not be associated with activities, customers or industries of dubious repute. The Group is open to all types of customers within defined market areas, and discrimination based on the customer`s age, gender, nationality, religion or marital status shall not occur.

Sparebanken Møre's geographic core region is the county of Møre og Romsdal. However, it is allowed to financially support investments/businesses outside its core region when, from an ownership perspective, they are linked to individuals or companies in/from Møre og Romsdal. Commitments outside the Group's market area will also be considered as part of the deliberate diversification of the portfolio in terms of segment and geographical exposure. In such cases the Group's strategy sets clear limits for the maximum risk level for an individual commitment.

The Department for Risk Management has established monthly portfolio management reports which ensure that any discrepancies from the strategic targets incorporated in the credit risk strategy are identified. Officers responsible for the concepts relating to corporate and retail banking respectively, have independent responsibility for the ongoing monitoring of the position, in order to identify discrepancies in relation to the same strategic targets, and in order to implement measures in the case of any discrepancies having occurred.

The Board of Directors is responsible for the Group’s granting of loans and credits. Within certain limits, power of attorney is delegated to the bank’s CEO for the operational responsibility with regard to decisions in credit matters. Within his powers of attorney, the CEO may delegate powers of attorney to other officers in the bank. The grant authorisations are personal and graded after criteria like the size of grant, the limit of the commitment (corporate customers), the customers total debt (retail customers), and class of risk. Further, the power of attorney is related to the employee`s job level.

Sparebanken Møre actively uses internal reports in order to monitor the level and development of the Group’s credit portfolio. Each member of staff with customer responsibility has access to reports which show the position and development in the credit risk in his or her portfolio. The reports are prepared on a hierarchical basis, enabling the bank’s management to monitor the development within their own area of responsibility. The reports are also used to analyse customers, portfolios and different sectors.

The Group has prepared separate risk models for the corporate and retail markets, which are used in monthly measuring and reporting of credit risk. The Group has also developed application score models for the two customer segments, which are being used in the credit granting process.

There are mainly three central parameters within credit risk for which models are applied:

1. Probability of default (PD): PD is calculated per customer and states the probability of the customer defaulting on his or her outstanding commitment during the next 12 months. A separate PD is calculated for each customer, based on statistical models using variables of both external and bank-internal information, in the form of both financial key figures and non-financial criteria.

2. Degree of loss in the case of default (LGD): LGD indicates how big a part of the commitment is expected to be lost in the case of default. The assessments take into consideration the values of the collateral provided by the customer, and the costs which would be incurred in the case of the recovery/collection of commitments in default.

3. Expected exposure in the case of default (EAD): EAD indicates the level of exposure which is expected in connection with a commitment if and when it goes into default.

The abovementioned parameters form the basis for calculation of expected loss (EL), and are included in the computation of financial capital. By classifying customers according to probability of default, and by estimating the level of loss and the requirement for financial capital at customer level, the Group obtains information about the level and development of the aggregate credit risk in the total portfolio. In-house migration analyses show the development of the number of customers and EAD between different risk classes during different periods.

Treasury risk
Treasury risk is part of Sparebanken Møre's total credit risk. Board adopted limits for the Group's credit exposure in this area have been defined.

Credit exposure is linked to bonds and certificates in the Group's liquidity portfolio, short-term lending to other banks, including accounts held in foreign banks, and exposure in connection with financial derivatives which are signed to neutralise already present interest and currency risk which the bank has assumed. The portfolio consists of reputable domestic and foreign relationships. Credit quality is considered to be high, mainly due to investments in issuers with high ratings and low capital weight.

Sparebanken Møre's policy is that, especially in relation to placements in international banks and other debtors outside Norway, the Group shall use assessments carried out by the major official ratings agencies. The credit risk shall be at a minimum, but even highly rated issuers/papers can be exposed to risk. If a counterparty's status is changed to a negative outlook or their rating falls, Sparebanken Møre carries out a new internal assessment of existing lines of credit. If necessary the line of credit, and any exposure, is reduced or eliminated.

Treasury risk is also viewed in connection with the funding indicators LCR and NSFR. The LCR regulations entail a movement towards lower risk weighted counterparties, including state and state guaranteed papers and covered bonds.

The pre-classification process emphasises considering banks with which Sparebanken Møre has a mutual (reciprocity) and long business relationship. It is also necessary to have sufficient competition in products and instruments that are traded, as well as diversification in market and geography for Sparebanken Møre.

If changes occur in general conditions, the market, economic trends or Sparebanken Møre's activities which have a material effect on the Group's risk positions, limits must be assessed and possibly set for investment opportunities. This involves, for example, not investing in some countries, groups of countries, individual counterparties, counterparties with certain attributes, etc.

Sparebanken Møre and Møre Boligkreditt AS require the signing of CSA (Credit Support Annex) agreements before trading of derivatives against any counterparties. CSA agreements are part of an ISDA agreement and help to regulate the counterparty risk associated with changes in market conditions. This provides Sparebanken Møre with collateral for any given exposure. The agreements with counterparties define when the collateral shall be transferred between the parties. Sparebanken Møre practices cash collateral in relation to its counterparties. The market value of all derivatives signed between Sparebanken Møre and the counterparty is settled according to the different CSA-agreements and the counterparty risk will then largely be eliminated. EMIR - European Market Infrastructure Regulation –will ensure regulation and control of the market for derivatives traded outside regulated markets by requiring reporting of transactions to transaction records, and requirements for settlement (clearing) through central counterparties (CCPs).

Market risk
Sparebanken Møre’s market risk is managed through defined position limits for each risk area. Management of market risk is set out in Sparebanken Møre’s market risk strategy. The strategy is adopted by the Board of Directors, and provides the overall guidelines for the Group’s activities in the capital market, including the framework for Sparebanken Møre’s total exposures within currency, interest rate and shares.

The Group’s market risk can be divided into the following areas:

• Interest rate risk: Consists of market risk associated with positions in interest-bearing financial instruments, including derivatives with underlying interest instruments. Interest rate risk related to the liquidity portfolio, as well as hedging transactions related to it, are considered separately and will have its own set of risk parameters. See note 10.1 for the Group's interest rate risk.

