Guidance to banks on non-performing loans

ECB-RESTRICTED (until PUBLIC)

Guidance to banks on

non-performing loans

March 2017

Contents

1 Introduction 4

1.1 Context of this guidance 4

1.2 Applicability of this guidance 5

1.3 Scope of this guidance 6

1.4 Structure 7

2 NPL strategy 8

2.1 Purpose and overview 8

2.2 Assessing the operating environment 8

2.3 Developing the NPL strategy 12

2.4 Implementing the operational plan 15

2.5 Embedding the NPL strategy 16

2.6 Supervisory reporting 17

3 NPL governance and operations 18

3.1 Purpose and overview 18

3.2 Steering and decision making 18

3.3 NPL operating model 19

3.4 Control framework 27

3.5 Monitoring of NPLs and NPL workout activities 29

3.6 Early warning mechanisms/watch-lists 35

3.7 Supervisory reporting 38

4 Forbearance 39

4.1 Purpose and overview 39

4.2 Forbearance options and their viability 39

4.3 Sound forbearance processes 44

4.4 Affordability assessments 45

4.5 Supervisory reporting and public disclosures 46

Guidance to banks on non-performing loans

5 NPL recognition 47

5.1 Purpose and overview 47

5.2 Implementation of the NPE definition 49

5.3 Link between NPEs and forbearance 54

5.4 Further aspects of the non-performing definition 59

5.5 Links between regulatory and accounting definitions 61

5.6 Supervisory reporting and public disclosures 63

6 NPL impairment measurement and write-offs 65

6.1 Purpose and overview 65

6.2 Individual estimation of provisions 67

6.3 Collective estimation of provisions 74

6.4 Other aspects related to NPL impairment measurement 78

6.5 NPL write-offs 79

6.6 Timeliness of provisioning and write-off 81

6.7 Provisioning and write-off procedures 82

6.8 Supervisory reporting and public disclosures 85

7 Collateral valuation for immovable property 86

7.1 Purpose and overview 86

7.2 Governance, procedures and controls 87

7.3 Frequency of valuations 90

7.4 Valuation methodology 91

7.5 Valuation of foreclosed assets 95

7.6 Supervisory reporting and public disclosures 97

Annex 1 Glossary 98

Annex 2 Sample of NPL segmentation criteria in retail 101

Annex 3 Benchmark for NPL monitoring metrics 104

Annex 4 Samples of early warning indicators 106

Annex 5 Common NPL-related policies 108

Guidance to banks on non-performing loans

Annex 6 Affordability assessment for retail and corporate borrowers 114

Annex 7 Summary of supervisory reporting and disclosures related to

NPLs 119

Annex 8 Risk transfer of NPLs 129

ECB-RESTRICTED (until PUBLIC)

Guidance to banks on non-performing loans − Introduction

1 Introduction

1.1 Context of this guidance

A number of banks in Member States across the Euro area are currently

experiencing high levels of non-performing loans (NPLs), as shown in Figure 1.

There is broad consensus on the view that high NPL levels ultimately have a

negative impact on bank lending to the economy

, as a result of the balance sheet,

profitability, and capital constraints faced by banks with high NPL levels.

Figure 1

Texas ratio and Impaired loan ratio evolution in the euro area

Impaired loan ratios for euro area significant banking groups

(2007-2015; percentage of loans, median values)

Source: SNL Financial.

Notes: Based on publicly available data for a sample of 55 significant banking groups.

Countries most affected by the crisis include Cyprus, Greece, Ireland, Italy, Portugal,

Slovenia and Spain.

The deliberate and sustainable reduction of NPLs in banks’ balance sheets is

beneficial to the economy from both a microprudential and a macroprudential

perspective. At the same time, it is acknowledged that economic recovery is also an

important enabler of NPL resolution.

Addressing asset quality issues is one of the key priorities for European Central

Bank (ECB) banking supervision. The ECB’s focus on this issue began with the 2014

comprehensive assessment, which comprised two main pillars – an asset quality

review and a stress test. Subsequent to the comprehensive assessment, ECB

banking supervision continued to intensify its supervisory work on NPLs. In the

context of on-going supervisory engagement, the joint supervisory teams (JSTs)

See ECB and other international research, e.g. International Monetary Fund (IMF) discussion note

“Strategy for Resolving Europe’s Problem Loans”

20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15

countr ies most affected by the financial crisis

other countr ies

all countr ies

Ratio of non-performing loans to tangible equity and loan

loss reserves for euro area significant banking groups

(2007-2015; percentages; median values)

Source: SNL Financial.

Notes: Based on publicly available data for a sample of significant banking groups.

Countries most affected by the financial crisis are Cyprus, Greece, Ireland, Italy,

Portugal, Slovenia and Spain.

10 0

12 0

20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15

countr ies most affected by the financial crisis

other countr ies

Guidance to banks on non-performing loans − Introduction

have observed varying approaches by banks to the identification, measurement,

management and write-off of NPLs. In this regard, in July 2015 a high-level group on

non-performing loans (comprising staff from the ECB and national competent

authorities) was mandated by the Supervisory Board of the ECB to develop a

consistent supervisory approach to NPLs.

Furthermore, in its supervisory priorities, ECB banking supervision has highlighted

credit risk and heightened levels of non-performing loans as key risks facing euro

area banks.

Through the work of the high-level group, ECB banking supervision has identified a

number of best practices that it deems useful to set out in this public guidance

document. These practices are intended to constitute ECB banking

supervision's supervisory expectation from now on.

This guidance contains predominantly qualitative elements. The intention is to

extend the scope of the guidance based on the continuous monitoring of

developments concerning NPLs. As a next step in this regard, the ECB plans to

place a stronger focus on enhancing the timeliness of provisions and write-offs.

While it is acknowledged that addressing non-performing loans will take some time

and will require a medium-term focus, the principles identified will also serve as a

basic framework for conducting the supervisory evaluation of banks in this specific

area. As part of their ongoing supervisory work, the JSTs will engage with banks

regarding the implementation of this guidance. It is expected that banks will apply the

guidance proportionately and with appropriate urgency, in line with the scale and

severity of the NPL challenges they face.

1.2 Applicability of this guidance

This guidance is addressed to credit institutions within the meaning of Article 4(1) of

Regulation (EU) 575/2013 (CRR)

, hereinafter named “banks”. It is generally

applicable to all significant institutions (SIs) supervised directly under the Single

Supervisory Mechanism (SSM), including their international subsidiaries. However,

the principles of proportionality and materiality apply. Hence, parts of this document,

namely chapters 2 and 3 on NPL strategy, governance and operations, may be more

relevant for banks with high levels of NPLs (“high NPL banks”) that need to deal with

this extraordinary situation. Nonetheless, SIs with a relatively low overall level of

NPLs might still find it useful to apply certain parts of those chapters, e.g. to high

NPL portfolios. Chapters 4, 5, 6 and 7 are considered applicable to all SIs.

For the purpose of this guidance, the ECB’s banking supervision defines high NPL

banks as banks with an NPL level that is considerably higher than the EU average

Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on

prudential requirements for credit institutions and investment firms and amending Regulation (EU)

No 648/2012 (OJ L 176, 27.6.2013, p. 1).

Guidance to banks on non-performing loans − Introduction

level.

However, this definition is highly simplified and banks not falling under its

terms might still benefit from applying the full content at their own initiative or on

request by supervisors, especially in the case of significant NPL inflows, high levels

of forbearance or foreclosed assets, low provision coverage or an elevated Texas

ratio

This NPL guidance is currently non-binding in nature. However, banks should

explain and substantiate any deviations upon supervisory request. This guidance is

taken into consideration in the SSM regular Supervisory Review and Evaluation

Process and non-compliance may trigger supervisory measures.

This guidance does not intend to substitute or supersede any applicable regulatory

or accounting requirement or guidance from existing EU regulations or directives and

their national transpositions or equivalent, or guidelines issued by the European

Banking Authority (EBA). Instead, the guidance is a supervisory tool with the aim of

clarifying the supervisory expectations regarding NPL identification, management,

measurement and write-offs in areas where existing regulations, directives or

guidelines are silent or lack specificity. Where binding laws, accounting rules and

national regulations on the same topic exist, banks should comply with those. It is

also expected that banks do not enlarge already existing deviations between

regulatory and accounting views in the light of this guidance, but rather the opposite:

whenever possible, banks should foster a timely convergence of regulatory and

accounting views where those differ substantially.

This guidance should be applicable as of its date of publication. SIs may, however,

close identified gaps thereafter based on suitable time-bound action plans which

should be agreed with their respective JSTs. In order to ensure consistency and

comparability, the expected enhanced disclosures on NPLs should start from 2018

reference dates.

1.3 Scope of this guidance

“NPLs” is generally used in this guidance as a shorthand term. However, in technical

terms, the guidance addresses all non-performing exposures (NPEs), following the

EBA definition

, as well as foreclosed assets, and also touches on performing

exposures with an elevated risk of turning non-performing, such as “watch-list”

exposures and performing forborne exposures. “NPL” and “NPE”’ are used

interchangeably within this guidance.

A suitable reference to determine EU average NPL ratios and coverage levels is the quarterly

published European Banking Authority (EBA) risk dashboard.

Definitions of different concepts used in this Guidance can be found in the Glossary in Annex 1.

See chapter 5 for details.

Guidance to banks on non-performing loans − Introduction

1.4 Structure

The document structure follows the life cycle of NPL management. It starts with the

supervisory expectations on NPL strategies in chapter 2, which closely link to NPL

governance and operations, covered in chapter 3. Following this, the guidance

outlines important aspects for forbearance treatments, in chapter 4, and NPL

recognition, in chapter 5. Qualitative guidance on NPL provisioning and write-off is

treated in chapter 6 while collateral valuations are addressed in chapter 7.

Guidance to banks on non-performing loans − NPL strategy

2 NPL strategy

2.1 Purpose and overview

An NPL strategy establishes strategic objectives for high NPL banks for the time-

bound reduction of NPLs over realistic but sufficiently ambitious time-bound horizons

(NPL reduction targets). It should lay out the bank’s approach and objectives

regarding the effective management (i.e. maximisation of recoveries) and ultimate

reduction of NPL stocks in a clear, credible and feasible manner for each relevant

portfolio.

The following steps are considered to be the core building blocks related to the

development and implementation of an NPL strategy:

1. assessing the operating environment, including internal NPL capabilities,

external conditions impacting NPL workout and capital implications (see section

2.2);

2. developing the NPL strategy, including targets in terms of development of

operational capabilities (qualitative) and projected NPL reductions (quantitative)

over the short, medium and long-term time horizons (see section 2.3);

3. implementing the operational plan, including any necessary changes in the

organisational structure of the bank (see section 2.4);

4. fully embedding NPL strategy into the management processes of the bank, also

including a regular review and independent monitoring (see section 2.5).

Governance aspects relating to the NPL strategy are mostly covered in chapter 3.

2.2 Assessing the operating environment

Understanding the full context of the operating environment, both internally and

externally, is fundamental to developing an ambitious yet realistic NPL strategy.

The first phase in the formulation and execution of a fit-for-purpose NPL strategy is

for the bank to complete an assessment of the following elements:

1. the internal capabilities to effectively manage, i.e. maximise recoveries, and

reduce NPLs over a defined time horizon;

2. the external conditions and operating environment;

3. the capital implications of the NPL strategy.

Guidance to banks on non-performing loans − NPL strategy

2.2.1 Internal capabilities/self-assessment

There are a number of key internal aspects that influence the bank’s need and ability

to optimise its management of, and thus reduce, NPLs and foreclosed assets (where

relevant). A thorough and realistic self-assessment should be performed to

determine the severity of the situation and the steps that need to be taken internally

to address it.

The bank should fully understand and examine:

• Scale and drivers of the NPL issue:

• the size and evolution of its NPL portfolios on an appropriate level of

granularity, which requires appropriate portfolio segmentation as outlined

in chapter 3;

• the drivers of NPL in-flows and out-flows, by portfolio where relevant;

• other potential correlations and causations.

• Outcomes of NPL actions taken in the past:

• types and nature of actions implemented, including forbearance measures;

• the success of the implementation of those activities and related drivers,

including the effectiveness of forbearance treatments.

• Operational capacities (processes, tools, data quality, IT/automation,

staff/expertise, decision making, internal policies, and any other relevant area

for the implementation of the strategy) for the different process steps involved,

including but not limited to:

• early warning and detection/recognition of NPLs;

• forbearance;

• provisioning;

• collateral valuations;

• recovery/legal process/foreclosure;

• management of foreclosed assets (if relevant);

• reporting and monitoring of NPLs and effectiveness of NPL workout

solutions.

For each of the process steps involved, including those listed above, banks should

perform a thorough self-assessment to determine strengths, significant gaps and any

areas of improvement required for them to reach their NPL reduction targets. The

resulting internal report should be shared with the management body and

supervisory teams.

Guidance to banks on non-performing loans − NPL strategy

Banks should repeat or update relevant aspects of the self-assessment at least

annually and also regularly seek independent expert views on these aspects if

necessary.

2.2.2 External conditions and operational environment

Understanding the current and possible future external operating

conditions/environment is fundamental to the establishment of an NPL strategy and

associated NPL reduction targets. Related developments should be closely followed

by banks, which should update their NPL strategies as needed. The following list of

external factors should be taken into account by banks when setting their strategy. It

should not be seen as exhaustive as other factors not listed below might play an

important role in specific countries or circumstances.

Macroeconomic conditions

Macroeconomic conditions will play a key role in setting the NPL strategy and are

best incorporated in a dynamic manner. This also includes the dynamics of the real

estate market

and its specific relevant sub-segments. For banks with specific sector

concentrations in their NPL portfolios (e.g. shipping or agriculture), a thorough and

constant analysis of the sector dynamics should be performed, to inform the NPL

strategy.

A reduction of the risk stemming from NPLs can be achieved and should be the aim,

even in less favourable macroeconomic conditions.

Market expectations

Assessing the expectations of external stakeholders (including but not limited to

rating agencies, market analysts, research, and clients) with regard to acceptable

NPL levels and coverage will help to determine how far and how fast high NPL

banks should reduce their portfolios. These stakeholders will often use national or

international benchmarks and peer analysis.

NPL investor demand

Trends and dynamics of the domestic and international NPL market for portfolio

sales will help banks make informed strategic decisions regarding projections on the

likelihood and possible pricing of portfolio sales. However, investors ultimately price

Unless exposures secured by real estate collateral are not relevant within the NPL portfolios.

An example of the target framework applied by Greek significant institutions is provided later in this

chapter.

Guidance to banks on non-performing loans − NPL strategy

on a case-by-case basis and one of the determinants of pricing is the quality of

documentation and exposure data that banks can provide on their NPL portfolios.

NPL servicing

Another factor that might influence the NPL strategy is the maturity of the NPL

servicing industry. Specialised servicers can significantly reduce NPL maintenance

and workout costs. However, such servicing agreements need to be well steered and

well managed by the bank.

Regulatory, legal and judicial framework

National as well as European and international regulatory, legal and judicial

frameworks influence the banks’ NPL strategy and their ability to reduce NPLs. For

example, legal or judicial impediments to collateral enforcement influence a bank’s

ability to commence legal proceedings against borrowers or to receive assets in

payment of debt and will also affect collateral execution costs in loan loss

provisioning estimations. Therefore, banks should have a good understanding of the

particularities of legal proceedings linked to the NPL workout for different classes of

assets and also in the different jurisdictions in which they operate where high levels

of NPLs are present. In particular, they should assess: the average length of such

proceedings, the average financial outcomes, the rank of different types of

exposures and related implications for the outcome (for instance regarding secured

and unsecured exposures), the influence of the types and ranks of collateral and

guarantees on the outcomes (for instance related to second or third liens and

personal guarantees), the impact of consumer protection issues on legal decisions

(especially for retail mortgage exposures), and the average total costs associated

with legal proceedings. Furthermore, the consumer protection legal environment

should also be borne in mind as it also plays a role in client communication and

interaction.

