31. Financial risk management

The goal of SATO’s financial risk management is to protect the company from unfavourable changes occurring in the financial markets. The main principles of financing and financial risk management are set out in the Treasury Policy, approved by the Board of Directors. SATO Treasury is responsible for the management of financial risks in accordance with the Treasury Policy. SATO Treasury reports to the CFO, who is responsible for organizing and managing the duties associated with the financing and financial risk management, as well as ensuring compliance with the principles set in the Treasury Policy.

Interest rate risk

The most significant of SATO market risks is the impact of market interest rate fluctuation on interest cash flows. To manage interest rate risk, the proportions of fixed and floating rate instruments are balanced in such a way that the risk of a rise in interest expenses is on an acceptable level and liquidity is secured. Interest rate risk is primarily attributable to market-based loans from financial institutions, but the interest rate risk of other types of financial liabilities is also monitored.

Market-based loans are primarily drawn at floating rates. In accordance with the Treasury Policy, the interest rate risk arising from these contracts is hedged using derivative instruments, mainly interest rate swaps and options, so that when hedging is applied, the fixed rate portion exceeds 60 per cent of the nominal value of the total loan portfolio, excluding ARAVA loans. On 31 December 2016, the fixed rate portion of the loan portfolio after hedging was 82.2 (73.2) per cent, the average maturity excluding ARAVA loans being 5.0 (5.7) years.

The interest rate derivatives are accounted for as designated cash flow hedges. No ineffectiveness has occurred, as the hedged items and the hedging instruments have the same interest periods. The effect of changes in market interest rates on net financial expenses is examined with sensitivity analyses on the next page.

Changes in market interest rates also affect interest expense on interest subsidised loans. However, in interest subsidised loans, a subsidy is received for the part exceeding the deductible rate, so the risk of increases in interest rates for interest subsidised loans are considerably lower than for market based loans. The deductible rate on interest subsidised loans varies between 2.75 to 3.5 per cent and on the so-called interim model interest subsidy loans, funded in years 2009 to 2011, is 3.40 per cent. A major part of the interest-subsidised loans is tied to long reference rates, ranging 3 to 10 years. Due to the subsidies and long reference rates, the interest rate risk on these loans is not material. In accordance with the Treasury Policy, SATO does not apply hedging to interest-subsidised loans.

In operations financed with state subsidies, rents are based on absorption cost, and hence any interest risk can be transferred to the rents. The interest on state-subsidised ARAVA loans is pegged to changes in Finnish consumer prices. The ARAVA rate is fixed in advance for the following financial period and hence there is no uncertainty of the following period interest expense. Some state-subsidised loans have interest rate cap, the level of which is based on the interest rate of government 10-year bonds. A risk in state-subsidised ARAVA loans is a substantial increase in interest, which would be difficult to transfer in its entirety to rents without delay. In accordance with the Treasury Policy, SATO does not apply hedging to state-subsidised ARAVA loans.

Currency risk

SATO is exposed to both transaction and translation risks due to investments in St. Petersburg. Transaction risk arises mainly from rouble denominated purchase agreements. Committed agreements are fully hedged with currency forward contracts. On 31 December 2016 SATO had EUR 0.0 (2.4) million in rouble-denominated commitments related to the investments. The translation risk, i.e., the consolidation of foreign currency denominated subsidiary accounts, arises due to the investment properties in St. Petersburg. The fair values of the properties are translated to euros in consolidated financial statements using the closing exchange rate on the reporting date.

Price risk

At present, SATO has no items which might be subject to a significant price risk.

Credit risk

SATO is not exposed to significant concentrations of credit risk. SATO’s accounts receivable consist mainly of accounts receivable from construction commissioning. For the most part there is no credit risk related to these receivables, as title to the properties to be sold is not usually transferred to the buyer until the price has been paid. A small proportion of accounts receivable involve rent receivables. SATO has over 25,000 tenants, so the risk entailed in a single receivable is insignificant. Additionally, most lease agreements have security for the rent receivable. SATO’s actual credit losses have averaged the equivalent of 1.0 (0.7) per cent of rental income. In addition, treasury functions, such as liquidity investments and derivative instruments, involve a counterparty risk, which is reduced by careful selection of counterparties and by diversification of contracts among a number of counterparties.

Liquidity risk

The Group constantly monitors the amount of financing demanded for business operations so that the adequacy of financing will be assured in all circumstances. The cash flow of operative business is steady and fluctuation mainly arises from investment activities.

