Critical accounting estimates and judgements

Critical Accounting Estimates and Judgements

NIBC makes estimates and assumptions that affect the reported amounts of assets and liabilities. Estimates and judgements are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.

Estimates and judgements are principally made in the following areas:

Estimated impairment of goodwill arising on consolidated non-financial companies;
Fair value of certain financial instruments;
Impairment of corporate loans;
Impairment of debt investments classified as amortised cost;
Impairment of debt investments classified as available for sale;
Impairment of equity investments classified as available for sale;
Securitisations and special purpose entities;
Pension benefits; and
Income taxes.

Estimated impairment of goodwill arising on consolidated non-financial companies

NIBC tests whether its goodwill is impaired on an annual basis in accordance with its accounting policy.

The recoverable amount of a group of CGUs related to consolidated non-financial companies is determined based on value-in-use calculations. These calculations use pre-tax cash flow projections based on financial budgets approved by the Managing Boards of the acquirer companies covering a ten year period (2010 - 2019). Cash flows beyond the ten year period are extrapolated using an estimated perpetual growth rate.

The key assumptions used in the value-in-use calculations are as follows:

	2009	2008

Perpetual growth rate	0.0% - 2.5%	2.0% - 2.5%
Pre-tax discount rate	11.7% - 12.6%	11.7% - 12.7%
Tax rate	25.5% - 29.0%	25.5% - 29.0%

Management determines budgeted results based upon past performance and its expectations of market developments. The discount rate (weighted average cost of capital) used is pre-tax and reflects specific risks relating to the operations of the group of CGUs.

NIBC has not recognised a goodwill impairment charge for the consolidated non-financial companies.

The rate used to discount the future cash flows of the group of CGUs can have a significant effect on the group of CGUs valuation. The discount rate calculated depends on inputs reflecting a number of financial and economic variables including the risk-free interest rate and a premium to reflect the inherent risk of the business being evaluated. These variables are established on the basis of management judgement.

If the estimated pre-tax discount rate applied to the discounted cash flow for the group of CGUs had been 1% higher than management estimates (12.7% - 13.6% instead of 11.7% - 12.6%) NIBC would also not have recognised a goodwill impairment charge.

Management judgement is also required in estimating the future cash flows of the group of CGUs. These values are sensitive to the cash flows projected for the periods for which detailed forecasts are available, and to assumptions regarding the long-term pattern of sustainable cash flows thereafter. While the acceptable range within which underlying assumptions can be applied is governed by the requirement to compare resulting forecasts with actual performance and verifiable economic data in future years, the cash flow forecasts necessarily and appropriately reflect management’s view of future business prospects.

When this exercise demonstrates that the expected cash flows of a group of CGUs have declined and/or that its discount rate has increased, the effect is to reduce the estimated recoverable amount. If this results in an estimated recoverable amount that is lower than the carrying value of the group of CGUs, a charge for impairment of goodwill will be recorded, thereby reducing by a corresponding amount NIBC’s profit before tax for the year.

If the budgeted profit before tax of the group of CGUs used in the value-in-use calculation had been 5% lower than management’s estimates at 31 December 2009, NIBC would also not have recognised a goodwill impairment charge in respect of its controlled non-financial companies.

Fair value of certain financial instruments

The fair value of financial instruments where no active market exists or where quoted prices are not otherwise available are determined by using valuation techniques. In these cases, the fair values are estimated from observable data, where available, in respect of similar financial instruments or using models. Where market-observable inputs are not available, they are estimated based on appropriate assumptions. Where valuation techniques (for example, models) are used to determine fair values, they are validated and periodically reviewed by qualified personnel independent of those who prepared them. All models are reviewed prior to use and models are calibrated to ensure that outputs reflect actual data and comparative market prices. To the extent practical, models use only observable data; however, areas such as applicable credit spreads (both own credit spread and counterparty credit spreads), volatilities and correlations may require management to make estimates.

Changes in assumptions about these factors could affect the reported fair value of financial instruments. For the identification of assumptions used in the determination of fair value of financial instruments and for additional sensitivity information for level 3 financial instruments, reference is made to note 46.

Fair value of financial assets venture capital organisation within operating segment Merchant Banking

The group estimates the fair value of its venture capital assets using valuation models, and it applies the valuation principles set forth by the International Private Equity and Venture Capital Valuation Guidelines to the extent that these are consistent with IAS 39.