Tax implications

National tax implications of provisioning and NPL write-offs will also influence NPL

Strategies.

2.2.3 Capital implications of the NPL strategy

Capital levels and their projected trends are important inputs to determining the

scope of NPL reduction actions available to banks. Banks should be able to

dynamically model the capital implications of the different elements to their NPL

strategy, ideally under different economic scenarios. Those implications should also

Guidance to banks on non-performing loans − NPL strategy

be considered in conjunction with the risk appetite framework (RAF) as well as the

internal capital adequacy assessment process (ICAAP).

Where capital buffers are slim and profitability low, high NPL banks should include

suitable actions in their capital planning which will enable a sustainable clean-up of

NPLs from the balance sheet.

2.3 Developing the NPL strategy

An NPL strategy should encompass, at a minimum, time-bound quantitative NPL

targets supported by a corresponding comprehensive operational plan. It should be

based on a self-assessment and an analysis of NPL strategy implementation

options. The NPL strategy, including the operational plan, should be approved by the

management body and reviewed at least annually.

2.3.1 Strategy implementation options

On the basis of the above-described assessment, banks should review the range of

NPL strategy implementation options available and their respective financial impact.

Examples of implementation options, not being mutually exclusive, are:

• Hold/forbearance strategy: A hold strategy option is strongly linked to operating

model, forbearance and borrower assessment expertise, operational NPL

management capabilities, outsourcing of servicing and write-off policies.

• Active portfolio reductions: These can be achieved either through sales and/or

writing off provisioned NPL exposures that are deemed unrecoverable. This

option is strongly linked to provision adequacy, collateral valuations, quality

exposure data and NPL investor demand.

• Change of exposure type: This includes foreclosure, debt to equity swapping,

debt to asset swapping, or collateral substitution.

• Legal options: This includes insolvency proceedings or out-of-court solutions.

Banks should ensure that their NPL strategy includes not just a single strategic

option but rather combinations of strategies/options to best achieve their objectives

over the short, medium and long term and explore which options are advantageous

for different portfolios or segments (see section 3.3.2 regarding portfolio

segmentation) and under different conditions.

Banks should also identify medium and long-term strategy options for NPL

reductions which might not be achievable immediately, e.g. a lack of immediate NPL

investor demand might change in the medium to long term. Operational plans might

need to foresee such changes, e.g. the need for enhancing the quality of NPL

exposure data in order to be ready for future investor transactions.

Guidance to banks on non-performing loans − NPL strategy

Where banks assess that the above-listed implementation options do not provide an

efficient NPL reduction in the medium to long-term horizon for certain portfolios,

segments or individual exposures, this should be clearly reflected in an appropriate

and timely provisioning approach. The bank should write off loans which are deemed

to be uncollectable in a timely manner.

Finally, it is acknowledged that NPL risk transfer and securitisation transactions can

be beneficial for banks in terms of funding, liquidity management, specialisation and

efficiency. However, these are usually complex processes and should be conducted

with care. Consequently, institutions wanting to engage in such transactions are

expected to conduct robust risk analysis and to have adequate risk control

processes

(see Annex 8 for more details).

2.3.2 Targets

Before commencing the short to medium-term target-setting process, banks should

establish a clear view of what reasonable long-term NPL levels are, both on an

overall basis but also on a portfolio-level basis. It is acknowledged that there is a

considerable amount of uncertainty around the timeframes required to achieve these

long-term goals, but they are an important input to setting adequate short and

medium-term targets. Banks working in tense macroeconomic conditions should also

explore international or historic benchmarks in order to define “reasonable” long-term

NPL levels.

High NPL banks should include, at a minimum, clearly defined quantitative targets in

their NPL strategy (where relevant including foreclosed assets), which should be

approved by the management body. The combination of these targets should lead to

a concrete reduction, gross and net (of provisions), of NPL exposures, at least in the

medium term. While expectations about changes in macroeconomic conditions can

play a role in determining target levels (if based on solid external forecasts), they

should not be the sole driver for the established NPL reduction targets.

Targets should be established at least along the following dimensions:

• by time horizons, i.e. short-term (indicative 1 year), medium-term (indicative 3

years) and possibly long-term;

• by main portfolios (e.g. retail mortgage, retail consumer, retail small businesses

and professionals, SME corporate, large corporate, commercial real estate);

• by implementation option chosen to drive the projected reduction, e.g. cash

recoveries from hold strategy, collateral repossessions, recoveries from legal

proceedings, revenues from sale of NPLs or write-offs.

As required for securitisations under Article 82(1) CRD.

For short to medium-term targets international benchmarks are less relevant.

Guidance to banks on non-performing loans − NPL strategy

For high NPL banks, the NPL targets should at a minimum include a projected

absolute or percentage NPL exposure reduction, both gross and net of provisions,

not only on an overall basis but also for the main NPL portfolios. Where foreclosed

assets are material

, a dedicated foreclosed assets strategy should be defined or, at

least, foreclosed assets reduction targets should be included in the NPL strategy. It

is acknowledged that a reduction in NPEs might involve an increase in foreclosed

assets for the short term, pending the sale of these assets. However, this timeframe

should be clearly limited as the aim of foreclosures is a timely sale of the assets

concerned. The supervisory expectation for the valuation and approach to foreclosed

assets is included in section 7.5. This should be reflected in the NPL strategy.

The targets described should be aligned with more granular operational targets. Any

of the monitoring indicators discussed in detail in section 3.5.3 can be implemented

as an additional target if deemed appropriate, e.g. related to NPL flows, coverage,

cash recoveries, the quality of forbearance measures (e.g. redefault rates), the

status of legal actions or the identification of non-viable (denounced) exposures. It

should be ensured that such additional NPL targets have an appropriate focus on

high risk exposures, e.g. legal cases or late arrears.

Example 1 shows high-level quantitative targets which have been implemented by

Greek significant institutions in 2016. Targets were initially defined for all main

portfolios on a quarterly basis for the first year. Each of these high-level targets was

also accompanied by a standard set of more granular monitoring items, e.g. NPE

ratio and coverage ratio for Target 1 or a breakdown of sources of collections for

Target 3.

Example 1

Example of high-level NPL targets implemented by Greek SIs in 2016

Result-oriented operational targets

1 NPE Volume (Gross)

2 NPL Volume (Gross)

3 Cash recoveries (collections, liquidations and sales) from NPEs / Total average NPEs

Sustainable solutions-oriented operational target

4 Loans with long term modifications / NPE plus Performing forborne exposures with Long Term Modifications

Action-oriented operational targets

5 NPE >720 dpd not denounced / (NPE >720 dpd not denounced + denounced)

6 Denounced loans for which legal action has been initiated / Total denounced loans

7 Active NPE SMEs

for which a viability analysis has been conducted in the last 12 months / Active NPE SMEs

8 SME and Corporate NPE common borrowers

for which a common restructuring solution has been implemented

9 Corporate NPE for which the bank(s) have engaged a specialist for the implementation of a company restructuring plan

For example if the ratio of foreclosed assets over total loans plus foreclosed assets is significantly

above the average for EU banks having the option to foreclose assets.

A company/ business is considered as “active” when it is not “idle”. The term “idle business” is based

on Greek law and refers to businesses with no activity during the reference period.

“Common” refers to debtors that have exposures with more than one bank.

Guidance to banks on non-performing loans − NPL strategy

Banks running the NPL strategy process for the first time will likely have a stronger

focus on qualitative targets for the short-term horizon. The aim here is to address the

deficiencies identified during the self-assessment process and thus establish an

effective and timely NPL management framework which allows the successful

implementation of the quantitative NPL targets approved for the medium to long-term

horizon.

2.3.3 Operational plan

The NPL strategy of a high NPL bank should be supported by an operational plan

which is also approved by the management body. The operational plan should

clearly define how the bank will operationally implement its NPL strategy over a time

horizon of at least 1 to 3 years (depending on the type of operational measures

required).

The NPL operational plan should contain at a minimum:

• clear time-bound objectives and goals;

• activities to be delivered on a segmented portfolio basis;

• governance arrangements including responsibilities and reporting mechanisms

for defined activities and outcomes;

• quality standards to ensure successful outcomes;

• staffing and resource requirements;

• required technical infrastructure enhancement plan;

• granular and consolidated budget requirements for the implementation of the

NPL strategy;

• interaction and communication plan with internal and external stakeholders (e.g.

for sales, servicing, efficiency initiatives etc.).

The operational plan should put a specific focus on internal factors that could present

impediments to a successful delivery of the NPL strategy.

2.4 Implementing the operational plan

The implementation of the NPL operational plans should rely on suitable policies and

procedures, clear ownership and suitable governance structures (including

escalation procedures).

Any deviations from the plan should be highlighted and reported to the management

body in a timely manner with appropriate remediation actions to be put in place.

Guidance to banks on non-performing loans − NPL strategy

Some high NPL banks might need to incorporate wide-ranging change management

measures in order to integrate the NPL workout framework as a key element in the

corporate culture.

2.5 Embedding the NPL strategy

As execution and delivery of the NPL strategy involves and depends on many

different areas within the bank, it should be embedded in processes at all levels of

an organisation, including strategic, tactical and operational.

Information

High NPL banks should put significant emphasis on communicating to all staff the

key components of the NPL strategy in line with the approach taken for the

institutions’ overall strategy and vision. This is especially important if the

implementation of the NPL strategy involves wide-ranging changes to business

procedures.

Ownership, incentives, management goals and performance

monitoring

All banks should clearly define and document the roles, responsibilities and formal

reporting lines for the implementation of the NPL strategy, including the operational

plan.

Staff and management involved in NPL workout activities should be provided with

clear individual (or team) goals and incentives geared towards reaching the targets

agreed in the NPL strategy, including the operational plan. These incentives should

be effective and should not be superseded by other, potentially contrary incentives.

Related remuneration policies and performance monitoring frameworks should take

the NPL targets sufficiently into account.

Business plan and budget

All relevant components of the NPL strategy should be fully aligned with and

integrated into the business plan and budget. This includes, for example, the costs

associated with the implementation of the operational plan (e.g. resources, IT, etc.)

but also potential losses stemming from NPL workout activities. Some banks might

find it useful to establish dedicated NPL loss budgets for the latter to facilitate

internal business control and planning.

Guidance to banks on non-performing loans − NPL strategy

Risk control framework and culture

The NPL strategy should be fully embedded in the risk control framework. In that

context, special attention should be paid to:

• ICAAP

: All relevant components of the NPL strategy should be fully aligned

with and integrated into the ICAAP. High NPL banks are expected to prepare

the quantitative and qualitative assessment of NPL developments under base

and stressed conditions including the impact on capital planning;

• RAF

: RAF and NPL strategy are closely interlinked. In this regard, there

should be clearly defined RAF metrics and limits approved by the management

body which are in alignment with the core elements and targets forming part of

the NPL strategy;

• Recovery plan

: Where NPL-related indicator levels and actions form part of

the recovery plan, banks should ensure they are in alignment with the NPL

strategy targets and operational plan.

A strong level of monitoring and oversight by risk control functions in respect of the

formulation and implementation of the NPL strategy (including operational plan)

should also be ensured.

2.6 Supervisory reporting

High NPL banks should report their NPL strategy, including the operational plan, to

their Joint Supervisory Teams (JSTs) in the first quarter of each calendar year. To

facilitate comparison, banks should also submit the standard template, as included in

Annex 7 of this guidance, summarising the quantitative targets and the level of

progress made in the past 12 months against plan. This standard template should be

submitted on an annual basis. The management body should approve these

documents prior to submission to supervisory authorities.

For a smooth process, banks should consult with JSTs at an early stage in the NPL

strategy development process.

As defined in Article 108 of Directive 2013/36/EU of the European Parliament and of the Council of 26

June 2013, on access to the activity of credit institutions and the prudential supervision of credit

institutions and investment firms (OJ L 176, 27.6.2013, p. 338), known as the CRD; see also Glossary.

As described in the Financial Stability Board’s “Principles for An Effective Risk Appetite Framework”;

See also section 7.2.4.

Guidance to banks on non-performing loans − NPL governance and operations

Foreclosed assets

If foreclosure is a part of banks’ NPL strategy, they should also monitor the volume,

ageing, coverage and flows in their portfolios of foreclosed assets (or other assets

stemming from NPLs). This should include sufficient granularity of material types of

assets. Furthermore, the performance of the foreclosed assets with respect to the

predefined business plan should be monitored in an appropriate way and reported to

the management body and other relevant managers on an aggregate level.

Early warning indicators

The management body, relevant committees and other relevant managers should

receive periodic reports about the early warning (or “watch-list”) status for segments

where downward trends are expected as well as the watch-list status at

exposure/borrower level for large exposures. The reporting should also include the

movement of the portfolio over time, e.g. monthly migration effects between the

levels of arrears (0 dpd, >0-30dpd, >30-60dpd, >60-90dpd, >90dpd). Indicators of

EWI effectiveness should also be included.

Miscellaneous

Other aspects that might be relevant for NPL reporting would include the efficiency

and effectiveness of outsourcing/servicing agreements. Indicators used for this are

most likely very similar to those applied to monitor the efficiency and effectiveness of

internal NPL WUs, though potentially less granular.

Generally, where NPL-related KPIs differ from a regulatory and an accounting or

internal reporting viewpoint, these differences should be clearly reported to the

management body and explained.

3.6 Early warning mechanisms/watch-lists

3.6.1 Early warning procedure

In order to monitor performing loans and prevent the deterioration of credit quality, all

banks should implement adequate internal procedures and reporting to identify and

manage potential non-performing clients at a very early stage.

Guidance to banks on non-performing loans − NPL governance and operations

Example 4

Example of early warning approach

The above example shows a generic early warning process including the different

steps and parties involved:

• early warning engine owned by the back office;

• early warning alert handling by the front office;

• potential hand-over to NPL units in the case of deteriorating credit quality;

• quality assurance and control via second and third lines of defence.

The following sections detail each of the process steps. It is important to note that

each step in the early warning (or watch-list) process should have clear owners.

Furthermore, adequate reporting and escalation procedures should be established,

and the process should be compatible with the procedures implemented for NPL

reporting and the hand-over of borrowers that become non-performing to the NPL

WUs.

3.6.2 Early warning engines/indicators

Banks should develop a suitable set of EWIs for each portfolio.

The computation of key EWIs should be carried out at least monthly. For certain

specific EWIs (e.g. research at industry/segment/portfolio or borrower level), updates

might be available less frequently.

NPL units

Internal data

(corporates

and retail )

External dat a

(e.g. credit

registers,

resear ch,

rating s)

Early warning

engine

Alerts

Aut omatic

alert s in front

of fice syst ems

Timely actions

taken by

relationship

manager

Early warning policies

Issue

tackled?

Alert closed

Yes

Early arrears/

NPL process

Independent qualit y assurance of early warning/watch

-list process

Regular reporting

Back office

Front office

Quality assurance and control

Ot her alert s

(e.g. based on

client

interaction)

Guidance to banks on non-performing loans − NPL governance and operations

In order to identify early signals of deterioration of performing clients the bank should

have a dual perspective: portfolio and transaction/borrower level.

Transaction/borrower level EWIs

At transaction/borrower level, EWIs should be involved in the credit monitoring

process to promptly trigger recovery procedures, as well as in the management

reporting system as a quality indicator of performing loans.

EWIs should be set on the basis of internal or external input data/information and

refer to a point in time or an observation period. Examples of EWIs could be internal

score systems (including behavioural) or external data issued by rating agencies,

specialised sector research, or macroeconomic indicators for business focused on

specific geographical areas.