• Equity risk: Consists of market risk on positions in equity instruments, including derivatives with underlying equity instruments. Shares in subsidiaries are not included. Sparebanken Møre has no trading portfolios. The financial risk of Sparebanken Møre is considered to be low. See note 13 for the equity risk of the Group.

• Currency risk: Consists of the risk of losses when exchange rates change. All financial instruments and other positions with currency risk are included in the assessment. Currency risk on the banking book, that is, foreign exchange risk arising as a result of hedging customer trading, including lending/deposit business, is considered separately and has its own set of risk parameters.

Sparebanken Møre`s exposure to currency risk is a result of mismatch between the underlying business and hedging transactions, as well as the necessary reserves of the Group's bank accounts in foreign banks. Changes in exchange prices in the market cause changes in the value of Sparebanken Møre`s currency position. The currency position also includes Sparebanken Møre`s cash holdings of notes denominated in foreign currencies. Sparebanken Møre has no trading portfolio of FX contracts. Sparebanken Møre`s currency risk is low and well within the limits specified in the regulations. See note 10.2 for the Group's currency risk.

• Spread risk: Defined as the risk of changes in market value of bonds and commitments as a result of general changes in credit spreads.

• Total market risk: The overall risk assessment is obtained by comparing the assessments of areas of interest rates, equities and foreign exchange. The FSA`s methodology in this area form the basis for assessing the overall market risk. Assessments are based on three risk factors:

• Exposure

• Risk spreading

• Market liquidity

Any diversification effects between asset classes are not taken into account.

Based on the recommendation from the CEO's Balance Board Committee, the Board of Directors annually approves a total limit for the market risk of Sparebanken Møre. The framework is adapted to the Group's activity level and risk tolerance. If required, the overall framework may be changed more frequently than the annual review.

Total limit for market risk is defined as the maximum loss on a stress scenario where the FSA`s methodology is applied. The approved overall market risk limit is delegated to the CEO, while the EVP of Treasury and Markets has administrative authority for the overall market risk limit. The EVP is responsible for administration of the limits within the various sub-portfolios being in compliance at all times.

Treasury and Markets has an independent responsibility for ongoing monitoring of positions within the various portfolios and daily follow up, or with the frequency required in relation to the level of activity. The Risk Management department has the primary responsibility for monitoring, reporting and control of the market risk area. Back Office is responsible for transaction control and processing of payment transactions.

SimCorp Dimension (SCD) is the principal risk management system in Sparebanken Møre within the market risk area. The system provides current status of market development. All financial instruments are recorded in the system and monitored continuously. The Risk Management department is responsible for good quality in valuation of financial instruments.

The Risk Management department monitors the compliance of the risk management framework and strategy continuously. If activities exceed limits or strategy, written reporting instructions are specified.

Reporting of the market activity is part of Sparebanken Møre`s periodic "Risk Report" to management, Audit and Risk Committee and Board of Directors. Monthly earnings performance reports are prepared, as well as actual risk exposure within each portfolio, both individually and in aggregate. The reports are compared to maximum activity frame and overall market risk limit (stress frame). The Board is also given a quarterly record of any violation of the framework, the strategy or laws and regulations.

There is no performance-based compensation to any person working in the market risk area beyond what is included in Sparebanken Møre`s general bonus scheme which deals with, and is equal to, all employees of the Group.

Funding risk
Liquidity may be defined as the Group’s ability to fund increases in assets and to meet its obligations as funding requirements occur. Sparebanken Møre is liquid when it is able to repay its debt as it falls due.

Management of the Group’s funding risk is based on the overall financing strategy, which is evaluated and approved by the Board of Directors at least once a year. The strategy reflects the moderate risk level accepted for this risk area.

The Group's funding risk requires special monitoring. This is due to the Group's special position as a manager of deposits for small and non-professional participants, as well as the central role the Group plays in payment systems. The banks’ duty to accept deposits from a non-specific base of depositors and the fact that these deposits are normally available on the same day, means that they face considerably greater risk than other financial institutions. The authorities' loan schemes and safety net for banks are based on these precise factors. The costs of reducing funding risk must be viewed in the context of the advantages lower funding risk provides. One fundamental prerequisite for maintaining the trust of depositors and other lenders is that the institutions always have sufficient liquidity to cover current liabilities.

LCR measures institutions' ability to survive a 30-day stress period. LCR increases the importance of high quality liquid assets. NSFR measures the longevity of an institution's funding. NSFR entails institutions having to fund illiquid assets with the aid of a greater proportion of stable and long-term funding. In this context, deposits are not regarded as an equally stable source of funding, which means that the quality of the deposits will increase in importance. This also means that financial institutions must, to a greater degree, fund themselves through bond issues with a higher maturity.

The Group also regularly reports on the trends for liquidity indicators to the supervisory authorities in line with the disclosure requirements.

The Group's long-term strategic plan, "Møre 2022", sets out a liquidity strategy protecting the structure and volume of the LCR requirement. The Authority's requirements amounts to 100 per cent.

At year-end 2018, the LCR indicator for the Group was 158 per cent and NSFR 108 per cent. In the composition of the external funding, priority is given to having a relatively high share of maturities above one year.

The funding section of Sparebanken Møre is organised within the Treasury and Markets Division. The division controls the funding on a day-to-day basis, and has the responsibility to meet the funding requirements in Sparebanken Møre, including utilization of the mortgage company Møre Boligkreditt AS. 

Liquidity control management is maintained by both the Treasury and Markets Division and by the Risk Management department. In this respect there is a distinction between the overall and the daily operational cash management and control. The daily operational management responsibility is handled by the Treasury and Markets Division, while the overall risk management, including strategies and framework controls, are handled by the Risk Management department.

Upon the occurrence of abnormal situations regarding liquidity, either in the market or within Sparebanken Møre, the bank's emergency task group comes together. The group consists of the following persons:

• CEO (leader)

• EVP Treasury and Markets

• EVP Information and Administration

• EVP Finance and Facilities Management

• EVP Risk Management and Compliance

• Head of Risk Management

• EVP Corporate Banking Divison

• EVP Retail Banking Division

• Managing director of Møre Boligkreditt AS

• Head of Treasury

The Board receives monthly reports on the liquidity situation. This report includes several key figures. In addition, early warning signals are reported by viewing the development of financial strength, balance sheet- and income statement-development, losses/defaults and the development of cost of funds.