On 31 December 2009, the fair value of this portfolio was estimated to be EUR 309 million (2008: EUR 296 million). This portfolio is reported as equity investments (including investments in associates) at fair value through profit or loss (2009: EUR 215 million; 2008: EUR 188 million) and as equity investments at available for sale (2009 EUR 94 million; 2008: EUR 108 million).

For the determination of the fair value of equity investments and sensitivity to key assumptions in the valuation, reference is made to note 46.

Impairment of corporate loans

NIBC assesses whether there is an indication of impairment of corporate loans classified as loans and receivables at amortised cost on an individual basis on at least a quarterly basis. NIBC considers a range of factors that have a bearing on the expected future cash flows that it expects to receive from the loan, including the business prospects of the borrower and its industry sector, the realisable value of collateral held, the level of subordination relative to other lenders and creditors, and the likely cost and likely duration of any recovery process. Subjective judgements are made in the process including, among others, the determination of expected future cash flows and their timing and the market value of collateral. Furthermore, NIBC’s judgements change with time as new information becomes available, or as recovery strategies evolve, resulting in frequent revisions to individual impairments, on a case-by-case basis. NIBC regularly reviews the methodology and assumptions used for estimating both the amount and timing of future cash flows, to reduce any differences between loss estimates and actual loss experience.

If, as at 31 December 2009, for each of NIBC’s impaired corporate loans, the net present value of the estimated cash flows had been 5% lower or higher than estimated, NIBC would have recognised an additional impairment loss or gain of EUR 7.1 million (2008: EUR 6.5 million).

Impairment of debt investments classified as amortised cost

NIBC assesses whether there is an indication of impairment on debt investments classified as amortised cost on an individual basis on at least a quarterly basis. NIBC considers a range of factors that have a bearing on the expected future cash flows that it expects to receive from the debt investment including rating downgrades and delinquencies and/or defaults in the underlying asset pools. Adjustments are also made to reflect such elements as deteriorating liquidity and increased refinancing risk.

If, as at 31 December 2009, for each of NIBC’s impaired debt investments, the net present value of the estimated cash flows had been 5% lower or higher than estimated, NIBC would have recognised an additional impairment loss or gain of EUR 0.1 million (2008: nil).

Impairment of debt investments classified as available for sale

NIBC assesses whether there is an indication of impairment on debt investments classified as available for sale on an individual basis on at least a quarterly basis. This requires similar judgement as applied to debt investments at amortised cost.

The level of the impairment loss that NIBC recognises in the consolidated income statement is equivalent to the cumulative loss that had been recognised directly in the revaluation reserve of other comprehensive income. If, as at 31 December 2009, for each of NIBC’s impaired debt investments, the fair value had been 5% lower or higher, NIBC would have recognised an additional impairment loss or gain of EUR 0.1 million (2008: nil).

Impairment of equity investments classified as available for sale

NIBC determines an impairment loss on the available for sale equity investments held in the investment portfolio of the venture capital organisation within the operating segment Merchant Banking when there has been a significant or prolonged decline in fair value below original cost. NIBC exercises judgement in determining what is ‘significant’ or ‘prolonged’ by evaluating, among other factors, whether the decline is outside the normal range of volatility in the asset’s price. In addition, impairment may be appropriate when there is evidence of deterioration in the financial health of the company whose securities are held by NIBC, a decline in industry or sector performance, adverse changes in technology or problems with operational or financing cash flows.

The level of the impairment loss that NIBC recognises in the consolidated income statement is the cumulative loss that had been recognised directly in the revaluation reserve of other comprehensive income. If NIBC had deemed all of the declines in fair value of equity investments below cost as ‘significant’ or ‘prolonged’, the effect would have been a EUR 8.5 million (2008: EUR 2.2 million) reduction in the profit before tax from continuing operations (gains less losses from financial assets) in 2009.

Securitisations and special purpose entities

NIBC establishes Special Purpose Entities (SPEs) primarily for the purpose of allowing clients to hold investments in separate legal entities, to allow clients to invest jointly in alternative assets, for asset securitisation transactions, and for buying or selling credit protection. NIBC does not consolidate SPEs that it does not control.