The early warning engine should analyse the multiple data inputs and establish clear

outputs in the form of triggers which then initiate different types of alerts and actions.

Annex 4 includes several examples of EWIs used by different banks as inputs into

the EW engine.

Portfolio-level EWIs

In addition to borrower-level EWIs, banks should also determine EWIs at the portfolio

level. They should first segment the credit risk portfolio into different classes, e.g. by

business lines/client segments, geographical area, products, concentration risks,

level of collateralisation and type of collateral provided, or debt-service ability.

For each subcategory the bank should then perform specific sensitivity analyses

based on internal and external information (e.g. market overview released by

external providers regarding specific sectors or area) in order to identify the portions

of the portfolio which could be affected by potential shocks. This analysis should at

least enable a sorting of the buckets in terms of riskiness. Policies should provide a

set of measures with the level of depth increasing as a function of the expected risk.

Afterwards, banks should identify specific EWIs in relation of each class of risk to

detect potential credit deterioration before negative events occurring at transaction

level.

On identifying potential trigger events at the level of a portfolio, segment or client

group, the banks should undertake a review of the portfolio concerned, define

measures and involve both the first and second lines of defence in mitigation actions.

Guidance to banks on non-performing loans − NPL governance and operations

3.6.3 Automated alerts and actions

The front office should be provided with effective tools and operational reporting

instruments customised to the relevant portfolio/borrower types, which give them the

opportunity to promptly identify the first signals of client deterioration. This should

include automated alerts at borrower level with a clear workflow and indications of

required actions as well as timelines, all of which should be aligned with the early

warning policies. Actions taken should be clearly tracked in the systems, so that

quality assurance processes can follow up.

The alerts to the relationship managers and related operational and management

reporting should be carried out at least monthly.

In the case of breaches of a set of EWIs or clearly evaluated and defined single

indicators (e.g. 30dpd), a clear trigger followed by a defined escalation process

should be activated. The involvement of dedicated units to assess the financial

situation of the client and discuss potential solutions with the counterparty should be

envisaged.

Finally, it should be noted that further to the automated alerts, alerts arising from, for

example, interactions with the borrower might play a role in the early warning

approach as well – relationship managers should always be alert to borrower

information that might impact the borrower’s creditworthiness.

3.7 Supervisory reporting

Material and structural changes in the NPL operating model or control framework

should be communicated to the respective supervisory teams in a timely fashion.

Furthermore, high NPL banks should proactively share periodic NPL monitoring

reports, at a suitable level of aggregation, with the supervisor.

Guidance to banks on non-performing loans − Forbearance

4 Forbearance

4.1 Purpose and overview

The key objective of granting forbearance

measures is to pave the way for non-

performing borrowers to exit their non-performing status, or to prevent performing

borrowers from reaching a non-performing status. Forbearance measures should

always aim to return the exposure to a situation of sustainable repayment.

However, supervisory experience has shown that in many cases, forbearance

solutions granted by banks to borrowers in financial difficulties are not fully in line

with that objective and thus may delay necessary actions to tackle asset quality

issues and lead to a misrepresentation of asset quality on the balance sheet. This is

the case, for instance, when forbearance measures consist of repeated grace

periods but do not address the fundamental issue of the over-indebtedness of a

borrower compared with its repayment capacities.

For this reason, this chapter has a particular focus on viable forbearance solutions.

The supervisory expectation is that banks should implement well-defined

forbearance policies aligned with the concept of viability and recognise in a timely

manner those borrowers who are non-viable.

The chapter starts with an overview of forbearance options and provides guidance

on how to distinguish between viable and non-viable forbearance measures

(section 4.2). It then expands on important aspects with regard to forbearance

processes, with the focus on affordability assessments (sections 4.3 and 4.4) and on

supervisory reporting and public disclosures (section 4.5).

In addition, chapter 5 provides guidance regarding the criteria for classifying forborne

exposures as non-performing or performing.

4.2 Forbearance options and their viability

When looking at different forbearance solutions, it is useful to distinguish between

short-term and long-term measures implemented via forbearance. Most solutions will

involve a combination of different forbearance measures, potentially over a different

time horizon with a mix of short-term and long-term options.

The guidance in this chapter applies to forbearance as defined by the EBA and elaborated in section

5.3. See the EBA Implementing Technical Standards on supervisory reporting on forbearance and non-

performing exposures under Article 99(5) of Regulation (EU) No 575/2013. Based on Commission

Implementing Regulation (EU) 2015/227 of 9 January 2015 amending Implementing Regulation (EU)

No 680/2014 laying down implementing technical standards with regard to supervisory reporting of

institutions according to Regulation (EU) No 575/2013 of the European Parliament and of the Council

(OJ L 48, 20.2.2015, p. 1).

Guidance to banks on non-performing loans − Forbearance

Short-term forbearance measures are defined as restructured repayment conditions

of a temporary nature designed to address financial difficulties in the short-term, but

which do not address the resolution of outstanding arrears unless combined with

suitable long-term measures. Such short-term measures should generally not

exceed two years and, in the case of project finance and the construction of

commercial property, one year.

Short-term forbearance measures should be considered and offered when the

borrower meets the two following criteria.

• The borrower has experienced an identifiable event which has caused

temporary liquidity constraints. Evidence of such an event should be

demonstrated in a formal manner (and not speculatively) via written

documentation with defined evidence showing that the borrower’s income will

recover in the short-term or on the basis of the bank concluding that a long-term

forbearance solution was not possible due to a temporary financial uncertainty

of a general or borrower-specific nature.

• The borrower has tangibly exhibited a good financial relationship with the bank

(including significant repayment of capital outstanding prior to the event) and

demonstrates clear willingness to cooperate.

The contractual terms for any forbearance solution should ensure that the bank has

the right to review the agreed forbearance measures if the situation of the borrower

improves and more favourable conditions for the bank (ranging from the forbearance

to the original contractual conditions) could therefore be enforced. The bank should

also consider including strict consequences in the contractual terms for borrowers

who fail to comply with the forbearance agreement (e.g. additional security).

Viable versus non-viable forbearance

Banks and supervisors have a clear need to distinguish between “viable

forbearance” solutions, i.e. those that truly contribute to reducing the borrower’s

balance of credit facilities, and “non-viable” forbearance solutions.

The following list outlines general supervisory guidance for the categorisation of

viable forbearance (further guidance on individual forbearance options is provided in

the table below):

• In general, a forbearance solution including long-term forbearance measures

should only be considered viable where:

• The institution can demonstrate (based on reasonable documented

financial information) that the borrower can realistically afford the

forbearance solution.

• The resolution of outstanding arrears is fully addressed and a significant

reduction in the borrower’s balance in the medium to long term is

expected.

Guidance to banks on non-performing loans − Forbearance

• In cases where there have been previous forbearance solutions granted in

respect of an exposure, including any previous long-term forbearance

measures, the bank should ensure that additional internal controls are

implemented to ensure this subsequent forbearance treatment meets the

viability criteria as outlined below. These controls should include, at a

minimum, that such cases are explicitly brought to the attention of the risk

control function ex ante. Furthermore, explicit approval of the relevant

senior decision-making body (e.g. NPL Committee) should be sought.

• In general, a forbearance solution including short-term forbearance measures

should only be considered viable where:

• The institution can demonstrate (based on reasonable documented

financial information) that the borrower can afford the forbearance solution.

• Short-term measures are truly applied temporarily and the institution has

satisfied itself and is able to attest, based on reasonable financial

information, that the borrower demonstrates the ability to repay the original

or agreed modified amount on a full principal and interest basis

commencing from the end of the short-term temporary arrangement expiry

date.

• The solution does not result in multiple consecutive forbearance measures

having been granted to the same exposure.

As indicated in the listed criteria, any assessment of viability should be based on the

financial characteristics of the debtor and the forbearance measure to be granted at

that time. It should also be noted that the viability assessment should take place

irrespective of the source of forbearance (for instance debtor using forbearance

clauses embedded in a contract, bilateral negotiation of forbearance between a

debtor and a bank, public forbearance scheme extended to all debtors in a specific

situation).

List of most common forbearance measures

As indicated above, most forbearance solutions will involve a combination of different

measures. The table below summarises the most common short-term and long-term

forbearance measures and provides further indications with regard to viability

considerations. It should be noted that package of long-term measures might include

short-term measures such as interest only, reduced payments, grace period or

arrears capitalisation for a limited timeframe, as indicated above.

Guidance to banks on non-performing loans − Forbearance

List of most common forbearance measures

Forbearance measure Description Viability and other important considerations

Short-term measures

1. Interest only During a defined short-term period, only interest is paid

on credit facilities and no principal repayment is made.

The principal amount thus remains unchanged and the

terms for the repayment structure are reassessed at

the end of the interest-only period, subject to the

assessed repayment ability.

This measure should only be granted/considered viable if the institutions can demonstrate

(based on reasonable documented financial information) that the financial difficulties

experienced by the borrower are of a temporary nature and that after the defined interest-

only period the borrower will be able to service the loan at least based on the previous

repayment schedule.

The measure should generally not exceed a period of 24 months and, in the case of

construction of commercial property and project finance, 12 months.

Once the defined period of this forbearance measure is over, institutions should reassess

the borrower’s debt servicing capacity in order to proceed with a revised repayment

schedule that is able to account for the unpaid capital element during this interest-only

period.

In most cases, this measure will be offered in combination with other measures of a

longer-term nature to compensate for the temporary lower repayments (e.g. extension of

maturity).

2. Reduced payments Decrease of the amount of repayment instalments over

a defined short-term period in order to accommodate

the borrower’s affected cash flow situation and then

continue with the repayments on the basis of projected

repayment ability. The interest remains to be paid in

full.

See “1. Interest only”

If the amount of payment reduction is moderate and all other conditions mentioned above

are met, this measure could be applied for a period longer than 24 months.

3. Grace period/payment

moratorium

An agreement allowing the borrower a defined delay in

fulfilling the repayment obligations, usually with regard

to the principal and interest.

See “1. Interest only”

4. Arrears/interest

capitalisation

Forbearance of arrears and/or accrued interest arrears

by the addition of those unpaid amounts to the

outstanding principal balance for repayment under a

sustainable rescheduled programme.

The measure should only be granted/considered viable where the institution has assessed

that the borrower’s verified income/expenditure levels (based on reasonable documented

financial information) and the proposed revised repayments are sufficient to enable the

borrower to service the revised loan repayment on a principal and interest basis for the

duration of the revised repayment schedule; and where the institution has formally sought

confirmation that the customer understands and accepts the capitalisation conditions.

Arrears capitalisation should only be provided selectively in cases where the recovery of

historical arrears or payments due under the contract is not possible and capitalisation is

the only option realistically available.

Institutions should generally avoid offering this measure to a borrower more than once;

and the measure should only be applied to arrears that do not exceed a predefined size

relative to the overall principal (which should be defined in the bank’s forbearance policy).

The institution should assess the percentage of arrears being capitalised compared to the

principal and interest repayments as adequate and appropriate for the borrower.

Long-term measures

5. Interest rate reduction Permanent (or temporary) reduction of interest rate

(fixed or variable) to a fair and sustainable rate.

Credit facilities with high interest rates are one of the common causes of financial distress.

The

financial difficulties of a borrower may partly derive from the fact that the interest rates

are excessively high compared to the income of the borrower or from the fact that the

evolution of interest rates, as opposed to a fixed rate, has resulted in the borrower

receiving finance at an exorbitant cost, compared with prevailing market conditions. In

such cases, an interest rate reduction could be considered.

However, banks should ensure that the relevant credit risk is sufficiently covered by the

interest rate offered to the borrower.

It should be clearly flagged if the affordability can only be achieved at below-risk or below

cost rates.

6. Extension of maturity/term Extension of the maturity of the loan (i.e. of the last

contractual loan instalment date), which allows a

reduction in instalment amounts by spreading the

repayments over a longer period.

If the borrower is subject to a compulsory retirement age, term extension should only be

considered viable where the institution has assessed and can demonstrate that the

borrower can, through a pension or other sources of verified income, service the revised

loan repayments on an affordable basis.

7. Additional security When additional liens on unencumbered assets are

obtained as additional security from the borrower in

order to compensate for the higher risk exposure and

as part of the restructuring process.

This option is not a viable standalone forbearance measure as it does not by itself resolve

the presence of arrears on a loan. It usually aims to improve or cure loan-to-value (LTV)

ratio covenants.

Additional security may take many forms, such as a pledge on a cash deposit, assignment

Taking additional security does not automatically result in a classification of the respective

exposure/client as “forborne”, although in most cases it coincides with forbearance measures being

taken.

Guidance to banks on non-performing loans − Forbearance

of receivables or a new/additional mortgage on immovable property.

Institutions should value second and third liens on assets as well as personal guarantees

with care.

8. Sale by agreement/assisted

sale

When the bank and the borrower agree to voluntarily

dispose of the secured asset(s) to partially or fully

repay the debt.

The institution should restructure any residual debt post the assisted sale with an

appropriate repayment schedule in line with the borrower’s reassessed repayment ability.

For forbearance solutions which may require the sale of the property at the end of the

term, banks should conservatively consider the future approach to any shortfall that could

remain after the sale of the property and address it as early as possible.

For loans that are repaid by repossession of collateral at a predefined moment, the

repossession does not constitute a forbearance measure unless it is exercised ahead of

the predefined moment due to financial difficulties.

9. Rescheduled payments The existing contractual repayment schedule is

adjusted to a new sustainable repayment programme

based on a realistic, current and forecasted

assessment of the borrower’s cash flows

Different repayment example options include:

i. Partial repayment: When a payment is made against the credit facility, e.g. from a sale

of assets that is lower than the outstanding balance. This option is applied to

significantly reduce the exposure at risk and to enable a sustainable repayment

programme for the remaining outstanding amount. This option should be preferred to

the bullet or step-up options described below.

ii. Balloon or bullet payments: When the rescheduled repayment ensures a large

payment of the principal at a later date before loan maturity. This option should only be

used/considered viable in exceptional circumstances and when the institution can duly

demonstrate future cash flow availability by the borrower to meet the balloon or bullet

payment.

iii. Step-up payments: Institutions should only consider a solution including this option

viable when they can ensure, and are able to demonstrate, that there is good reason to

expect that future increases in payments can be met by the borrower.

10. Conversion of currency When the currency of the debt is aligned to the

currency of the cash flows.

Banks should explain fully to borrowers the risks of foreign exchange and should also

refer to currency conversion insurance.

11. Other alteration of

contract conditions/covenants

When the bank discharges the borrower of covenants

or conditions included in a loan agreement not yet

listed above.

12. New credit facilities Providing new financing arrangements in order to

support the recovery of a distressed borrower.

This is usually not a standalone viable forbearance solution, but should be combined with

other forbearance measures addressing existing arrears. It should only be applied in

exceptional cases.

New credit facilities may be granted during a restructuring agreement, which may entail

the pledge of additional security. In the case of inter-creditor arrangements, the

introduction of covenants should be necessary to compensate for the additional risk

incurred by the bank.

This option should be usually applied for corporate exposures only and a thorough

assessment of the borrower’s ability to pay should be performed, including sufficient

involvement of independent sector experts to judge on the viability of provided business

plans and cash-flow projections. It should only be considered viable when the thorough

affordability assessment demonstrates repayment capacity in full.

13. Debt consolidation Entails the combination of multiple exposures into a

single loan or a limited number of loans.

This is usually not a viable standalone forbearance measure, but needs to be combined

with other forbearance measures addressing existing arrears.

This option is particularly beneficial in situations where combining collateral and secured

cash flows provides greater overall security coverage for the entire debt than individually.