The funding risk is attempted reduced by spreading funding on different markets, sources, instruments and maturities. In order to ensure the Group's funding risk is kept at a low level, lending to customers must primarily be financed by customer deposits and long-term securities issued. There is a major focus on efforts to increase ordinary deposits in all customer-related activities throughout the bank. The deposit to loan ratio in Sparebanken Møre was 57 per cent at year-end.

The Board shall be informed of the bank’s liquidity situation on a monthly basis, and immediately of any important events which may affect the bank’s current or future liquidity situation. The reporting tries to identify the funding situation during normal operations, identify any “early warning” signs and assess the bank’s stress capacity.

Møre Boligkreditt AS has a license from the FSA to operate as a mortgage company, and it provides the Group with increased diversification of its funding sources. The Parent Bank has throughout the year transferred parts of the mortgage portfolio to the mortgage company.

Operational risk
Operational risk includes all the potential sources of losses related to Sparebanken Møre's current operations. The Group has classified various types of operational risk into the following main categories:

• Internal fraud

• External fraud

• Employment conditions and safety at work

• Customers, products and business conduct

• Damage to assets

• Interruptions to operations and/or systems

• Settlements, delivery or other transaction processing

The Board of Directors of Sparebanken Møre has decided that a low risk profile is accepted related to operational risk. An overall strategy for this risk area is established, and there are several documents which support the Group’s risk management. These documents include the ICT-area, contingency plans for personnel and property, security handbooks, authorisation structures, ethical guidelines and insurance strategies.

For the Compliance Department, board adopted instructions, work plans and action plans have been established.

Operational responsibility for managing and controlling operational risk, and thus also the quality of Sparebanken Møre's operations, is borne by each manager involved. This responsibility follows from job descriptions and various guidelines and routines. All managers annually confirm to the CEO the quality of and compliance with internal controls within the risk areas stipulated in this document. They also suggest areas for improvement which are incorporated into special action plans. The CEO presents the report to the Audit and Risk Committee and the Board of Directors. The annual ICAAP also involves a review of the Group's material risk areas, including operational risk.

The Group’s established internal control routines are an important tool for reducing operational risk with regard to both identification and follow-up.

Internal Control
Internal control must be designed in order to provide reasonable certainty with regard to the achievement of goals and targets within the areas of strategic development, targeted and effective operations, reliable reporting and adherence to relevant laws, rules and regulations, including compliance with Group-internal guidelines and policies. Furthermore, a well-functioning internal control shall ensure that the bank’s risk exposure is kept within the agreed risk profile. 

The internal control in Sparebanken Møre is organised in a decentralized manner with Risk Management and Compliance as the coordinating unit and responsible for the annual reporting to the Audit and Risk Committee and the Board of Directors. The Compliance department monitors how the Group operationalises relevant laws, rules and regulations in operational context, and how the Group’s staff adhere to relevant rules and regulations, laws, licenses, agreements, standards for different industrial and commercial sectors, internal instructions etc. in the day-today operations. The Risk Management department is responsible for developing systems, guidelines and procedures in order to identify, measure, report and follow up on the Group’s most important inherent risks.

Reports on the Group’s operations and risk situations throughout the year are submitted to the Audit and Risk Committee and the Board of Directors on an ongoing basis. The bank’s CEO annually submits an overall assessment to the Board regarding the risk situation and whether the established internal control features function in a satisfactory manner. This report is based on confirmations received from managers at different levels throughout  Sparebanken Møre.

Sparebanken Møre’s Internal Auditor reports on a regularly basis to the Audit and Risk Committee and the Board of Directors on the Group’s internal control.

Discretionary Asset Management
The Group provides portfolio management for investment clients. The portfolio management is performed on behalf of clients, and related assets belong to the clients and not the Group. 

Financial derivatives
Sparebanken Møre utilizes financial derivatives in order to handle risk incurred as a result of the bank’s ordinary operations. In the case of customer transactions, these shall as a main principle immediately be covered by an opposite transaction in the market.

The following derivatives are in use in Sparebanken Møre:

• Forward exchange contracts
An agreement to buy or sell a certain amount in a foreign currency, against a certain amount in another currency, at a rate agreed in advance, with payment at a certain time later than two working days after the agreement was entered into.

• Swaps
A transaction in which two parties agree to swap cash flows for an agreed amount over a certain period of time. In an interest rate swap, only the interest involved is swapped. In the case of an interest rate and currency swap, both the interest rate and currency conditions are swapped.

• FRAs
A legally binding agreement concerning a rate of interest which shall apply for a future period for a defined principal amount. Upon settlement, only the difference between the agreed interest rate and the actual market interest rate is exchanged.

• Options
A right, but not an obligation, to buy (a call option) or sell (a put option) a certain product at a rate agreed in advance (strike price). When entering into an option contract, the person or company buying a call or put option will have to pay a premium to the person or company writing the option. Options can be offered on the basis of a financial instrument.

The risk relating to these financial instruments involves the credit risk of covering counterparts which are given prior credit clearance by the Board of Directors as well as operational risk.

These instruments are primarily utilized to provide the bank's customers with reliable cash flows and a desired risk position in the various markets. Limits for financial instruments involving customers are established by the staff responsible for the customers in question. The limits shall fix a maximum amount for the bank’s exposure against each individual customer in relation to the customer’s business volume in financial instruments and the market-related development in these. Each member of staff responsible for the customer in question, is responsible for the establishment of the limit and must make sure that such a limit has been subject to the necessary formal credit-handling procedures, and that a sufficient level of collateral and/or other security has been established to cover the limit. Furthermore, the member of staff responsible for the customer in question, together with the dealer involved, are both responsible for making sure that the credit risk as a result of the customer’s exposure to financial instruments is at all times within the limits which have been agreed. For all customers trading in financial instruments, a set-off agreement must be obtained. The purpose of this agreement is to reduce the bank’s credit exposure to the customer by having all contracts netted so that the bank ends up with just a net exposure towards the customer. It is the member of staff responsible for the customer in question who is responsible for establishing a set-off agreement with the customer, making sure that all customers using this type of financial instrument are made aware of the bank’s usual business terms and conditions.