Liquidity is managed with the commercial paper programme of EUR 400 (200) million, committed credit limits EUR 400 (290) million, and non-committed credit limits, EUR 5 (5) million. On 31 December 2016, the commercial papers issued amounted to EUR 110.0 (104.0) million in nominal value. The committed credit facilities were unused (EUR 0 in use on 31 December 2015). In liquidity management, it is taken into account that the assets of Group companies subject to non-profit restrictions due to interest subsidies or state subsidised ARAVA loans, are kept separately and allocated to those non-profit operations.

In May 2015, Moody's assigned SATO with a Baa3 credit rating with a stable outlook. With the investment grade credit rating, SATO aims to widen the investor base and to further limit dependence on any single financing counterparty.

SATO's funding agreements contain covenant clauses relating to the Group capital structure and interest payment capacity. These clauses require the ratio of unencumbered assets to total assets to be at least 35 per cent by the end of 2016, at least 40 per cent by the end of 2017 and at least 42.5 per cent by the end of 2018 and at any time thereafter, the solvency ratio to be no more than 70 per cent and the interest coverage ratio to be at least 1.8. On the reporting date, the ratio of unencumbered assets was 53.1 (42.4) per cent, the solvency ratio was 54.3 (55.3) per cent, and the interest coverage ratio was 4.4 (4.1).

Sensitivity analysis, interest rate risk 2016 2015

Profit and Loss Equity Profit and Loss Equity
MEUR 1% -0.1% 1% -0.1% 1% -0.1% 1% -0.1%
Floating rate loans -7.2 0.5 - - -8.3 0.5 - -
Cross-currency and interest rate swaps 0.8 -0.1 3.5 -0.4 0.8 -0.1 4.4 -0.5
Interest rate swaps 3.9 -0.4 27.1 -2.8 3.7 -0.4 21.4 -2.2
Total -2.4 -0.1 30.6 -3.2 -3.8 0.0 25.8 -2.7



Sensitivity analysis, currency risk 2016 2015

Profit and Loss Equity Profit and Loss Equity
MEUR 10% -10% 10% -10% 10% -10% 10% -10%
Foreign-currency denominated loans -10.0 10.0 - - -10.6 10.6 - -
Cross-currency and interest rate swaps 9.9 -9.9 - - 10.5 -10.5 - -
Foreign exchange forward contracts - - - - - - 0.2 -0.2
Total -0.1 0.1 0.0 0.0 -0.1 0.1 0.2 -0.2



Maturity analysis on financial instruments

31 Dec 2016

MEUR

within 1 year 2–5
years
6–10 years 11–15 years after 15 years 2016 Total
Financial liabilities







Market-based loans

-153.8 -1,103.4 -220.9 -47.7 -57.6 -1,583.5
Interest-subsidised loans

-19.9 -297.8 -43.4 -31.1 -69.2 -461.4
State-subsidised ARAVA loans

-8.8 -29.2 -22.3 -13.7 -7.5 -81.5
Accounts payable

-8.5



-8.5
Financial liabilities total

-190.9 -1,430.5 -286.6 -92.6 -134.3 -2,134.8



Financial instruments







Foreign exchange forward contracts, inflow






0.0
Foreign exchange forward contracts, outflow






0.0
Interest rate derivatives

-12.0 -32.4 -6.6

-51.0
Financial Instruments total

-12.0 -32.4 -6.6 0.0 0.0 -51.0
Total

-202.8 -1,462.9 -293.2 -92.6 -134.3 -2,185.8



31 Dec 2015

MEUR

within 1 year 2–5
years
6–10 years 11–15 years after 15 years 2015 Total
Financial liabilities







Market-based loans

-183.4 -794.2 -411.5 -73.2 -104.9 -1,567.1
Interest-subsidised loans

-20.6 -149.3 -63.7

-233.6
State-subsidised ARAVA loans

-10.7 -34.9 -28.7 -20.1 -6.3 -100.7
Accounts payable

-6.8



-6.8
Financial liabilities total

-221.5 -978.4 -503.9 -93.3 -111.2 -1,908.2



Financial instruments







Foreign exchange forward contracts, inflow

1.6



1.6
Foreign exchange forward contracts, outflow

-2.3



-2.3
Interest rate derivatives

-10.6 -29.5 -3.5

-43.6
Financial Instruments total

-11.4 -29.5 -3.5 0.0 0.0 -44.4
Total

-232.9 -1,007.9 -507.3 -93.3 -111.2 -1,952.6

Above figures represent contractual, non-discounted cash flows, including interest payments.