For example, by minimising cash leaks or by facilitating re-allocation of cash flow surplus

between exposures.

14. Partial or total debt

forgiveness

This corresponds to the bank forfeiting the right to

legally recover part or the whole of the amount of debt

outstanding by the borrower.

This measure should be used where the bank agrees to a “reduced payment in full and

final settlement”, whereby the bank accepts to forgive all of the remaining debt if the

borrower repays the reduced amount of the principal balance within an agreed timeframe.

Banks should apply debt forgiveness options carefully since the possibility of forgiveness

can give rise to moral hazard and thus might encourage “strategic defaults”. Therefore,

institutions should define specific forgiveness policies and procedures to ensure strong

controls are in place.

The above list of measures is not to be considered exhaustive and there may be

further common forbearance approaches also linked to national specificities. One

example is the split loan solution as applied in certain jurisdictions for non-performing

residential mortgages, which has been developed as a consequence of difficulties in

enforcing the underlying collateral.

Guidance to banks on non-performing loans − Forbearance

4.3 Sound forbearance processes

Further to the guidance provided on the governance and operation of NPL workout

processes in chapter 3 of this guidance (e.g. referring to separate NPL WUs for

forbearance activities), this section highlights further best practices specifically

related to forbearance processes.

No forbearance without borrower affordability assessment

Before granting any forbearance measures, the lending officer responsible should

conduct a complete assessment of the borrower’s financial situation. This includes

the assessment of all relevant factors, taking particular account of the debt servicing

capacity and overall indebtedness of the borrower or the property/project. This

assessment should be based on documented current and verified financial

information. (See section 4.4 for more details on affordability assessments).

Standardised forbearance products and decision trees

The institution should have adequate policies and procedures in place with a range

of sustainable and effective solutions for the borrower when granting forbearance.

Portfolio segmentation (see section 3.3.2) is a key part of any strategy as it enables

the institutions to adopt and tailor different forbearance solutions to different

segments of the loan books.

In this context, the institution should consider developing “decision trees” and related

standardised forbearance solutions (or “products”) for segments of heterogeneous

borrowers with less complex exposures. Decision trees may help to determine and

implement appropriate and sustainable forbearance (and more generically NPL

workout) strategies for specific segments of borrowers in a consistent manner based

on approved criteria. They may also help to foster the standardisation of processes.

Comparison with other NPL workout options

Banks should use a net present value (NPV) approach to determine the most

suitable and sustainable workout option for borrowers’ varied circumstances, i.e. the

NPV of the envisaged forbearance solution should be compared with the NPV of

repossession and other available liquidation options. Parameters used in the

calculation, such as the assumed liquidation time horizon, discount rate and extent of

reflection of capital cost, and liquidation cost should be based on observed empirical

data. Banks should review the range of workout options on an on-going basis and

investigate the feasibility of new/alternative options.

Guidance to banks on non-performing loans − Forbearance

Forbearance milestones and monitoring

The forbearance contract and documentation should include a well-defined borrower

milestone target schedule, detailing all necessary milestones to be achieved by the

borrower in order to repay the loan over the course of the contract term. These

milestones/targets should be credible, appropriately conservative and take account

of any potential deterioration of the borrower’s financial situation. The performance of

the forborne borrower, including the borrower’s compliance with all agreed

milestones/targets, should be closely monitored by the NPL WU responsible for

granting the forbearance, at least for the duration of the EBA-defined probation

period.

Based on the collective monitoring of the performance of different forbearance

options and on the examination of potential causes and instances of re-defaults

(inadequate affordability assessment, issue with the characteristics of the

forbearance treatment product, change in the borrower’s conditions, external

macroeconomic effects etc.), institutions should regularly review their forbearance

policies and products.

4.4 Affordability assessments

The affordability assessment of the borrower should be based on the borrower’s

current and conservatively assessed prospective future servicing capacity for all

borrowings. In this context, assumed prospective future increases in the debt

servicing ability of the borrower should be credible and conservative.

The main areas for banks to analyse in the context of a borrower affordability

assessment, depending on the segment, are the following:

• regular/recurring income;

• expenditure;

• other assets;

• other debt;

• reasonable living expenses;

• employment prospects;

• property attractiveness/outlook;

• cash flows and business plan (also see section 6.2.4);

• willingness to repay (behaviour history) and cooperativeness.

For the comprehensive and verified disclosure of the borrower’s financial position in

order to analyse exposures, institutions should develop standardised financial

information templates for retail borrowers and homogeneous segments of corporate

Guidance to banks on non-performing loans − Forbearance

borrowers (if proportionate). Internal processes should ensure the proper and timely

completion of these templates.

External information sources like central credit registers should also be used to

inform the bank regarding the overall indebtedness of the borrower and to analyse

the wider borrower behaviour profile.

The affordability assessment should be based on reasonable documented and

verified borrower income and expenditure levels. Banks should satisfy themselves,

and be able to demonstrate, that appropriate conservatism has been applied in

relation to the variable elements of current income that are taken into account. In

particular, the assumptions used should be fair and reasonable and should

incorporate key economic indicators relevant to the future capacity of the borrower.

For example, variable elements of pay and/or rental income etc. should be

discounted (applying haircuts) to reflect the possibility that they will not be realised.

All assumptions should be documented on the credit file to ensure that an audit trail

is in place.

Future income increases should only be taken into account where there is sound

reason to expect that those increases will be realised. Banks should also satisfy

themselves, and be able to demonstrate, that adequate conservatism has been

applied in considering the extent to which future increases are taken into account.

Unless specific information exists to the contrary, assumed salary increases,

bonuses, overtime, career progression, increases in rental income and any other

increases should not be out of line with industry/sector/market norms and may need

to be discounted (applying haircuts) to reflect the risk that they will not be fully

realised.

Annex 6 specifies borrower affordability assessment and documentation

expectations in more detail for retail and corporate borrowers.

4.5 Supervisory reporting and public disclosures

Supervisors expect consistent disclosures on forbearance, especially on key areas

including credit quality of forbearance, quality and effectiveness of forbearance and

ageing profile of forbearance on a regulatory portfolio basis. To facilitate consistent

disclosures on forbearance, banks should submit the quantitative information and

standard templates as included in the Annex 7 of this guidance. The management

body should approve this information prior to submission to supervisory authorities.

For examples of templates issued by the Central Bank of Cyprus and Central Bank of Ireland

see: Template Cyprus and Template Ireland

Guidance to banks on non-performing loans − NPL recognition

5 NPL recognition

5.1 Purpose and overview

NPE definition

The commonly used term “non-performing loan” (NPL) is based on different

definitions. The EBA therefore issued a uniform definition of “non-performing

exposure” (NPE) in order to overcome the problems deriving from the existence of

different definitions.

However, the NPE definition is – strictly speaking – currently only binding for

supervisory reporting purposes.

Nevertheless, institutions are strongly encouraged

to use the NPE definition also in their internal risk control and public financial

reporting. Furthermore, the NPE definition is used in several relevant supervisory

exercises (e.g. SSM asset quality review (AQR), EBA stress test and transparency

exercises).

The purpose of this chapter is to provide a short outline on selected issues regarding

the definition and recognition of NPEs in accordance with the EBA definition and to

give some best practice examples to reduce the diversity in implementation.

Section 5.2 starts by providing guidance on the definition of NPEs, as referred to in

Commission Implementing Regulation (EU) No 680/2014 (referred to as the “EBA

ITS on supervisory reporting”)

, with the aim of ensuring the consistent

implementation of the key drivers of the NPE definition, namely the “past-due”

criterion and the “unlikely-to-pay” criterion. Section 5.3 deals with the close links

between the NPE definition and the forbearance definition. Section 5.4 addresses

further important aspects related to the consistent and accurate implementation of

the NPE definition, such as the identification of identical or connected clients.

Regulatory versus accounting view

Section 5.5 explains the links between the supervisory definition of NPEs and the

accounting definition of “impaired” (International Accounting Standard (IAS) 39) and

the prudential definition of “default” (CRR). One of the aims of the NPE definition is

to make data more comparable by overcoming the differences in the default and

Information on NPEs is collected regularly in the context of financial reporting using several FINREP

templates, including in table F.18 of Annexes III and IV of Commission Implementing Regulation (EU)

680/2014, in which performing and non-performing exposures, and associated accumulated credit

losses, are broken down by measurement basis, type of exposure, counterparty and trigger for

classification as NPEs.

See footnote 29.

Guidance to banks on non-performing loans − NPL recognition

impaired definition across the EU. To this extent, the non-performing definition

should act as a harmonised asset quality concept.

In recent years, a significant amount of guidance has emerged of relevance to the

regulatory default definition, most notably the “Guidelines on the application of the

definition of default under Article 178 of Regulation (EU) No 575/2013” (EBA GL

2016/07) and the “Regulatory Technical Standards on the materiality threshold for

credit obligations past due under Article 178 of Regulation (EU) No 575/2013” (EBA

RTS 2016/06). In addition, the Basel Committee on Banking Supervision’s Guidance

on credit risk and accounting for expected credit losses (referred to as “BCBS

Guidance on CRAECL”) was published in December 2015.

Paragraph 147 of Annex V of the EBA ITS on supervisory reporting states that

“Exposures in respect of which a default is considered to have occurred in

accordance with Article 178 CRR and exposures that have been found impaired in

accordance with the applicable accounting framework shall always be considered as

non-performing exposures”.

The relationship between the different definitions can be seen in the graph below.

NPE is a concept potentially broader than the concept of “impaired” and “default”. All

impaired exposures and all defaulted exposures are necessarily NPEs, but NPEs

can also encompass exposures that are not recognised as impaired or as defaulted

in the applicable accounting or regulatory framework. The exact relationship will be

treated in section 5.5.

Figure 2

Illustrative connection between NPE, defaulted and impaired definitions

NPE: EBA-ITS

Default: CRR Art. 178

Impaired: IAS / IFRS

Althoug h ther e may be some differences

in categ orisations, for most

exposures the three concepts ar e ali g ned (

impaired=default=NPE).

Main driver of t he dif ferences (if they e xi st) is

the extent to

whi c h the automatic fact or

of 90

da ys p ast d ue

use d in NPE is not ap pli ed

f or

impaired

Main drivers of the di ff ere nces (if they e xi st)

are the e xt ent to which a ut om atic fact ors

used in NPE ar e n ot applied for d ef ault, s uch

as:

• 1-year cur e peri od

to exi t NPE

• oth er expos ures p ast du e > 90 da ys p as t

due prevent exiting NPE

• NPE d ue to sec on d f or b earance or 30

da ys pas t d ue of a p erfor mi ng forborne in

probation

• NPE due to 20% “pulling effect”

Guidance to banks on non-performing loans − NPL recognition

5.2 Implementation of the NPE definition

According to paragraph 145 of Annex V of the EBA ITS on supervisory reporting

“non-performing exposures are those that satisfy either or both of the following

criteria:

1. material exposures which are more than 90 days past-due;

2. the debtor is assessed as unlikely to pay its credit obligations in full without

realisation of collateral, regardless of the existence of any past-due amount or

of the number of days past due.”

Therefore, the definition of NPE is based on the “past-due” criterion and the

“unlikely-to-pay” criterion, which are discussed in this section.

5.2.1 Remarks on the “past-due” criterion and day counting

Paragraph 145(a) of Annex V of the EBA ITS on supervisory reporting defines the

past-due criterion. Material exposures with amounts more than 90 days past due are

considered to be non-performing. The materiality threshold to be used should be the

same as in the definition of default in accordance with Article 178 of the CRR, as

specified in the relevant EBA RTS 2016/06 (section 3.4).

An exposure can only be past due if there was a legal obligation to make a payment

and payment is compulsory. In the event that there is no legal obligation or payment

is not compulsory, non-payment does not constitute a breach. For example, non-

payment of discretionary interest on an Additional Tier 1 capital instrument does not

constitute a past-due situation. However, banks should carefully assess whether

non-payment of discretionary interest is linked to other events for classification as

non-performing.

In cases where it is uncertain whether a legal obligation already exists, banks should

carefully consider the situation. When an exposure to a debtor is identified as an

NPE but that NPE identification (most likely via the past-due criterion) actually results

solely from isolated disputes that are unrelated to the solvency of the counterparty,

then other exposures to entities from the same group as the debtor do not need to

be considered as NPEs.

Once the legal obligation for a mandatory payment has been established, the

counting of days past due starts as soon as any material amount of principal, interest

or fee has not been paid at the date it was due.

Banks may use or be required to use cash allocation conventions, such as first in,

first out (FIFO), which assumes that any received payments always settle the earliest

payment obligation missed by the clients. Within the FIFO allocation conventions,

laws or regulations may specify whether a cash payment should first settle unpaid

interest or unpaid principal.

Guidance to banks on non-performing loans − NPL recognition

The definition of NPE does not require the use of a specific allocation convention or

any order of priority between unpaid interest and unpaid principal. The allocation

convention and order of priority used should be the one prescribed by applicable law

or regulation. In the event that applicable laws or regulations are silent, the allocation

and order of priority used should be allowed for in the respective loan contract and

should not contradict any other law or regulation, in particular consumer protection

rights, or insolvency or bankruptcy laws. This may require the use of different

conventions for different contracts. For instance, it means that if the applicable law is

silent and a particular loan contract or other laws prohibit the use of the FIFO

convention, the first past-due instalment on that contract will not be settled until all

other missed instalments have been cleared.

5.2.2 Remarks on the “unlikely-to-pay” criterion

In contrast with triggers relating to past-due payments, the triggers relating to

unlikeliness to pay as referred to in paragraph 145(b) of Annex V of Commission

Implementing Regulation (EU) No 680/2014 rely less on quantitative criteria but

define some events that trigger the non-performing classification. As this gives some

leeway for interpretation, it is imperative for banks to have clearly defined internal

criteria to identify indicators of unlikeliness to pay (UTP). These indicators should

refer to clearly defined situations (UTP events). Banks should ensure that the

definition of NPE and the criteria for identifying UTP are implemented

homogeneously in all parts of the group.

Banks should have pre-defined automatic events – wherever possible – and manual

events in place. In the case of automatic events, the exposure is automatically

identified as non-performing without any further manual inputs or the need for a

manual confirmation. Examples of automatic events are bankruptcy of the debtor,

which can be ascertained based on data from bankruptcy registers, or the booking of

specific credit adjustments. However, most triggers linked to the UTP criterion

require regular manual assessments. Therefore, a bank should regularly assess the

creditworthiness and repayment capacity of its customers. For standard non-retail

customers this should be done, at least, at key reporting dates. These reviews

should be accompanied by updated financial information and an updated rating of

the customer. Banks should collect the latest financial information from non-retail

customers in a timely fashion, ideally based on a contractual requirement for the

customer to provide the credit institution with this information within a given

timescale. The non-provision or the unreasonably late provision of information may

be seen as a negative sign for the customer’s creditworthiness. For customers who

have been identified as financially weak, such as customers on a watch-list or with a

weak rating, more frequent review processes should be in place depending on the

materiality, segment and the customer’s financial standing.

Guidance to banks on non-performing loans − NPL recognition

Realisation of collateral and unlikeliness to pay (UTP)

According to paragraph 148 of Commission Implementing Regulation (EU) No

680/2014, the classification of exposures as non-performing should be done without

taking into account the existence of any collateral. Consequently, all exposures,

even fully collateralised ones, in unlikely-to-pay situations should always be

classified as non-performing.