The Department for Risk Management is responsible for follow-up and for all internal reporting and reporting to the relevant authorities relating to the bank’s exposure to different counterparts as a result of trading in financial instruments.  

Credit risk is the Group’s most significant area of risk and is defined as the risk of loss relating to customers or other counterparties being unable to meet their obligations at the agreed time and in accordance with written agreements, and when the collateral held does not cover the outstanding claim. The Group is exposed to this type of risk through its lending products for the retail market and corporate customers, and through the activities of the Group's Treasury & Markets Division. Note 2, concerning Risk Management, specifies the strategies for the credit risk in the Group, as well as processes for management and control of this area of risk. A central feature in this connection is the calculation of the probability of default for each individual customer and portfolio.

Credit risk also includes remaining risk and concentration risk. Remaining risk is the risk that the collateral of a commitment is less effective than expected. Concentration risk is risk associated with large commitments with the same customer, concentration within geographic areas, with similar industries or similar groups of customers.

Concentration risk is managed in relation to the relevant targets for sector-based percentages, the largest individual commitments and the aggregate target for large commitments. Periodic stress tests are carried out in order to assess the loss potential in the credit portfolio due to large, but not implausible, negative changes in operating conditions. Management and measurement of credit risk is further described in the report Risk and Capital Management (Pillar 3). Reference is also made to note 28 where credit risk for the Group is quantified through risk-adjusted capital. As described in note 2, the probabilities of default (PD) for the commitments contained in Sparebanken Møre’s credit portfolio are calculated. PD is calculated per customer and indicates the probability of a customer defaulting on his or her commitment within the next 12 months and is modeled to be in line with the Capital Requirements Directive’s specifications for fundamental IRB. Calculated expected loss (PD x LGD x EAD) is used as basis when assessing customer profitability and is taken into consideration when fixing interest rate terms and conditions.

Loans and receivables
All loans and receivables are valued in the balance sheet at fair value at first assessment, with the addition of directly attributable transaction costs for instruments which are not assessed at fair value with value changes recognised in the income statement. Fair value when first assessed is normally the same as the transaction price. When determining the loan’s value at the time of transaction (transaction price), establishment fees are deducted and subject to accrual accounting over the lifetime of the loan as part of the loan’s effective interest rate. Loans are subsequently assessed at amortised cost by applying the effective interest rate method. The effective rate of interest is the rate at the signing time which exactly discounts estimated, future cash flows over the loan’s expected lifetime, down to the net value of the loan as shown in the balance sheet. By conducting this calculation, all cash flows are estimated, and all contract-related terms and conditions relating to the loan are taken into consideration.

The classification of loans and receivables at amortised cost assumes that the following requirements are met:

• The asset is acquired to receive contractual cash flows
• The contractual cash flows consist solely of principal and interest

Collateral and other risk reducing measures
In addition to the assessment of debt servicing level, the Group accepts different kinds of collateral in order to reduce risk depending upon the market and type of transaction involved.

The main principle for value assessment of collateral is based on the realisation value of the asset in question, and what that value is deemed to be when the Bank needs the security. With the exception of commitments against which impairment has been made, the value of the collateral is calculated on the assumption of a going concern. When assessing the value of collateral, estimated sales costs are taken into consideration.

In the calculations of individual impairment on loans, the bank's valuation of the security objects is considered. Additional information is presented in note 6.

The main types of collateral used are: mortgage on property (residential and commercial), guarantees, surety, registered moveable property (chattels), charge on goods (stocks), operating equipment and licenses or set-off agreements. Guarantees represent a minor part of the bank’s risk exposure; guarantors relating to private persons (consumer guarantees), companies (professional), guarantee institutes and banks are accepted.

Collateral and other security is updated at least once every year or, in the case of the retail customers, when a new credit proposal is dealt with. In the case of corporate customers, the security involved is updated either when a new credit proposal is dealt with or when certain commitments are followed up. Value assessment is part of the credit decision.

When calculating capital requirement for credit risk, the bank does not apply set-off relating to exposure on, or off, the balance sheet.

Sparebanken Møre requires establishment of a CSA agreement before entering into derivatives trading with any interbank counterparty. This provides Sparebanken Møre with security for a given exposure. The agreement with the counterparty defines when the collateral is to be transferred between the parties. Sparebanken Møre practices cash collateral with their counterparties. The market value of all derivatives entered into between Sparebanken Møre and its counterparties are settled according to the actual CSA-agreement. Derivatives are presented gross in the balance sheet, either as asset or debt, depending on positive or negative value of the derivative, and net only when counterparty is the same and agreement with counterparty entitles set-off.          

In addition to an assessment of debt servicing level and future realisation value of collateral, the financial commitment terms (covenants) are included in most credit agreements for large corporate customers. These conditions are a supplement to reduce risks and to ensure proper monitoring and control of Commitments.  

Implementation effect of IFRS 9 as of 1 January 2018
IFRS 9 came into force on 1 January 2018, replacing the then current standard IAS 39. The impairment rules according to IFRS 9 are based on a model of expected credit losses (ECL). IFRS 9 applies to financial assets measured at amortised cost or at fair value with value changes recognised through other comprehensive income (OCI). In addition, also financial guarantee contracts are included. Losses shall be allocated to all commitments from day one.

The following table shows the effect of the implementation of IFRS 9. The table shows a reconciliation of the total impairments according to IAS 39 against the ECL-provision under IFRS 9:  

Methodology for measuring expected credit loss (ECL) according to IFRS 9
Sparebanken Møre has developed an ECL-model based on the IRB-parameters in the Group, dividing the commitments into three stages when calculating expected credit loss (ECL) on loans to customers and financial guarantees in accordance with IFRS 9: 

Stage 1: At initial recognition and if there’s no significant increase in credit risk, the commitment is classified in stage 1 with 12-months ECL.

Stage 2: If a significant increase in credit risk since initial recognition is identified, but without objective evidence of loss, the commitment is transferred to stage 2 with lifetime ECL measurement.

Stage 3: If the credit risk increases further and there’s objective evidence of loss, PD = 100 % and/or individual impairments have been made, the commitment is transferred to stage 3 with lifetime ECL measurement. As opposed to stage 1 and 2, the effective interest rate in stage 3 is calculated on net impaired commitments (total commitments less expected credit losses) instead of gross commitments. 