The determination of whether NIBC exercises control over an SPE requires NIBC to make judgements about its exposure to the risks and rewards derived from the SPE as well as its ability to make operational decisions for the SPE in question. In many instances, elements are present that, considered in isolation, indicate control or lack of control over an SPE, but when considered together make it difficult to reach a clear conclusion. In such cases, the SPE is consolidated.

When assessing whether NIBC has to consolidate an SPE, it evaluates a range of factors, including whether:

It will obtain the majority of the benefits of the activities of an SPE;
It retains the majority of the residual ownership risks related to the assets in order to obtain the benefits from its activities;
It has decision-making powers to obtain the majority of the benefits; and
The activities of the SPE are being conducted on NIBC’s behalf according to NIBC’s specific business needs so that it obtains the benefits from the SPEs operations.

The evaluation mentioned above is necessarily subjective.

Were the group not to consolidate the assets, liabilities and the results of these consolidated SPEs, the net effect on the balance sheet would be a decrease in net assets of EUR 6.4 billion (2008: EUR 7.0 billion) and the net effect on the income statement in both 2009 and 2008 would be insignificant.

Derecognition of assets and recognition of continuous involvement

NIBC executed transactions under its Commercial Mortgage-Backed Securities (CMBS) programme. The purpose of this programme is to offer NIBC real estate clients access to the capital markets. NIBC established SPEs for the commercial backed securities program. All loans transferred to the SPEs are collateralised by commercial real estate properties. The SPEs obtain funding from the capital markets by issuing CMBS notes. The commercial real estate loans, included in the commercial mortgage-backed securities programme, were originated by NIBC or by other banks prior to the securitisation. The total amount of commercial loans originated by NIBC prior to the securitisation and that were subsequently transferred to these SPEs amounts to EUR 1,288 million. The notional amount at 31 December 2009 was EUR 1,200 million (2008: EUR 1,222 million). The loans that continued to be recognised to the extent of NIBC’s continuing involvement amounted to EUR 684 million at 31 December 2009 (2008: EUR 695 million). The reason for recognising this continuing involvement is that, based on a risks and rewards analysis, NIBC did not transfer substantially all risks and rewards associated with the securitised assets. The continuing involvement is reflected in the balance sheet as EUR 614 million (2008: EUR 623 million) in securitised loans valued at amortised cost and with a corresponding amount in debt securities in issue related to securitised mortgages and loans, EUR 65 million (2008: EUR 65 million) in loans at fair value through profit or loss and with a corresponding amount in debt securities in issue related to securitised mortgages and loans and EUR 5 million (2008: EUR 7 million) in debt investments at fair value through profit or loss which concerns the fair value of NIBC’s investment in certain CMBS notes.

Pension benefits

The present value of pension obligations depends on a number of factors that are determined on an actuarial basis using a number of assumptions. The assumptions used in determining the net cost (income) of pensions include the discount rate, the expected return on plan assets, future salary increases, future inflation and future pension increases. Any changes in these assumptions will impact the carrying amount of pension obligations.

The group determines the appropriate discount rate at the end of each year. This is the interest rate that should be used to determine the present value of estimated future cash outflows expected to be required to settle pension obligations. In determining the appropriate discount rate, the group considers the interest rates of high-quality corporate bonds that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating the terms of the related pension liability.

Other key assumptions for pension obligations are based in part on current market conditions. Additional information is disclosed in note 42.

Were the discount rate used to differ by 10% from management’s estimates, the carrying amount of pension obligations would be an estimated EUR 15.4 million (2008: EUR 12.9 million) lower or EUR 17.8 million (2008: EUR 14.2 million) higher. The service cost would be EUR 0.7 million (2008: EUR 0.4 million) lower or EUR 0.8 million (2008: EUR 0.4 million) higher.

Income taxes

NIBC is subject to income taxes in a number of tax jurisdictions. NIBC makes estimates in determining its worldwide provision for income taxes, and files its tax returns after the finalisation of its financial statements. The ultimate tax determination by tax authorities for certain transactions arising in the ordinary course of business may remain uncertain for several years after their occurrence. NIBC recognises assets and or liabilities for taxation when it is probable that the relevant taxation authority will require NIBC to receive and or pay taxation. Where the final outcome of such determination is different from the amounts that were initially estimated and recorded, these differences will impact the income tax expenses or deferred tax position in the period in which the determination is made.