External data sources and UTP recognition

When relying on external data sources, banks should ensure the equivalence of their

definition of UTP with that of non-performing, or if applicable the default definition

used in the external data sources, including by making adjustments, consistently with

the provisions of Article 178 (4) of the CRR for the definition of default. Examples of

such external data sources are bankruptcy registers, company registers in the event

that different events are registered (bankruptcies, actions and sanctions imposed by

authorities which may indicate a UTP situation), real estate or land registers, pledge

registers (which may provide information on a UTP situation if a third party registers

an enforcement order against a customer) as well as credit registers. Wherever such

data is accessible and provides useful information for the identification of UTP

situations, credit institutions should ensure an automatic data feed from external

sources to their systems. If no automatic data feed can be established, for instance

because no unique identifiers are available, banks should nevertheless check these

registers on a regular basis, e.g. during customer reviews, in order to ensure a

proper identification of UTP situations.

Best practice examples of UTP events

When defining the set of UTP events, banks should take into account the situations

and events listed in the CRR definition of default and in the IFRS definition of

impairment requirements, considering that all defaulted exposures and all impaired

exposures are to be identified as non-performing. Additional triggers to identify NPEs

that are not explicitly listed in Article 178 of the CRR or in the definition of impairment

in the applicable accounting framework should be considered where relevant. The

alignment of UTP events is recommended for operational purposes when setting up

internal CRR default, IFRS impairment and NPE identification processes.

Different sets of UTP triggers may be defined on a portfolio-by-portfolio basis

(mortgages, SMEs, commercial real estate (CRE), corporates, etc.). For instance, for

mortgage portfolios UTP triggers such as debt service coverage capacity or loan to

value (LTV) are highly relevant, whereas in the case of SME portfolios triggers

related to the financial performance of debtors (e.g. decrease of turnover) might be

considered. These reviews should be accompanied by updated financial and non-

financial information and an updated rating of the customer.

Guidance to banks on non-performing loans − NPL recognition

Table 2 below provides supervisory guidance for the implementation of the UTP

triggers. The column on the right-hand side lists UTP events which can be found in

various international banks (best practice) as well as events based on the

impairment triggers used during the AQR exercises in 2014 and 2015 and the Draft

EBA Guidelines on the CRR definition of default. This list is not exhaustive, nor

should it serve as a prescription of a minimum set of UTP criteria. It should rather be

seen as a list of examples and best practices and as an orientation point as to how

the definition of non-performing can be implemented.

Nevertheless, it is expected that the indicators in white will lead directly to a

recognition of non-performing, as in most cases these events, by their very nature,

directly fulfil the definition of UTP and there is little room for interpretation. The

triggers shown in grey are “soft” triggers and should be seen as indicative examples

of UTP. If one of these triggers applies, this does not automatically mean that an

exposure is non-performing, but that a thorough assessment should be performed.

With regard to these soft triggers (i.e. AQR examples), fixed thresholds for single

UTP triggers are difficult to define and calibrate given the differences in underwriting

practices, regulations, tax regimes and average incomes across jurisdictions. Thus,

banks should develop their own thresholds based on national specifics.

The regular assessment of the borrower repayment capabilities should also apply to

bullet loans: the mere continuous payment by the borrower of the interest amounts

due is not enough to assume that the final bullet repayment of the loan will take

place and that the exposure is therefore to be regarded as performing. For bullet

loans, the UTP triggers in the following table should be applied on a selective basis.

Special emphasis should be placed on the availability of refinancing/roll-over options

for such customers, which will depend to a large degree on the financial strength of

the customer and the collateralisation of the loan. In addition, the economic lifetime

of projects and the ability to repay the exposure within this lifetime should be a factor

for determining the correct classification of bullet loans.

Guidance to banks on non-performing loans − NPL recognition

Table 2

Interrelation between non-performing, default and impairment “Unlikely-To-Pay” indicators

Article 178 CRR UTP events IAS 39.58 impairment triggers Non-performing UTP events

White: indicators

Grey: examples

1 (a) The institution considers that the obligor is

unlikely to pay its credit obligations to the

institution, the parent undertaking or any of its

subsidiaries in full, without recourse by the

institution to actions such as realising security.

(a) significant financial difficulty of the issuer or

obligor;

loan is accelerated or called

institution has called any collateral including a guarantee (EBA) *)

lawsuit, execution or enforced execution in order to collect debt

license of the borrower is withdrawn **)

the borrower is a co-debtor when the main debtor is in default

postponements/extensions of loans beyond economic lifetime ***)

postponements/extensions in the event that a significant economic loss is

likely (indicator: balloon payments, strongly increasing payments)

multiple restructurings on one exposure

a borrower’s sources of recurring income are no longer available to meet the

instalment payments (EBA); customer becomes unemployed and repayment

is unlikely

there are justified concerns about a borrower’s future ability to generate

stable and sufficient cash flows (EBA)

the borrower’s overall leverage level has significantly increased or there are

justified expectations of such changes to leverage (EBA); equity reduced by

50% within a reporting period due to losses

for exposures to an individual: default of a company fully owned by a single

individual where this individual provided the institution with a personal

guarantee for all obligations of the company (EBA)

a financial asset was purchased or originated at a material discount that

reflects the deteriorated credit quality of the debtor (EBA)

for retail exposures where the default definition is applied at the level of an

individual credit facility, the fact that a significant part of the total obligation of

the obligor is in default (EBA)

debt service coverage ratio indicates that debt is not sustainable

5Y credit default swaps (CDS) above 1.000 bps in the last 12 months

loss of major customer or tenant

material decrease of turnover/operating cash flows (20%)

connected customer has filed for bankruptcy

restricted or qualified opinion of external auditor

it is expected that a bullet loan cannot be refinanced at current market

conditions

disappearance of refinancing options

fraud cases

(b) a breach of contract, such as a default or

delinquency in interest or principal payments

breach of the maximum LTV in the case of asset-based finance or margin

call not met ****)

This table is not intended to provide a precise mapping of the NPE criteria to either UTP indicators or

the accounting criteria for impairment, but rather to show similarities and possible overlaps.

Guidance to banks on non-performing loans − NPL recognition

the borrower has breached the covenants of a credit contract (EBA)

e) the disappearance of an active market for that

financial asset because of financial difficulties

disappearance of an active market for the debtor's financial instruments

3 (a) Institution puts the credit obligation on non-

accrued status.

relating to the borrower’s financial difficulty,

grants the borrower a concession that the lender

would not otherwise consider

credit institution stops charging of interest (also partially or conditionally)

direct write-off

3 (b) Institution recognises a specific credit

adjustment resulting from a significant perceived

decline in credit quality subsequent to the

institution taking on the exposure.

write-off against provisions

value adjustment (specific loan loss provisions (LLP) booking)

3 (c) Institution sells the credit obligation at a

material credit-related economic loss.

claim sold with loss which is credit-related

3 (d) Institution consents to a distressed

restructuring of the credit obligation where this is

likely to result in a diminished financial obligation

caused by the material forgiveness or

postponement of principal, interest, or, where

relevant, fees. This includes, in the case of equity

exposures assessed under a probability of

default/loss-given default (PD/LGD) approach,

distressed restructuring of the equity itself.

relating to the borrower’s financial difficulty,

grants the borrower a concession that the lender

would not otherwise consider

restructuring with a material part which is forgiven (net present value (NPV)

loss)

restructuring with conditional forgiveness

3 (e) Institution has filed for the obligor's

bankruptcy or a similar order in respect of an

obligor’s credit obligation to the institution, the

parent undertaking or any of its subsidiaries.

d) it is becoming probable that the borrower will

enter bankruptcy or other financial reorganisation

credit institution or leader of consortium starts bankruptcy/insolvency

proceedings

International Swaps and Derivatives Association (ISDA) credit event

declared

out-of-court negotiations for settlement or repayment (e.g. stand-still

agreements)

3 (f) Obligor has sought or has been placed in

bankruptcy or similar protection, where this would

avoid or delay repayment of a credit obligation to

the institution, the parent undertaking or any of its

subsidiaries.

d) it is becoming probable that the borrower will

enter bankruptcy or other financial reorganisation

obligor has filed for bankruptcy or insolvency

third party has started bankruptcy or insolvency proceedings

payment moratorium (sovereigns, institutions)

*) If collateral or a guarantee is called, this usually means that the non-performing definition is directly fulfilled (realisation of collateral).

**) The withdrawal of a license is especially relevant in the context of companies which need a public license to conduct their business, such as banks and insurance companies. In

some Member States this can also encompass companies such as telecommunications and media companies, pharmaceutical companies, mining and extraction companies or

transport companies.

***) Economic lifetimes are especially important in the context of project-financing types of loans. Generally, the expected net cash flow from a project during its economic lifetime

should exceed the loan obligation including interest payments. Beyond the economic lifetime, cash flows are typically less reliable and less plannable due to factors such as

obsolescence, the need for major re-investments or refurbishments and an increasing likelihood of technological failure. Economic lifetimes do not represent maximum tenors, which

can or should be approved when granting loans. Nevertheless, a debtor can be expected to be in financial difficulties if cash flows from a project are not sufficient to service loan

obligations within its economic lifetime.

****) Asset-based loans can appear in different forms (Lombard loans, margin loans, asset-based secured by real estate – such as reverse mortgages, asset-based secured by

receivables etc.), but they have in common the fact that the institution does not rely on the borrower's income or cash flow to repay the loan, but instead lends money against an

asset. Borrowers are typically required to maintain a certain loan-to-value ratio throughout the lifetime of the loan. This loan-to-value ratio can also appear in the form of a minimum

equity covenant, e.g. in the case of real estate finance. If this ratio is exceeded, the borrower has to replenish the equity stake (“margin call”) or the credit institution has the right to

call the loan and to sell the collateral. Typically, banks also have significantly higher initial equity requirements for asset-based loans than for secured cash-flow-based loans. This is

required in order to maintain a cushion for volatility of the price of collateral and to cover the cost of selling the collateral.

5.3 Link between NPEs and forbearance

5.3.1 General definition of forbearance

For the purposes of this guidance the EBA definition of “forbearance” in Commission

Implementing Regulation (EU) No 680/2014, in particular paragraphs 163-183 of

Annex V, is used. This section focuses on aspects of this definition where

supervisors have noted inconsistent implementation.

Guidance to banks on non-performing loans − NPL recognition

Forbearance measures consist of “concessions“ extended to any exposure – in the

form of a loan, a debt security as well as a (revocable or irrevocable) loan

commitment – towards a debtor facing or about to face difficulties in meeting its

financial commitments (“financial difficulties”). It means that an exposure can only be

forborne if the debtor is facing financial difficulties which have led the bank to make

some concessions.

According to paragraph 164 of Annex IV of Commission Implementing Regulation

(EU) No 680/2014, a concession refers to either of the following actions:

i) modification of the previous terms and conditions of the contract, or ii) total or

partial refinancing of the exposure. Therefore, the definition of concession is a

broader one and is not restricted to modifications where the net present value of

cash flows from the exposure is influenced.

Proper identification of forbearance supposes the ability to identify signs of possible

future financial difficulties at an early stage. In order to do so, an assessment of the

financial situation of the borrower should not be limited to exposures with apparent

signs of financial difficulties. An assessment of financial difficulties should also be

conducted for exposures where the borrower does not have apparent financial

difficulties, but where market conditions have changed significantly in a way that

could impact the ability to repay. Examples of such exposures are bullet loans where

the repayment relies on a sale of real estate (e.g. drop in real estate prices impacts

affordability) or foreign currency loans (e.g. move in underlying exchange rate

impacts affordability).

The assessment of any financial difficulties on the part of a debtor should be based

on the situation of the debtor only, disregarding collateral or any guarantees provided

by third parties.

To identify the condition of financial difficulties of the debtor the following triggers can

be used (not an exhaustive list):

• debtor/facility more than 30 days past due during the three months prior to its

modification or refinancing;

• increase of probability of default (PD) of institution’s internal rating class during

the three months prior to its modification or refinancing;

• presence in watch-list during the three months prior to its modification or

refinancing.

Exposures should not be identified as forborne when concessions are made to

debtors that are not in financial difficulties. Banks should distinguish between

renegotiations or rollovers granted to debtors not in financial difficulties and

forbearance measures (i.e. concessions granted to debtors in financial difficulties).

Granting new conditions such as a new interest rate more favourable than the rate

debtors with a similar risk profile could obtain is an indication of concession.

Nevertheless, receiving more favourable new conditions than those practised by the

market is not a prerequisite for the identification of concessions and therefore

Guidance to banks on non-performing loans − NPL recognition

forbearance. However, when a debtor is in financial difficulties, a change in

conditions in line with what other debtors with a similar risk profile could get from the

credit institution should qualify as a concession. This is also the case when debtors

are embedded in public forbearance schemes that are offered by banks.

Borrowers may request modifications in the contractual conditions of their loans

without facing or being about to face difficulties in meeting their financial

commitments. Nevertheless, an assessment of the financial situation of a borrower

should always be performed when changes in the contractual conditions are

requested.

Figure 3

Illustration of forbearance in the context of the NPE definition

Following paragraph 178 of Annex V of Commission Implementing Regulation (EU)

No 680/2014, a forborne exposure can be performing or non-performing. When

granting forbearance measures to performing exposures, banks should assess

whether these measures lead to a need to reclassify the exposure as non-

performing. However, granting forbearance measures to non-performing exposures

§ 157

 1 year si nce for bearance measur es

 No past -due amounts foll owing forbearance measures

 Payment s of amounts previously past-due or wr itten-off

 No other transaction non-performing (when non-performi ng status assessed on a

debtor basis, par a. 154-155)

§ 176

 M i ni mum 2 year probation per iod since performi ng status

 Regular payment s of more than an insignificant ag g r eg ate amount of interest/

principal over at least 1 year

 No other transaction past due > 30 d a ys

Forbearance measures (FM)

From Performing forborne to Performing

From Non-performing to Performing forborne

Sources and notes of the figure: Al l paragraphs r efer to Annex V, Par t 2, Regulati on (EU) 680/2014

FM (

163 ff,

176, 178)

§ 157

appli es

Non-performing

Performing forborne

(cont’d)

Performing

Non-performing Performing forborne

Performing forborne

(cont’d)

Performing

Performing forborne Performing

Non-performing Performing forborne

FM or

past due

> 30 days

(§ 179)

§ 176

appli es

§ 176

appli es

§ 157

appli es

§ 176

appli es

§ 157

appli es

§ 176

appli es

1 year minimum

2 years minimum

2 years minimum (cont’d)

1 year minimum 2 years minimum

1 year minimum

2 years minimum

2 years minimum (cont’d)

2 years minimum

§ 176

appli es

Guidance to banks on non-performing loans − NPL recognition

does not clear their non-performing status: the exposures should continue to be

identified as non-performing for at least one year after the granting of the

forbearance measures.

5.3.2 Classification of forborne exposures as non-performing

Unless there is evidence to the contrary, forborne exposures meeting any of the

following criteria should be classified as non-performing in any case:

• they are supported by inadequate payment plans (either initial or subsequent

payment plans, as applicable) which encompass, inter alia, a repeated failure to

comply with the payment plan, changes to the payment plan to avoid breaches,

or the payment plan’s resting on expectations that are not supported by

macroeconomic forecasts or by realistic assumptions on the repayment

capability or willingness of the debtor;

• they include contract terms that delay the time for the regular repayment

instalments on the transaction, in such a way that hinders its assessment for a

proper classification, such as when grace periods of more than two years for

the repayment of the principal are granted;

• they include de-recognised amounts that exceed the accumulated credit risk

losses for non-performing exposures with a similar risk profile.