An increase in credit risk, reflects both customer-specific circumstances and development in relevant macro factors for the particular customer segment. The assessment of what is considered to be a significant increase in credit risk is based on a combination of quantitative and qualitative indicators, as well as “backstops” (see separate section regarding “backstops”).

The calculation of expected credit losses is based on the following principles:  

• The loss provision for commitments which are not credit-impaired is calculated as the present value of exposure at default (EAD) multiplied by the probability of default (PD) multiplied by loss given default (LGD). PD, LGD and EAD use the IRB framework as a starting point, but are converted into being point-in-time and forward-looking as opposed to through the cycle and conservative.

   

• Past, present and forward-looking information is used to estimate ECL. For this purpose, Sparebanken Møre’s loan portfolio is divided into 7 segments (retail portfolio and 6 industry spesific corporate portfolios). All customers within a segment are exposed to the same risk drivers

   

• For credit-impaired financial instruments in stage 3, individual assessments are performed.

The model used for calculating ECL follows four steps: Segmentation, determination of macro adjustments, staging/migration and calculation of ECL.

Segmentation and macro adjustments
The assessment of significant increase in credit risk and the calculation of ECL incorporates past, present and forward-looking information.  Segmentation of the portfolio is based on the customers’ fields of operation, and each segment is subject to separate macro adjustments. 

Theory of cyclical cycles has been used to model macro factors to estimate lifetime ECL in the model. A trend curve is prerequisite to show long-term GDP growth. Based on an assessment by the Chief Economist and the corporate unit managers in SBM, key indicators have been selected for the retail market and the various corporate sectors. Indicators issued by Statistics Norway (SSB) have been used to a large extent. Volatility in the indicators is taken into account when calculating the macro-factors. Standard deviations are calculated for each indicator, which entails that high/low volatility indicators will cause a higher/lower impact on the macro factor.

Important indicators for macro adjustment can be:
- Unemployment 
- Interest rate development 
- Debt burden 
- Housing price development

Calculation of expected credit loss
The determination of a significant increase in credit risk and the measurement of ECL are based on parameters already used in credit risk management and for capital adequacy calculations: PD, LGD and EAD. The parameters have been adjusted in order to give an unbiased estimate of ECL.

Probability of default (PD)
Sparebanken Møre applies several different models to determine a customer’s PD. The choice of model depends on whether it is a retail or corporate customer. PD models are key components both in calculating the ECL and in assessing whether a significant increase in credit risk has occurred since initial recognition. These models fulfil the IFRS 9 requirement to provide an unbiased probability-weighted estimate of ECL. Sparebanken Møre has been granted permission to use internal ratings based approach (IRB) models for determining PD in capital adequacy calculations. In order to apply these PDs for IFRS 9, modifications have been made to allow that the PDs used for IFRS 9 reflect management’s current view of expected cyclical changes and that all PD estimates are unbiased.

Loss given default (LGD)
LGD represents the percentage of EAD which the Group expects to lose if the customer fails to meet his obligations, taking the collateral provided by the customer, future cash flows and other relevant factors into consideration. 

Similar to PDs, Sparebanken Møre uses IRB LGDs for capital adequacy calculations. In order to convert the IRB LGDs to IFRS LGDs, modifications have been made to remove the margin of conservatism to produce unbiased projections rather than downturn projections as well as removing the effect of regulatory floors. 

These modifications imply that the LGDs used for IFRS 9 should reflect management’s current view and that all LGD estimates are unbiased.

Exposure at default (EAD)
EAD is the share of the approved credit that is expected to be drawn at the time of any future default. The EAD is adjusted to reflect contractual payments of principal and interest. The proportion of undrawn commitments expected to have been drawn at the time of default is reflected in the credit conversion factor.  

Significant increase in credit risk
The assessment of a significant increase in credit risk is based on a combination of quantitative and qualitative indicators and backstops. A significant increase in credit risk has occurred when one or more of the criteria below are met.

Quantitative criteria
A significant increase in credit risk is determined by comparing the PD at the reporting date with the PD at initial recognition. If the actual PD is higher than initial PD, an assessment is made of whether the increase is significant.

Significant increase in credit risk since initial recognition is considered to have occurred when either

• PD has increased by 100 % or more and the increase in PD is more than 0.5 percentage points, or
•  PD has increased by more than 2.0 percentage points  

Qualitative criteria
Qualitative information is normally reflected in the respective PD models for each group of customers.

«Backstops»

Backstops are used and a significant increase in credit risk has occurred if:

• the customer’s contractual payments are 30 days past due
• the customer has been granted forbearance measures due to financial distress, though it is not severe enough for the financial instrument to be classified as credit-impaired.  
  
  

Definition of default, forbearance and individual impairment
A commitment is defined to be in default if a claim is more than 90 days overdue and the overdue amount exceeds NOK 1 000.

A commitment is defined to be subject to forbearance if the bank agrees to changes in the terms and conditions because the debtor is having problems meeting payment obligations.

A commitment is defined to be credit-impaired if the commitment, as a result of a weakening of the debtor's creditworthiness, has been subject to an individual assessment, resulting in an individual impairment. The principles and estimation techniques for credit-impaired financial instruments are not affected by IFRS 9.

Expert credit judgement
The new rules require significant professional judgement of the input parameters in the ECL-measurement. The assessment of the macro prognoses and their impact are key judgements and Sparebanken Møre has established an advisory forum to address this. The forum’s purpose is to assess if the predicted macro prognoses for each segment reflect the management’s view on the expected future economic development.  

Validation
The ECL model is subject to annual validation and review.    

Individual impairment
Individual impairment for losses is made when there are indications that a loan is impaired. An impairment is reversed when the loss is reduced and when it can be related to an event which has occurred after the time of impairment. All commitments which are regarded as significant, and a selection of other loans, are assessed individually in order to determine whethe there are indications of credit deterioration

A financial asset is impaired when one or more events that have a negative impact on the financial asset's estimated future cash flows have taken place. Indications that a financial asset is impaired include observable data on the following events:  

a) the debtor having significant financial problems,  
b) breaches of contract, for example default or overdue payments,  

A financial asset is considered as defaulted if the borrower does not pay overdue installments, or overdrafts are not covered, maximum within 90 days  

c) When the borrower's lender, for financial or contractual reasons related to the borrower's financial difficulties, has given the borrower concessions that the lender would otherwise not have considered,
d) when it becomes likely that the borrower will go bankrupt or be subjected to another form of financial reorganization,  
e) when an active market for the financial asset disappears due to financial difficulties, or  
f) purchase or creation of a financial asset with a significant discount that reflects accrued credit losses.

It may not be possible to identify a single separate event - instead, the overall impact of several events may have been the cause of financial assets deteriorating.

Provisions for guarantee liabilities are made if the liability is likely to be settled and the liability can be estimated in a reliable manner. Best estimate is applied when determining the amount of the provisions to be made. Claims for recourse related to guarantees where provisions have been made are capitalized as an asset maximum equal to provisions made.

In case of individual impairment the impairment amount is calculated as the difference between the carrying amount (principal + accrued interest at the valuation date) and the present value of future cash flows, discounted at the effective interest method over the commitments` expected lifetime. 

The discounting rate for loans with floating interest rates is equal to the effective rate of interest at the time of assessment. For loans with fixed interest rates, the discounting rate is equal to the original, effective interest rate. For commitments which have altered interest rates as a result of debtors’ financial problems, the effective rate of interest ruling before the commitment’s interest rate was altered is applied. When estimating future cash flows, a possible takeover and sale of related collateral is taken into consideration, also including costs relating to the takeover and sale.

Impairment of commitments is recognised in the income statement as losses on loans. Interest calculated on loans which have previously been impaired, is recognised as interest income. Reversal of impairment is recognised in the income statement as a correction of losses. Estimates of future cash flows from a loan should also consider the acquisition and sale of related collateral. When evaluating security coverage there should be a qualified assessment of the collateral`s nature and market value, taking into account the costs of the acquisition and sale. Realisation values for different collateral in a realizable situation are determined by the use of best judgment. Timing for liquidation of loans with impairment is based on judgment and experiences from other liquidation engagements and bankruptcies. When all collateralised assets have been realised and when there is definitely no likelihood of the bank receiving any more payments relating to the outstanding commitment, the loss is confirmed. The claim against the customer will still exist and continued being followed up, unless the bank has agreed to debt forgiveness for the customer.

Write-off
Loans and debt securities are written off (either partially or in full) when there is no reasonable expectation of recovering a financial asset in its entirety or a portion thereof. This is generally the case when the Group determines that the borrower does not have assets or sources of income that could generate sufficient cash flows to repay the amounts subject to the write-off. This assessment is carried out at the individual asset level. Recoveries of amounts previously written off are included in “Impairment on loans, guarantees etc.” in the Statement of income. Financial assets that are written off could still be subject to enforcement activities in order to comply with the Group’s procedures for recovery of amounts due. 

The accounting policies on commitments in default and estimated losses are disclosed in note 6. The table Commitments in default shows the total of a customer's outstanding commitments broken down into the number of days past due caused by lack of ability or willingness to pay.  If a customer has one commitment that is overdue, then all the other commitments with this customer are regarded as overdue. Defaulted loans and overdrafts are continuously supervised. Impairment is assessed for commitments where a probable deterioration of customer solvency is identified. 

The table Problem loans consists of total commitments in default above 3 months and other commitments subject to individual impairment without being in default.      

Financial guarantees
The Group issues financial guarantees as part of its ordinary operations. Credit risk is presented in note 3 and also includes financial guarantees and commitments. These guarantees are evaluated for impairment in accordance with the principles applied to loans, and are referred to in note 6.

Uncertain liabilities
These are uncertain liabilities and provisions, not directly related to the lending activities in the Bank. An item of provisioning is shown in the accounts when the Group has a valid (legal or assumed) liability as a result of events which have occurred, and if it can be argued as likely (more likely than not) that a financial settlement will be made as a result of the event involved, and that the amount can be estimated in a reliable manner. Any provisions raised are reviewed on each balance sheet date in question and their value assessed on the basis of the best estimate of the liability involved. In the case of insignificant time discrepancies, the amount of provisioning raised equals the cost of getting out of the liability. When the time discrepancy is significant, the amount of provisioning raised equals the present value of future payments to be made in order to cover the liability. An increase in the amount of provisioning raised as a result of the time involved, is shown as interest costs.

An uncertain liability where a financial settlement is not likely to happen is regarded as a contingent liability. A provision shall not be made for contingent liabilities. Mention has been made of significant contingent liabilities, with the exception of contingent liabilities where the likelihood of any liability being low. A contingent asset is not recognised in the annual accounts, but disclosed if it is likely that a benefit will accrue to the Group.  

The management of Sparebanken Møre’s funding structure is defined in an overall liquidity strategy which is evaluated and agreed by the Board of Directors at least once every year. In this strategy document, the bank’s targets relating to the maintenance of its financial strength are described, and actual limits for the bank’s liquidity management within different areas are defined. Liquidity management also includes stress tests according to which the liquidity effect of different scenarios is simulated by quantifying the probability of refinancing from the various sources of funding involved. Part of the bank’s strategy is to apply diversification to its funding with regard to sources, markets, financial instruments and maturities, the object being to reduce the overall risk.

To ensure the Group's liquidity risk being kept at a low level, lending to customers should primarily be funded by customer deposits and long-term debt securities. Liquidity risk is managed through both short-term limits that restrict net refinancing needs, and a long-term management target.

The Group`s deposit-to-loan ratio, calculated including transferred mortgages to Møre Boligkreditt AS, amounted to 57.0 per cent at the end of 2018, opposed to 57.7 per cent by the end of 2017.

The average residual maturity of the portfolio of senior bonds and covered bonds were respectively 1.9 years and 3.7 years at the end of 2018, compared with 2.4 years and 3.5 years a year earlier.

The bank also has holdings of securities, which are included as part of the ongoing liquidity management. See additional information in note 13 and 15.

The Additional Tier 1 capital NO0010532765 is classified as liability. This is, like previous years, presented as a liability in the bank’s balance sheet, as the bank has interpreted the agreement in a manner which does not give the bank an unconditional right to, at any time, refrain from paying interests.