5.3.3 Cure/exit from non-performing status

In accordance with paragraph 176 of Annex V of the EBA ITS on supervisory

reporting, forborne exposure can be performing or non-performing. Specific

requirements in paragraph 157 for reclassifying non-performing forborne exposures

comprise the completion of a “cure period” of one year from the date the forbearance

measures were extended and a requirement for the debtor’s behaviour to

demonstrate that concerns regarding full repayment no longer exist. Institutions are

required to perform a financial analysis of the debtor to establish the absence of

such concerns. For the requirements set out in paragraph 157 to be met and for the

financial analysis to dispel concerns regarding full repayment under the post-

forbearance conditions, all of the following criteria should be satisfied:

1. the exposure is not considered as impaired or defaulted;

2. there is no past-due amount on the exposure;

3. the borrower has settled, by means of regular payments, an amount equivalent

to all those previously past due (if there were past-due amounts at the date the

forbearance measures were granted) or a total equal to the amount written off

as part of the forbearance measures (if there was no past-due amount), or the

borrower has otherwise demonstrated its ability to comply with the post-

forbearance conditions.

Guidance to banks on non-performing loans − NPL recognition

The absence of any past-due amount in criterion 2 means that the exposure is

current and that any accrued unpaid principal and interest instalments have been

repaid. The past-due amounts and the written-off amounts referred to in criterion 3

are those existing – or not–- on the date the forbearance measures were granted.

The credit institution’s policies for the reclassification of non-performing forborne

exposures should specify practices for dispelling concerns regarding the borrower’s

ability to comply with the post-forbearance conditions. These policies should

establish thresholds in terms of the payments made during the cure period referred

to in condition 3 above. The supervisory expectation is that these policies define the

borrower’s ability to comply with post-forbearance conditions (to the extent that full

repayment of the debt is likely) at least by demonstrating payments of a not--

insignificant amount of principal. This should apply whether institutions do or do not

use the repayment of amounts that were past-due or written off at the date of the

forbearance measures to assess the lack of concerns regarding the debtor.

Additionally, where a debtor has other exposure(s) to a credit institution which are

not the subject of a forbearance arrangement the institution should consider the

performance (i.e. presence of arrears) of these exposures in its assessment of the

borrower’s ability to comply with post-forbearance conditions. The consideration of

arrears does not change the level of application of non-performing status in

accordance with paragraphs 154 or 155 of the EBA ITS on supervisory reporting, as

applicable.

The existence of contract terms that extend the repayment period, such as grace

periods for the principal, mean that the forborne exposure should remain classified

as non-performing until the requirements in 1. to 3. above have been satisfied. As

criterion 3 requires regular repayments to be made, the elapsing of the one-year

“cure period” does not automatically lead to reclassification to performing unless

regular payments have been made over the 12 months.

5.3.4 Identification as performing forborne

Once forborne exposures are classified as performing, either because they have met

the conditions for being reclassified from the non-performing category or because

the granting of forbearance measures did not lead to the classification of the

exposure as non-performing, they will continue to be identified as forborne until all

the following conditions have been met, in accordance with paragraph 176 of the

EBA ITS on supervisory reporting:

1. an analysis of the financial condition of the debtor showed that the transactions

no longer met the conditions to be considered as non-performing;

2. a minimum of two years has elapsed since the later of the date of the

concession or the date of reclassification from non-performing;

Guidance to banks on non-performing loans − NPL recognition

3. the borrower has made regular payments of more than an insignificant

aggregate amount of principal or interest during at least half of the probation

period;

4. the borrower does not have any other transactions with amounts more than 30

days past due at the end of the probation period.

Once all the requirements above have been met, the elapsing of the two-year period

should not automatically lead to a removal of the identification of the exposure as

“forborne”.

In practice, requirement 3 as referred to above, relating to the regular payment of

more than an insignificant aggregate amount, should not be fulfilled with payment of

interest only. The credit institution’s policies for the identification of forborne

exposures should require payments of both principal and interest.

The credit institution’s policies for identifying forborne exposures should also specify

practices for dispelling concerns regarding the debtor’s financial difficulties.

Otherwise, the exposure will remain classified as forborne. For this purpose, the

entity’s policies should require the borrower to have settled, by means of regular

payments, an amount equal to all the amounts (principal and interest) that were

previously past due or de-recognised at the time of the concession, or to otherwise

demonstrate its ability to comply with the post-forbearance conditions under

alternative objective criteria that imply a repayment of principal.

During the probation period, new forbearance measures granted to performing

forborne exposures that have been reclassified out of the non-performing category

will entail the reclassification of these transactions to the non-performing category.

The same will apply when these exposures become more than 30 days past-due.

5.4 Further aspects of the non-performing definition

5.4.1 Consistent definition at the banking group level

Banks should ensure that the identification of NPEs is consistent at the entity and at

the banking group levels, with a harmonised implementation of the definition in all

subsidiaries and branches.

A uniform NPE definition at the group level may differ from local standards in

different jurisdictions outside the EU.

• At the initial stage, banks should therefore clarify whether local NPE recognition

standards are more lenient or stringent in comparison with the overarching

group standards.

• Second, banks should evaluate to what extent more lenient or stringent local

standards lead to artificially inflated or deflated NPE stocks.

Guidance to banks on non-performing loans − NPL recognition

• Third, artificially inflated or deflated NPE stocks with respect to local standards

should be aligned at the group level via appropriate mapping between

classifications.

• Finally, in the event that local standards for non-performing recognition

requirements substantially diverge from the standards of Commission

Implementing Regulation (EU) No 680/2014, banks will be recommended to

provide reporting in both standards for internal risk control purposes.

A consistent application of the definition of non-performing is required on a solo and

on a consolidated level.

Thus, a unique obligor could be a client of several institutions within a group. Banks

are expected to ensure that if a unique non-retail customer is classified as non-

performing in one of the group’s institutions, this default status event is

communicated (“propagated”) and registered in all other members of the group at

short notice.

To that end, a group of credit institutions should establish an IT system at group level

that allows for the identification of each obligor in any credit institution of the group

with a unique identifier and the reporting of every occurrence of a non-performing

status for any obligor on a timely basis.

In some cases, the consistent identification of non-performing status might not be

fully possible if consumer protection, bank secrecy or legislation prohibits the

exchange of client data within a group. Furthermore, consistent identification might in

some cases be limited if it is too burdensome for banks to verify the status of a

customer in all legal entities and geographical locations within a banking group. In

that case, and in keeping with the approach set out in paragraph 82 of the EBA

Guidelines on the definition of default, banks may refrain from performing the check

for consistency on condition that they are able to demonstrate that the effect of non-

compliance is immaterial and provide evidence that there are no, or only a very

limited number of, common clients between relevant entities within a group.

5.4.2 Groups of connected clients

Banks’ policies should ensure consistent treatment of individual clients and groups of

connected clients as defined in the CRR and the relevant Committee of European

Banking Supervisors (CEBS) Guidelines

, and a consistent assessment of the

underlying legal relationships between legal entities across a group of connected

clients. In view of possible contagion, banks should, whenever feasible, apply a

group perspective when assessing the status of a debtor’s exposure as non-

performing, unless it is affected by isolated disputes that are unrelated to the

solvency of the counterparty.

Committee of European Banking Supervisors (CEBS) Guidelines on the implementation of the revised

large exposure regime.

Guidance to banks on non-performing loans − NPL recognition

To apply a group perspective to clients, the banks should take the definition of Article

4(1)(39) of the CRR at least as a starting point. The main criteria are control and

economic interconnection.

If a bank can provide reasonable evidence to differentiate a group member of a non-

performing connection as performing, using the criteria of control and economic

interconnectedness, then the bank can make such a distinction under the CRR and

the applicable accounting standards.

Consistently with paragraphs 109(c) and 113 in the EBA Guidelines on default, credit

institutions should keep a register of all classification criteria.

5.4.3 Obligor “pulling effect”

According to paragraph 155 of Annex V of Commission Implementing Regulation

(EU) No 680/2014, if more than 20% of the exposures of one obligor are past due by

more than 90 days, all other exposures to this obligor (on and off-balance sheet)

should be considered as non-performing

5.4.4 Classification of the operation in its entirely

According to paragraph 148 of Annex V of Commission Implementing Regulation

(EU) No 680/2014, exposures should be categorised as non-performing for their

entire amount. Thus, a given exposure cannot be classified partly as performing and

partly as non-performing.

5.5 Links between regulatory and accounting definitions

5.5.1 Prudential definition of “default” (CRR)

Articles 127 and 178 of the CRR define default for the purposes of the standardised

and internal ratings-based (IRB) approaches respectively.

The following table shows important gaps between the CRR default definition and

the NPE definition (for the purpose of supervisory reporting under the EBA ITS).

Practice shows that some institutions have tried to align their implementation of the

default definition with the NPE definition in order to streamline processes and foster

the convergence of the two definitions, also in light of the recent regulatory

developments regarding the definition of default.

Guidance to banks on non-performing loans − NPL recognition

Table 3

Important gaps between CRR default and NPE definitions

Gap between default definition and

NPE definition

Description

Pulling effect According to paragraph 155 of Annex V, Part 2, of the EBA ITS on supervisory reporting, if 20% of the exposure to one debtor is more

than 90 days past due, all exposures to that customer shall be considered non-performing.

Groups of connected customers In the case of a group of debtors as different entities belonging to the same group, non-defaulted group members (paragraph 155 of

Annex V, Part 2, of the EBA ITS) can be assessed as NPE, except when a debtor’s exposure is recognised as a NPE because of

disputes unrelated to its solvency.

Re-forbearance In the case of performing forborne exposures within the two-year probation period, which were re-classified from NPE to performing

exposures (paragraph 176(b) of Annex V, Part 2, of the EBA ITS), they are identified as NPE again if they become more than 30 days

past due or if another forbearance measure is granted (“re-forbearance”).

Exit from NPE and in particular cure

period for forborne NPE cases

NPEs are subject to specific reclassification criteria in addition to the existing criteria for the discontinuation of the impairment or default

statuses – for instance, for non-performing forborne exposures there is a one-year observation period in which the exposure has to be

kept non-performing (paragraph 157 of Annex V, Part 2, of the EBA ITS).

According to Article 178(1)(b) of the CRR, for certain segments the past-due period

may be extended by the competent authorities from 90 days to 180 days. However,

the option to recognise defaults only after 180 days past due for some portfolios has

been disregarded in the Regulation (EU) 2016/445 of the ECB

which became

effective in October 2016. Article 4 of the Regulation requires a uniform application

of the 90-day period.

5.5.2 Accounting definition of impaired

Exposures that have been found impaired in accordance with the applicable

accounting framework should always be considered as non-performing exposures.

Exposures with “collective allowances for incurred but not reported losses” for which

no loss event has been identified in specific assets should not be considered as non-

performing exposures.

Impaired and defaulted exposures are mandatorily to be considered as NPEs. Both

the CRR and IFRS distinguish between breach of agreed payment obligations (past-

due payments) and the economic triggers related to unlikeliness to pay.

Table 4

Definitions of defaulted and impaired

Default of an obligor (Article 178 CRR) Credit-impaired financial assets

(IFRS 9 Appendix A, which goes back to IAS 39)

1(b) the obligor is more than 90 days past due on any material credit obligation to the

institution, the parent undertaking or any of its subsidiaries

(b) a breach of contract, such as a default or past due event. [A financial asset is past

due when a counterparty has failed to make a payment when contractually due.]

2(a) for

overdrafts, days past due commence once an obligor has breached an advised limit,

has been advised a limit smaller than the current outstanding amount, or has drawn credit

without authorisation and the underlying amount is material;

[Remark: Overdrafts not specifically mentioned in IFRS 9, but included in the more

general trigger “breach of contract”]

Table 2 in chapter 5.2.2 shows a comparison of the CRR and IFRS definitions,

where the loss events in IAS 39 were ordered to match the default events listed in

Regulation (EU) 2016/445 of the European Central Bank of 14 March 2016 on the exercise of options

and discretions available in Union law (ECB/2016/4).

Guidance to banks on non-performing loans − NPL recognition

the CRR. Not all default events listed in the CRR automatically represent loss events

under this accounting standard.

Outlook: IFRS 9

IFRS 9 defines credit-impaired financial assets in Appendix A. This definition is not

only relevant for financial assets, but also for financial guarantees and loan

commitments. The definition in IFRS 9 does not differ significantly from the definition

under IAS 39.

Under IFRS 9, a transfer to Stage 2 and thus lifetime credit losses is generally

expected to be recognised before the financial instrument becomes past due or other

borrower-specific default events are observed. Banks’ credit risk analyses should

take into account that the determinants of credit losses very often begin to

deteriorate a considerable time (months or, in some cases, years) before any

objective evidence of delinquency appears (BCBS Guidance on CRAECL (2015),

paragraph A19, and EBA draft Guidelines on ECL, paragraph 102).

For the purpose of assessing the significance of an increase in credit risk, banks

should thus have a clear policy including well-developed criteria to distinguish

increases in credit risk for different types of lending exposures (such criteria should

be disclosed). The credit risk assessment should focus exclusively on the default

risk, without considering the effects of credit risk mitigants such as collateral or

guarantees (BCBS Guidance on CRAECL (2015), paragraph A22, and EBA draft

Guidelines on ECL, paragraph 105).

Under IFRS 9, credit impairment leads to a transfer from Stage 2 to Stage 3.

However, both Stages 2 and 3 require provisions for lifetime losses and lifetime

losses grow continuously as creditworthiness decreases, depending on the level of

collateralisation. It is expected that as of the date IFRS9 comes into force at least all

Stage 3 exposures will fall into the scope of this NPL guidance.

5.6 Supervisory reporting and public disclosures

On disclosures, banks should consider the EBA ITS supervisory reporting

requirements as established in Commission Implementing Regulation (EU) No

680/2014 as a benchmark. These were supported by the European Securities and

Markets Authority (ESMA), which encouraged financial institutions to use the

definitions of NPE and forbearance in Commission Implementing Regulation (EU) No

680/2014 for their financial statement disclosures and to explain the relationship

between NPLs, defaulted and impaired loans applied in the institution.

See ESMA PS and ESMA, Review of Accounting practices, Comparability of IFRS Financial

Statements of Financial Institutions in Europe (2013)

Guidance to banks on non-performing loans − NPL recognition

Therefore, banks are strongly encouraged to use the definitions of NPE and

forbearance (Annex V of Commission Implementing Regulation (EU) No 680/2014)

in their public financial statement or, if not, to publish a reconciliation between their

own definitions of impaired and modified financial assets and the definitions in Annex

V of Commission Implementing Regulation (EU) No 680/2014. This reconciliation

should comprise both a conceptual explanation of the differences and quantitative

information on the effects of these conceptual differences.

For the sake of comparability and transparency, disclosure should therefore contain,

in addition to the requirements of accounting standards (e.g. IFRS 7, which already

covers data on portfolio quality and trigger events), the expectations as set out in

Annex 7 of this guidance.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

6 NPL impairment measurement and

write-offs

6.1 Purpose and overview

Provisioning plays a crucial role in ensuring the safety and strength of banking

systems and hence is a key focus of bank supervisors. Supervisory initiatives such

as asset quality reviews (AQRs) and stress tests (STs) have further highlighted the

need for consistent provisioning methodology and adequate provisioning levels

across banks.

This chapter has three principal objectives, namely to foster (within the context of

relevant and applicable accounting standards):

1. adequate measurement of impairment provisions across all loan portfolios

through sound and robust provisioning methodologies (sections 6.2, 6.3 and

6.4);

2. timely recognition of loan losses within the context of relevant and applicable

accounting standards (with a focus on IAS/IFRS accounting standards) and

timely write-offs (sections 6.5 and 6.6);

3. enhanced procedures including significant improvement to the number and

granularity of asset quality and credit risk control disclosures (sections 6.7 and

6.8).

The guidance in this chapter is consistent with the international recommendation and

principles on sound credit risk assessment published by the Basel Committee (BCBS

2006, further updated in 2015 to incorporate considerations on the expected credit

losses model to be introduced by IFRS 9). It summarises what are considered as

best practices, taking into account the historical experience in different jurisdictions

and/or practices already utilised by supervisors to assess credit riskiness (for

instance, the SSM AQR methodology).