The Additional Tier 1 capital NO0010796154 is classified as equity in the balance sheet and is included in the Tier 1 capital. Based on the fact that the bank has a unilateral right not to pay interest or principal to investors, it does not qualify as debt under IAS 32. The interest cost is not presented in the income statement, rather as a reduction of retained earnings. The cost is recognised by payment. Interests totalling NOK  15.2 million has been paid in 2018. An additional NOK 0.7 mill has incurred in interest expense by year-end, so that together NOK 11.4 million of the profit after tax are allocated to the owners of Additional Tier 1 capital.

There is no option to convert the subordinated loan capital/additional tier 1 capital to EC-capital (Equity Certificates). The Group had no investments in subordinated loan capital in other enterprises (including financial institutions) at the end of 2018. Loan agreements are made available on the bank's website.    

The debt securities in the Parent bank consist of bonds and certificates quoted in Norwegian kroner. Møre Boligkreditt AS has issued covered bonds quoted in NOK and EUR.

The bank’s loans at floating interest rates are assessed at amortised cost. Loans at fixed interest rates are assessed by using fair value hedging, with value changes recognised in the income statement. The bank hedges the value of interest rate and FX-risk on an individual basis. There is a clear, direct and documented relationship between value changes relating to the hedging instrument and the hedged object. The relationship is documented through a test of the hedging effectiveness when entering into the transaction and through the period of the hedging relationship. Hedging gains and losses result in an adjustment of the balance sheet value of hedged loans. The hedging adjustments are amortised over the remaining period of the hedging by adjusting the loans’ effective interest rate if the hedging no longer is effective, if hedging is discontinued or by other termination of hedging. By applying this principle, one establishes a correct accounting presentation which is in accordance with the bank’s interest rate and FX management and the actual financial development.  

Implementation effects of IFRS 9 as of 1 January 2018
The new regulations regarding classification and measurement did not result in any significant changes for the Group compared to measurement of financial instruments in IAS 39. The category Stocks available for sale with changes in value over Other comprehensive income ceased to exist from 1 January 2018. The Group’s change in value on equities and equity instruments were recognised in the income statement from this date onwards. For the Parent Bank, loans prepared for sale to Møre Boligkreditt AS are classified at fair value as these loans are not held to receive contractual cash flows, and changes in value on these loans are recognised in the income statement, included under Other operating Income.   

The table below shows a reconciliation of carrying amounts according to IAS 39 compared to balances reported under IFRS 9 as of 1 January 2018:  

Financial assets and financial liabilities are recognised in the balance sheet at the date when the Group becomes a party to the contractual provisions of the instrument. A financial asset is derecognised when the contractual rights to the cash flows from the financial asset expire, or the company transfers the financial asset in such a way that risk and profit potential of the financial asset is substantially transferred. Financial liabilities are derecognised from the date when the rights to the contractual provisions have been extinguished, cancelled or expired.  

CLASSIFICATION AND MEASUREMENT
The Group’s portfolio of financial instruments is at initial recognition classified in accordance with IFRS 9. Financial assets are classified in one of the following categories:    

• Fair value with value changes through the income statement

• Amortised cost  

The classification of the financial assets depends on two factors:  

• The purpose of the acquisition of the financial instrument

• The contractual cash flows from the financial assets

Financial assets assessed at amortised cost
The classification of the the financial assets assumes that the following requirements are met:

  • The asset is acquired to receive contractual cash flows

• The contractual cash flows consist solely of principal and interest

All lending and receivables are recorded in the accounts at amortised cost, based on expected cash flows. The difference between the issue cost and the settlement amount at maturity, is amortised over the lifetime of the loan.

Financial liabilities assessed at amortised cost
Debt securities, including debt securities included in fair value hedging, loans and deposits from credit institutions and deposits from customers, are valued at amortised cost based on expected cash flows. The portfolio of own bonds is shown in the accounts as a reduction of the debt.   

Financial instruments assessed fair value, any changes in value recognised through the income statement
The Group's portfolio of bonds in the liquidity portfolio is classified at fair value through the income statement, based on the business model of the bank. The portfolio is not held soley to receive principle and interest. The Group’s portfolio of fixed interest rate loans are assessed at fair value to avoid accounting mismatch in relation to the underlying interest rate swaps. 

Financial derivatives are contracts signed to mitigate an existing interest rate or currency risk incurred by the bank. Financial derivatives are recognised at fair value through the income statement and recognised gross per contract as an asset or liability.

The Group’s portfolio of shares is assessed at fair value with any value changes through the income statement.

Losses and gains as a result of value changes on assets and liabilities assessed at fair value, with any value changes being recognised in the income statement, are included in the accounts during the period in which they occur.

LEVELS IN THE VALUATION HIERARCHY
Financial instruments are classified into different levels based on the quality of market data for each type of instrument.

Level 1 – Valuation based on prices in an active market
Level 1 comprises financial instruments valued by using quoted prices in active markets for identical assets or liabilities. This category includes listed shares and mutual funds, as well as bonds and certificates in LCR-level 1, traded in active markets.

Level 2 – Valuation based on observable market data
Level 2 comprises financial instruments valued by using information which is not quoted prices, but where prices are directly or indirectly observable for assets or liabilities, including quoted prices in inactive markets for identical assets or liabilities. This category mainly includes debt securities issued, derivatives and bonds which are not included in level 1.

Level 3 – Valuation based on other than observable market data
Level 3 comprises financial instruments which can not be valued based on directly or indirectly observable prices. This category mainly includes loans to and deposits from customers, as well as shares.  

Interest income is recognised as income using the effective interest rate method. This implies interest income being recognised when received plus amortisation of establishment fees. The effective interest rate is set by discounting contractual cash flows within the expected term. All fees exceeding direct transaction costs related to interest-bearing loans and borrowings are included in the calculation of the balance sheet item's effective interest rate and are amortised over the expected term.

Recognition of interest income using the effective interest rate method is used for both balance sheet items valued at amortised cost, and balance sheet items valued at fair value through the income statement, with the exception of establishment fees on loans at fair value which are recognised as income when earned. Interest income on impaired loans is calculated as the effective interest rate on the impaired value. Interest income on financial instruments is included in the line item "Net interest income".