Role of provisioning adequacy

The SSM’s role in the assessment of credit risk and capital adequacy requires

supervisors to make decisions on whether banks’ provisions are adequate and

timely.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

There has been international expert support (from the International Monetary Fund

(IMF)

) for supervisors to play an effective role in loan loss provisioning and an

active role by supervisors has been recommended by the BCBS.

The Basel Committee highlights supervisory responsibilities in assessing banks’

processes for credit risk and asset valuation, as well as in ensuring sufficient loan

loss provisions, particularly from the standpoint of the assessment of credit risk

exposures and capital adequacy. This is reflected in the Basel Committee’s

guidelines, including:

• “Guidance on credit risk and accounting for expected credit losses” (2015);

• “Core Principles for Effective Banking Supervision” (2012), and Basel II Pillar 2

(2006).

If supervisors determine that provisions are inadequate for prudential purposes, they

have the responsibility to request banks to reassess and increase provisioning levels

for prudential purposes.

As part of this process, supervisors need to provide guidance, as well as information

as to their expectations, regarding accounting for credit losses in order to ensure an

adequate level of consistency across supervised entities, particularly where the

applicable accounting standards are principle-based.

While this guidance cannot provide specific accounting requirements, it describes

best practices on provisioning principles and methodology for non-performing loans

that may be applied within existing accounting frameworks in order to fulfil

supervisory expectations.

IMF working paper entitled: Supervisory Roles in Loan Loss Provisioning in Countries Implementing

IFRS, September 2014.

Article 74 of Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on

access to the activity of credit institutions and the prudential supervision of credit institutions and

investment firms, requires banks to have “adequate internal control mechanisms, including sound

administration and accounting procedures,...that are consistent with and promote sound and effective

risk management“.

Article 79 of Directive 2013/36/EU requires competent authorities to ensure that “(b) institutions have

internal methodologies that enable them to assess the credit risk of exposures to individual obligors

(…) and credit risk at the portfolio level”’ and “(c) the ongoing administration and monitoring of the

various risk-bearing portfolios and exposures of institutions, including for identifying and managing

problem credits and for making adequate value adjustments and provisions, is operated through

effective systems”’. Article 88(1)(b) of Directive 2013/36/EU also includes the principle that “‘the

management body must ensure the integrity of the accounting and financial reporting systems,

including financial and operational controls and compliance with the law and relevant standards. In

accordance with Article 97(1) of Directive 2013/36/EU, competent authorities must review the

arrangements, strategies, processes and mechanisms implemented by institutions to comply with that

Directive and Regulation (EU) No 575/2013. In this regard, Article 104(1) of Directive 2013/36/EU

enumerates the minimum powers that competent authorities must have, including the power ‘to require

the reinforcement of the arrangements, processes, mechanisms and strategies implemented in

accordance with Articles 73 and 74’ (Article 104(1)(b)), ‘to require institutions to apply a specific

provisioning policy or treatment of assets in terms of own funds requirements’ (Article 104(1)(d))”.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

Scope of this chapter

IAS 39, and in the future IFRS 9, lays down the principles for impairment recognition.

This is the standard applied by SSM banks, which prepare their consolidated and/or

individual financial statements in accordance with IFRS as endorsed by the EU.

IFRS 9 financial instruments, which will replace IAS 39 for the accounting periods

beginning on or after 1 January 2018, require among other things the measurement

of impairment loss provisions based on an expected credit loss (“ECL”) accounting

model rather than on an incurred loss accounting model as under IAS 39.

Although not formally in force at the time of publication, given the relevance of IFRS

9 to the subject matter outlined in this chapter, reference to both IAS 39 and IFRS 9

is included below. For the avoidance of doubt, all reference to IFRS 9 is proposed in

the context of Stage 3 only. References to IFRS 9 are included in this guidance (in

separate boxes) to highlight to the reader what changes may occur under this new

standard.

The principles identified in this guidance should be adapted and taken into account

also by banks applying national generally accepted accounting principles (n-GAAPs).

6.2 Individual estimation of provisions

6.2.1 Individually significant and non-significant exposures

Under IAS 39, the amount of the loss allowance is measured as the difference

between the asset’s carrying amount and the estimated future cash flows discounted

at the financial asset’s original effective interest rate. This process requires, at least,

the following choices:

1. determine when an individual allowance (i.e. for an individual financial

asset/debtor) or an allowance determined collectively (i.e. for a group of

financial assets with similar credit risk characteristics) should be made;

2. determine the methods and parameters for the estimation of the loss allowance

(individual and collective assessment).

With reference to point 1., IAS 39 provides a number of criteria based on a

materiality concept and the application of expert judgement. Any application of

specific quantitative thresholds should be determined by the banks and properly

disclosed.

According to this accounting standard, exposures which are individually significant

should be subject to individual assessment of impairment, while for exposures that

are not individually significant the impairment assessment and loss allowance

estimation can be performed either on an individual or collective basis. For loans that

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

are individually significant but are not individually impaired, a collective assessment

should be performed.

The scope given by IAS 39 for expert judgement should not lead to any type of

arbitrage in the impairment estimation process. Banks are expected to clearly define,

in their internal policy, the criteria to make these decisions according to the principles

presented in this guidance.

With reference to point 2), banks should define the internal criteria to follow when

determining the methodology for impairment assessment and inputs for the

calculation of the loss allowance, taking into account the principles established in this

guidance.

For individual estimations, the expected future cash flows will depend on the type of

scenario that banks apply, i.e. a going concern approach or a gone concern

approach (please refer to section 6.2.4 for further details).

For collective estimations of impairment the critical aspects that should be

considered by the banks are related to i) grouping the NPLs in homogenous clusters

(based on similar credit risk characteristic), ii) calculation of the historical loss

experience for the identified group, i.e. how to reliably determine the risk parameters

(i.e. LGD, cure rate, etc.), and iii) how to calibrate the impairment estimation

according to the principles established by IAS 39. The classification of a loan as an

NPL is objective evidence that the loan should be assessed for impairment. The

amount of impairment to be recognised should be estimated either individually or

collectively.

6.2.2 Criteria for individual estimation of provisions

Banks’ policies should include the criteria to identify exposures subject to individual

estimation of loss allowances. Such criteria should take the following factors into

account.

• Individual significance of the exposure. As stated in IAS 39, provisions for

individually significant exposures should be assessed on an individual basis.

Institutions are responsible for defining the relevant thresholds (absolute and

relative thresholds), taking into account, among other factors, the possible

impact of the exposure in the financial statements and the concentration level

(individual and sectorial). Provisions for exposures that are not individually

assessed should be collectively estimated.

• Other cases where exposures do not share common risk characteristics or for

which no relevant historical data that enable a collective analysis (e.g. not

enough volume to create a group of exposures, portfolios not material, low

default portfolios) are available.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

The criteria used to identify exposures subject to an individual estimation should be

documented in the internal policy of the entity and should be applied consistently.

This documentation should be available to the supervisor on request.

IFRS 9

The criteria for classification in “Stage 3” of IFRS 9 are similar to the criteria for

classification as “impaired” under IAS 39. For financial assets considered credit-

impaired (“Stage 3”) the impairment allowance covers that specific loan and its

estimation could be done either on an individual basis or a collective basis.

6.2.3 General methodology for individual estimation of allowances

When conducting a specific assessment for impairment, banks are expected to apply

a true and fair view to the estimation of both the future cash flows and the collateral

valuations based on the best practice included in this guidance.

The estimated recoverable amount should correspond to the amount calculated

under the following method

• the present value of estimated future cash flows (excluding future losses not

incurred) discounted at the financial asset’s original effective interest rate;

• the estimation of the recoverable amount of a collateralised exposure reflects

the cash flows that may result from the liquidation of the collateral.

Given the relevance of the collateral valuation in the impairment provision calculation

process, the banks should follow the general principles included in chapter 7 of this

guidance.

Banks should maintain in the credit file of the transactions the documentation

needed so that a third party can replicate the individual estimations of accumulated

credit losses made over time. This documentation should include, inter alia,

information on the scenario used to estimate the cash flows it is expected to collect

(going concern vs. gone concern scenario), the method used to determine cash

flows (either a detailed cash-flow analysis or other more simplified methods such as

the “steady state approach” or the “two-step cash-flow approach”), their amount and

timing as well as the effective interest rate used for discounting cash-flows (please

refer to section 6.2.4 for further details).

The entity should establish and document the periodic procedures for checking the

reliability and consistency of its individual estimations over the course of the various

As a practical expedient, IAS 39, paragraphs 63 and AG84, allows measurement using the fair value

price.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

stages of the credit-risk control cycle. In particular, this periodic check of its individual

estimates should be conducted by means of back-testing exercises whereby the

entity assesses their accuracy by comparing them a posteriori with the actual losses

observed on transactions.

Banks should amend their individual estimation methods when the periodic back-

testing exercises recurrently reveal significant differences between the estimated

losses and the actual loss experience. In such cases, the credit institution should

draw up a plan specifying the measures it needs to take to correct the differences or

non-compliances, accompanied by an implementation timetable. The entity’s internal

audit department should monitor the implementation of this plan, verifying that the

corrective measures are adopted and that the timetable is followed correctly.

IFRS 9

Forecasts of future economic conditions when calculating expected credit losses

should be considered.

The lifetime expected losses should be estimated based on the probability-weighted

present value of the difference between:

1. the contractual cash flows that are due to an entity under the contract and

2. the cash flows that the holder expects to receive.

6.2.4 Estimating future cash flows

The bank should to estimate future cash flows, which are usually the result of an

active workout of the loan and/or the sale of collateral. They may also come from the

sale of the collateralised or uncollateralised loan if this reflects the NPL strategy, e.g.

sale to a specialised collection agency or fund. In that case, the expected cash flow

should reflect a realisable market price.

The estimation of future cash-flow allowances should be done under the following

two broad approaches

• Under a “going concern” scenario, the operating cash flows of the debtor or the

"effective" guarantor, in line with the principles of the CRR, continue and can be

used to repay the financial debt to all creditors. In addition, collateral may be

exercised to the extent it does not influence operating cash flows (e.g. premises

pledged as collateral cannot be exercised without impacting cash flows). This

could be the case if:

AQR Manual, page 122.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

• future operating cash flows of the debtor are material and can be reliably

estimated;

• there is only limited collateralisation of the exposure.

• Under a “gone concern” scenario, the collateral is exercised and the operating

cash flows of the debtor cease. This could be the case if:

• The exposure has been past due for a long period. There is a rebuttable

presumption that the allowance should be estimated under gone concern

criteria when arrears are longer than 18 months.

• Future operating cash flows of the debtor are estimated to be low or

negative.

• Exposure is significantly collateralised, and this collateral is central to

cash-flow generation.

• Application of the going concern scenario would impact materially and

negatively the amount recoverable by the institution.

• There is a significant degree of uncertainty surrounding the estimation of

the future cash flows. This would be the case if the earnings before

interest, taxes, depreciation and amortisation (EBITDA) of the two

previous years had been negative, or if the business plans of the previous

years had been flawed (due to material discrepancies in the back-testing).

• Insufficient information is available to perform a going concern analysis (if

the gone concern approach is considered inadequate, the bank should

assess whether the inclusion of those exposures in the collective

assessment of impairment would be reasonable).

Estimation of operating cash flows under a going concern scenario

The following aspects should be taken into account.

• Since the allowance estimation is based on the assumption of operating cash

flows of the debtor, or the guarantor, updated and reliable information on cash

flows and the business plan is a requisite for such estimation.

• Future operating cash flows should be based on the financial statements of the

debtor. When projections assume a growth rate, a steady or declining growth

rate over a maximum growth period of 3-5 years should be used, and

afterwards steady cash flows. The growth rate should be based on the financial

statements of the debtor or on a robust and implementable business

restructuring plan, taking into account the resulting changes in the structure of

the business (e.g. due to divestments or the discontinuation of unprofitable

business lines). (Re)-investments that are needed to preserve cash flows

should be considered, as well as any foreseeable future cash-flow changes

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

(e.g. if a patent or a long-term contract expires). When planning future cash

flows, the bank should also consider the future default or re-default risk based

on an appropriate expected credit standing (e.g. by applying empirically derived

cumulative default tables). Deviations from this approach in individual cases

require specific justification.

• Estimation of amounts obtained under the realisation of a financial guarantee

alone will be admissible when there is reliable information as to the

creditworthiness of the guarantor and the legal effectiveness of the guarantee.

• Appropriate and reliable adjustments may be applied when data for the

previous year do not yet lead to a sustainable level of cash flows due to

financial accounting choices/methodology (on a best-efforts basis according to

the available information). This is the case, for example, when reversals of

provisions improve results

(AQR).

• When the recoverability of the exposure relies on the realisation of the disposal

of some assets by the debtor, the selling price should reflect the estimated

future cash flows that may result from the sale of the assets less the estimated

costs associated with the disposal. Allocation of cash flows to claims should be

made according to their seniority ranking.

• The length of the projection should be restricted to the length of the reliable

cash-flow projection (projections over a period of five years are only admissible

in exceptional circumstances).

A detailed cash-flow analysis requires the entities to conduct a thorough analysis of

the debtor’s financial situation, the available cash flows, financial indicators, business

plans, forecasts etc. to determine the most realistic future cash flows to be collected.

In application of the simplicity principle, it may be appropriate to use more simplified

methods such as the “steady state approach” or the “two-step cash-flow approach”.

Business plans and cash-flow projections should be scrutinised with great attention

by banks, taking into consideration worst case or more adverse scenario

hypotheses. The availability of financial forecasts is generally a key point for

assessing exposures. It is typically when forward-looking statements are not

available or reliable (and this is a frequent situation) that less sophisticated methods

should be applied and possibly combined.

Banks should document in their policies when it is appropriate to apply each method

for individual estimation and to use the selected method consistently over time.

The “steady state approach” is a method to approximate future recurrent cash-flows

to be generated by the debtor by means of applying multiples to adjusted EBITDA.

AQR Manual, page 133

Use of observable market price as an alternative to the going concern approach: institutions may derive

the present value from cash flows using an observable market price taking into account the maturity of

the exposure and ensure the applicability of the market price to the exposure by applying specific

criteria. Market prices only are an acceptable “practical expedient” to estimate a recoverable amount

when they are observable on active markets.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

For instance, the 2014 AQR exercise provided a benchmark multiple of 6 (general

case), 10 (utilities) or 12 (infrastructures). The cash flows should then be allocated to

each exposure. One of the critical issues in this approach is the estimation of an

adjusted EBITDA (neutralising some non-recurring items and adjusted for capital

expenditure and one-off effects).

In the “two-step cash-flow approach”, the present value of the cash flows to be

allocated to each exposure requires a period-by-period analysis followed by an

estimation of the terminal value (TV) which should be calculated:

• either by assessing a sustainable one-period at the end of the projection and

applying a multiple as stated in the steady cash-flow approach; or

• by assuming a “gone concern approach”.

A detailed cash-flow analysis with multi-period cash-flow projections can be widely

used but appears more suitable if the financing transaction is targeted at income-

generating business or asset-based lending transactions. Acceptable businesses for

the multi-period cash-flow projection approach are, for instance:

• shipping with long-term charter (i.e. greater than the time period in the cash-

flow projection) and/or collateral to be sold after the end of the cash-flow

projection period;

• commercial real estate where real estate is forecasted to be sold after the end

of the cash-flow projection period;

• project finance where generated income is pledged and/or collateral is

forecasted to be sold;

• real estate where residential or commercial property is forecasted to be sold;

• income-producing business where the service of loans is based on the sale of

one or more commercial properties.