Loans are assessed at fair value at first assessment, with the addition of direct transaction costs. When determining the loan’s value at the time of transaction (transaction price), establishment fees are deducted and subject to accrual accounting over the lifetime of the loan as part of the loan’s effective interest rate. Loans are subsequently assessed at amortised cost by applying the effective interest rate method. The effective rate of interest is the rate at the signing time which exactly discounts estimated, future cash flows over the loan’s expected lifetime, down to the net value of the loan as shown in the balance sheet. By conducting this calculation, all cash flows are estimated, and all contract-related terms and conditions relating to the loan are taken into consideration. Fair value of the instruments traded in active markets is based on traded price on the balance sheet date. For those financial instruments not traded in an active market, own valuations based on current market conditions are applied, alternatively valuations from another market player.   

Financial instruments are recognised at fair value at the time of entering into the agreement. Fair value of the instruments traded in active markets is based on the traded price on the balance sheet date. Financial instruments not traded in an active market are assessed by applying the bank’s own valuations based on currently applicable market conditions, or, alternatively, value assessment provided by another player in the market. Financial instruments which are assessed at fair value, but not traded in an active market, consist of the portfolios of fixed interest rate loans and unlisted shares. Acquisition cost or impaired value is applied for unlisted shares where a sufficiently reliable assessment of fair value cannot be made. Transaction costs relating to financial assets and liabilities recognised at fair value, with changes in value recognised through the income statement, are not recognised in the balance sheet.

A change in the discount rate of 10 basis points would result in a change of approximately NOK 10 million on fixed rate loans.

Approach to valuation of financial instruments in Level 3 of the fair value hierarchy:

Fixed rate loans:
There have been no significant changes in the approach to the valuation of fixed-rate loans in 2018. Fair value is calculated based on contractual cash flows discounted at a market interest rate matching the rates applicable to the corresponding fixed-rate loans at the balance sheet date. In 2018, a total of NOK 7.3 million is recognised as a result of changes in value including changes in credit spreads on fixed rate loans. In the income statement, the change in value is presented under Other operating income.

Shares:
Shares presented in level 3 of the valuation hierarchy are primarily the bank's investment in Eksportfinans ASA (NOK 66 million) and the bank's claim on Vipps AS (NOK 39 million).

The bank's ownership in Eksportfinans ASA is valued based on its relative share of Eksportfinans` equity, adjustment made for unrealised changes in value of underlying financial investments and borrowings in Eksportfinans. In the valuation, a liquidity discount of 20 per cent is deducted. The value of Eksportfinans is reduced by NOK 7 million in 2018.

Transactions involving subsidiaries
These are transactions between the Parent Bank and wholly-owned subsidiaries which have been done at arm’s length and at arm’s length’s prices.

Settlement of financing costs and -income between the different segments is done on an ongoing basis using the Parent Bank’s funding cost. The internal rate of interest for this is defined as the effective 3-month NIBOR + a funding supplement for long-term financing (1.83 per cent in 2018 and 1.65 per cent in 2017).

Rent is allocated according to the floor space used for each segment, based on the same principles and the same prices as those applicable to the Parent Bank, at market rent.

Other services (office supplies, IT-equipment etc.) are bought by the segment involved from the Parent Bank at the same price as the Parent Bank obtains from external suppliers.

There are transactions between Sparebanken Møre and Møre Boligkreditt AS related to the transfer of loan portfolio to Møre Boligkreditt AS, as well as Sparebanken Møre providing loans and credits to the mortgage company. The economic conditions for the transfer of loans from Sparebanken Møre are market value. If mortgages with fixed interest rates are purchased, the price will be adjusted for premium/discount.

Sparebanken Møre is responsible for ensuring that loans transferred to Møre Boligkreditt AS are properly established and in accordance with the requirements set forth in the agreement between the mortgage company and the Parent Bank. In case of violation of these requirements, the Bank will be liable for any losses that the mortgage company would experience as a result of the error. Sparebanken Møre and Møre Boligkreditt AS have formalised settlement of interest for transaction days from the date of transfer of the portfolio of loans to the date of settlement of the consideration.

To ensure timely payment to holders of covered bonds (OMF) and associated derivatives, a revolving credit facility (" Revolving Credit Facility Agreement ") is established between Sparebanken Møre and Møre Boligkreditt AS. Sparebanken Møre guarantees timely coupon payments and payments linked to derivatives on outstanding covered bonds from Møre Boligkreditt AS, and repayment of principal on the covered bonds maturing in the ongoing next 12 months. In addition to the revolving credit facility, Møre Boligkreditt AS has a credit facility in Sparebanken Møre with an allocated limit of NOK 5 billion.

The pricing of services provided to Møre Boligkreditt AS from Sparebanken Møre distinguishes between fixed and variable costs for the mortgage company. Fixed costs are defined as costs which the mortgage company must bear, regardless of the activity related to the issuance of covered bonds, acquisition of portfolio etc. Variable costs are defined as costs related to the size of the portfolio acquired from Sparebanken Møre, and the work that must be exercised by the Bank`s staff to provide adequate services given the number of customers in the portfolio.  

The operations in the Group are divided into three strategic business areas/segments, according to type of services, customers and products involved, also being reporting segments according to IFRS 8. The classification corresponds to the structure in the ongoing reporting to the CEO and the Board of Directors, defined as the primary decision makers. The different operating segments partly sell different products, have a somewhat different risk profile, but target many of the same groups of customers. 

The classification into different operating segments and financial information relating to segments are presented in the table below. Most of the income and operating costs involved apply to the Bank’s different operating segments according to actual usage or according to activity-based distribution formulae. Segment profit is presented before tax. Tax is not allocated to the segments.

Transactions between different operating segments are based on market values/prices, similar to transactions with subsidiaries. Please see note 16 for additional information on terms.  

Geographical segments
The Group’s operations are mainly limited to Møre og Romsdal which is defined as the Group’s home market. In view of this, balance sheet and income statement figures are not split into geographical segments. Activities in areas other than the home county are not different from the Group’s other activities with regard to risk or return. Please see note 3 and note 5 for further information. Eliminations/other include Sparebankeiendom AS, handling real estate management of the Group’s own properties.