Estimation of the recoverable amount of the collateral under the

gone concern approach

The recoverable amount should correspond to the present value of estimated future

cash flows that may result from sale of collateral less the cost of obtaining and

selling the collateral. Please refer to chapter 7 – Collateral valuation for immoveable

property.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

6.3 Collective estimation of provisions

6.3.1 General principles related with internal methodologies

Collective estimation should be applied to calculate the provisions for non-performing

loans for which an individual estimation is not performed. The future cash flows of a

group of exposures that are collectively evaluated for impairment are calculated

based on the estimated contractual cash flows, the exposures in the group and the

historical loss experience for exposures with credit risk characteristics similar to

those in the group.

Internal methodologies for the estimation of collective provisions should comply with

the general requirements established in section 6.2 of this guidance.

When performing the collective assessment of impairment, banks should take into

account the following principles.

Internal governance

A bank´s management body should be responsible for ensuring that the bank has

appropriate methods and procedures for estimating allowances on a collective basis

in order to comply with the internal risk control practices, accounting standards and

supervisory/prudential requirements.

Integration in risk control

Methods and procedures for estimating allowances should be integrated in the

entity´s credit risk control system and form part of its processes.

Simplicity and effectiveness

The methods and processes for monitoring and updating estimates of allowances

and provisions should ensure at all times that the results obtained are based on a

robust method for the estimation of the provisioning levels which can be justified

based on empirical data. In the absence of sufficient empirical data, they should

ensure that the assumptions are representative of a true and fair view based on

reasonable information. This includes aligning the assumed estimations to actual

(historical observed) experience and assessing the appropriate level of collateral

discount for both forced and voluntary liquidations.

Robust policies and procedures should be in place to validate the accuracy and

consistency of the collective allowance estimations on an on-going basis.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

The expectation is that banks will “back-test” the allowance estimations for every

significant portfolio, at least once a year. The methods for estimating allowances and

provisions should be comprehensible to users and, in any event, ensure that the

results obtained do not contradict the underlying economic and financial logic of the

various risk factors. In addition, the bank should periodically analyse the sensitivity to

changes in the methods, assumptions, factors and parameters used to estimate

allowances and provisions.

IFRS 9

IFRS 9 requirement to incorporate forward-looking information in the collective

estimation of allowances.

This principle is also included in BCSB – 2015 “Guidance on credit risk and

accounting for expected credit losses”’ as follows:

Principle 6: A bank’s use of experienced credit judgment, especially in the robust

consideration of reasonable and supportable forward-looking information, including

macroeconomic factors, is essential to the assessment and measurement of

expected credit losses.

This principle corresponds to Principle 6 under the EBA draft Guidelines on credit

institutions’ credit risk management practices and accounting for expected credit

losses.

6.3.2 Methodology for collective estimation of allowances

Criteria for grouping exposures for collective assessment

Groups of loans created to estimate allowances on a collective basis should be

sufficiently granular to ensure that grouped exposures have shared credit risk

characteristics, so that banks can reasonably assess changes in credit risk and their

impact on the estimate of allowances. It is expected that, when collective allowances

relate to unimpaired exposures, such as when the allowances are raised to cover

incurred but not reported losses, separate portfolios will be constituted for performing

exposures and for NPE.

An internal policy of the entity should establish the methodology for grouping

exposures to assess credit risk. The following indicators may, inter alia, be

considered when grouping exposures:

• instrument type;

• product terms and conditions;

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

• industry/market segment;

• collateralisation (considering both the loan-to-value and the type of collateral);

• geographical localisation;

• past due status;

• forbearance measures applied;

• borrower employment status.

Loans should not be grouped in such a way that an increase in the credit risk of a

particular exposure is masked by the performance of the group as a whole. Grouping

of lending exposures should be re-evaluated and exposures re-segmented if a

reassessment of credit risk (e.g. linked to the emergence of a new credit risk driver)

suggests that a permanent adjustment is needed. If the bank is not able to re-

segment its exposures in a timely manner, a temporary adjustment may be used

Given the importance of the ageing of arrears and the number of payments in

arrears to determine the level of impairment, it is essential to guarantee that the IT

systems are capable of providing these data in an accurate manner.

Parameters included in the collective estimation of allowances

Allowances estimated on a collective basis should be based on historical loss

experience for assets with credit risk characteristics similar to those in the group.

They should be adjusted on the basis of current observable data to reflect the effects

of current conditions that did not affect the period on which the historical loss

experience is based and the effects of conditions in the historical period that do not

exist currently should be removed.

In applying these requirements, the following should be taken into account:

• when estimating parameters for collective provisioning models, the levels of

management judgement should be minimal, with parameter estimations for

collective provisioning models being based on time series data;

• any parameters should be reflective of the credit characteristics of each

appropriately stratified loan pool (especially when banks estimates loss given

default (LGD), cure rates and re-default rates);

• the assessment of financial/economic conditions should take into account all

relevant factors that have a bearing on loss rates, including (but not limited to)

macroeconomic variables (e.g. GDP, unemployment, property prices), changes

in relevant laws (e.g. bankruptcy code), institutional factors (e.g. duration of

BCBS Guidance on credit risk and accounting for expected credit losses, paragraphs 49-51.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

court procedures) and changes in international, national and local economic

and business conditions;

• for collateralised exposures, the collective estimations should be consistent with

the criteria established for estimating the recoverable amount of collateral as

referred to in chapter 7 – Collateral valuation for immoveable property;

• the impact arising from changes in the risk portfolio as a whole, including

increases in the volume of impaired exposures, restructurings and the existence

of/increase in the level of credit concentrations;

• any possible impact deriving from changes in lending policies and procedures,

extension of forbearance measures, write-off policy and recovery practices.

Banks should be able to demonstrate on the basis of specific evidence that model

parameters for any given group of collectively assessed assets have been updated

to reflect recent changes in financial/economic conditions.

Furthermore, where applicable, the following should be taken into account with

respect to specific model parameters applied to each portfolio:

• the approach for calculating cure rates and cured loans should be defined in

line with section 5.3 of this guidance;

• LGD parameters should reflect estimated recoveries from collateral whose key

determinants are demonstrably in line with empirical evidence as outlined in

chapter 7 of this guidance;

• banks should create a full data set for the calculation of key parameters

assumed within collective provisioning methodologies;

• the methodology and assumptions used for the impairment estimations should

be reviewed on an annual basis to reduce any differences between loss

estimates and actual loss experience. In addition, the methodology and

assumptions should be appropriately documented and approved by the

management body.

IFRS 9

The principles of IFRS 9 are more aligned to prudential calculation of expected

losses from the perspective that IFRS 9 is based on expected losses and, although

necessarily methods for accounting and prudential estimation differ in some

elements, certain key elements of the internal model systems for both should be

aligned to the maximum extent possible:

• both systems should be based, on the one hand, on estimated inflows into

transactions in default (such as estimates of PDs) and, on the other, on

estimates of recovery flows in the event of default (by considering possible

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

outcomes of recovery processes and estimates of the losses produced in each

of them).

• all other key elements of the systems, related to their practical implementation,

should be aligned. These other elements include, inter alia, the definition of

homogeneous risk groups and the databases and controls used.

6.4 Other aspects related to NPL impairment measurement

6.4.1 Impairment allowances for financial guarantee contracts and loan

commitments given

Off-balance-sheet items such as financial guarantees and loan commitments

represent potential additional credit losses. Financial guarantees and loan

commitments may be designated as at fair value under IAS 39; financial guarantees

may also be accounted for according to IFRS 4.

To measure

the most likely drawn exposure, reliable cash-flow forecasts or

estimated credit conversion factors should be used. This reliability should be

confirmed through the existence of robust historical data and back-testing

procedures demonstrating adherence of past estimations to the incurred credit

losses. As an alternative, the credit conversion factors stipulated in Article 166(10) of

the CRR should be applied following the classifications in Annex I of the CRR on the

nominal value of the commitment.

IFRS 9

For financial guarantees not accounted for at fair value, when estimating lifetime

expected credit losses, specifically Stage 3 for undrawn loan commitments or

financial guarantees given, the bank should:

1. estimate the expected portion of the loan commitment that will be drawn down;

2. calculate the present value of the difference between the contractual cash flows

if that expectation is verified and the cash flows that the entity effectively

expects to receive.

Probability-weighted estimations as required by IFRS 9 should be taken into

account. Regarding the financial guarantee contracts, the expected credit losses will

correspond to the difference between the probability-weighted expected payments to

AQR Manual page 125.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

reimburse the holder for a credit loss less any amounts that the bank expects to

receive from the holder, the debtor or any other party.

6.4.2 Recognition and reversal of impairment losses

Any additional impairment to be recognised corresponds to the difference between

the carrying amount, i.e. the net book value after any impairment recognition or

write-off, and the estimated recoverable amount.

Reversal of impairment should occur when there is objective evidence that the

impairment is lower than previously computed with the available information at that

time. This may be assumed in the following cases (non-exhaustive list):

• the debtor has repaid a higher fraction of the outstanding debt than anticipated

at the time of the previous impairment;

• the debtor has provided additional collateral since the previous impairment;

• cash flows have improved;

• at least one of the loss events that led to the impairment tests has been

reversed;

• any other event that has led to an improvement in the recoverable amount from

this debtor is taken into consideration.

Regarding foreclosed assets, in alignment with section 7.5 (“Valuation of foreclosed

assets”), once foreclosed assets have been classified as held for sale any

impairment loss is based on the difference between the adjusted carrying amount of

the asset and fair value less the cost of selling it. Banks should develop internal

policies that clearly define the main methodologies and assumptions used to

determine both the fair value of foreclosed assets and the cost of selling them.

These methodologies should take into account, at least, a market price discount

(haircut) according to the liquidity of each type of asset and any “cost to sell”. If the

open market value reflects the condition after future completion work, the discount

should also incorporate completion costs. Banks are expected to develop their own

assumptions based on robust and empirical evidence.

6.5 NPL write-offs

International commentators such as the IMF have underscored the need for banking

supervisors to have a general policy requiring timely write-off of uncollectable loans

and assist banks in formulating sound write-off criteria

BCBS 2006 paper entitled “Sound Credit Risk Assessment and Valuation for Loans”, page 13.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

In the same context, the IMF has also noted

that supervisors fulfil their roles of

assessing credit risk and enforcing the capital adequacy of banks, in part, by

ensuring sufficient and timely loan loss provisioning, and has highlighted the many

benefits of timely write-off of uncollectable loans. In addition, the BCBS 2015 paper

entitled “Sound Credit Risk Assessment and Valuation” states that uncollectability is

to be recognised in the appropriate period through allowances or write-offs

The timely recognition of provisions and the timely write-off of

uncollectable/unrecoverable loans is a key supervisory focus as it serves to

strengthen banks' balance sheets and enables them to (re)focus on their core

business, most notably lending to the economy. When loans are deemed

uncollectable/unrecoverable, they should be written off in a timely manner.

The importance of write-offs is implied in IFRS 7, which requires disclosure of write-

off criteria. IFRS 9 provides a high-level definition of write-off.

Under IFRS 9, the gross carrying amount of a financial asset is reduced when there

is no reasonable expectation of recovery. A write-off constitutes a de-recognition

event. Write-off can relate to a financial asset in its entirety, or to a portion of it.

Therefore, the gross carrying amount of a financial asset is reduced by the amount

of the write-off.

An entity is required to disclose the contractual amount of financial assets written off

that are still subject to enforcement activity.

An entity should write off a financial asset or part of a financial asset in the period in

which the loan or part of the loan is considered unrecoverable.

For the avoidance of doubt, a write-off can take place before legal actions against

the borrower to recover the debt have been concluded in full. A write-off does not

involve the bank forfeiting the legal right to recover the debt; a bank’s decision to

forfeit the legal claim on the debt is called “debt forgiveness”.

Once an amount has been written off from the balance sheet, it is not possible to

write-back/reverse that adjustment, in opposition to impairment provisions, which can

be retaken through the statement of profit and loss where there are changes in the

estimation. Write-offs should not be written-back and if cash or other assets are

eventually collected these collections would be directly recognised as income in the

statement of profit or loss.

See IMF working paper entitled “Supervisory roles in Loan Loss provisioning in Countries implementing

IFRS” (https://www.imf.org/external/pubs/ft/wp/2014/wp14170.pdf).

BCBS 2015 paper entitled “Guidance on credit risk and accounting for expected credit losses”, page

21.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

6.6 Timeliness of provisioning and write-off

The timely recognition of provisions and timely write-off of unrecoverable loans is a

key supervisory focus as it serves to strengthen the balance sheet of banks and

enables them to (re)focus on their core business, most notably lending to the

economy.

All banks should include in their internal policies clear guidance on the timeliness of

provisions and write-offs. Especially for exposures or parts of exposures that are not

covered by collateral, banks should determine suitable maximum periods for full

provisioning and write-off. For parts of exposures covered by collateral, the

establishment of a minimum provisioning level depending on the type of collateral is

deemed supervisory best practice. Empirical evidence and conservatism should be

applied when calibrating the described provisioning and write-off periods referred to

above. When assessing the recoverability of NPLs and in determining internal NPL

write-off approaches, banks should pay particular attention to the cohorts shown

below as they may represent higher levels of permanent unrecoverability; this should

be assessed case-by-case.

• Exposures with prolonged arrears: Different thresholds may be adequate for

different portfolios. Banks should assess the recoverability of exposures

classified as non-performing due to arrears for a prolonged length of time. If,

following this assessment, an exposure or part of an exposure is deemed as

unrecoverable, it should be written off in a timely manner.

• Exposures under insolvency procedure: where the collateralisation of the

exposure is low, legal expenses often absorb a significant portion of the

proceeds from the bankruptcy procedure and therefore estimated recoveries

are expected to be very low.

• A partial write-off may be warranted where there is reasonable financial

evidence on the credit file to demonstrate an inability on the borrower’s behalf

to repay the full amount of the monies owing i.e. a significant level of debt

overhang which cannot be reasonably demonstrated to be recoverable

following implementation of a forbearance treatment and/or the execution of

collateral.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

6.7 Provisioning and write-off procedures

6.7.1 Policies

Provisioning

As per the BCBS guidance on credit risk, a bank´s management body should be

responsible for ensuring that the bank has appropriate credit risk practices, including

an effective system of internal control, to consistently determine adequate

allowances

Furthermore, entities should adopt, document and adhere to sound methodologies

that address policies, procedures and controls for assessing and measuring

allowances on non-performing loans

• These methodologies should be reviewed regularly.

• Methodologies should clearly document the key terms, judgements,

assumptions and estimates related to the assessment and measurement of

allowances for non-performing loans (e.g. migration rates, loss events, costs to

be incurred in order to enforce the collateral)

. They should be based on robust

analysis and be supported by objective evidence.

• Clear guidance on the timeliness of provisions should be established by types

of exposure (see section 6.6).

• Banks should adopt and adhere to written policies and procedures detailing the

credit risk systems and controls used in their credit risk methodologies

• The management judgements, estimates, considered assumptions and related

sensitivity analysis should be subject to appropriate disclosures.

Banks should, as a matter of best practice, back-test their impairment estimations

against their actual losses on a regular basis. Supervisory expectation is that this

would occur at a minimum every 6 months.

In addition, banks should, when considering the write-back/reduction of existing

provisions, ensure that the revised estimates and assumptions reflect current

economic conditions and the current view of the expected economic outlook.

Banks should also consider the contractual obligation of expected cash flows before

considering including them in discounted cash flows.

BCBS Guidance on credit risk and accounting for expected credit losses, principle 1.

BCBS Guidance on credit risk and accounting for expected credit losses, principle 2.

BCBS Guidance on credit risk and accounting for expected credit losses, paragraph 29.

BCBS Guidance on credit risk and accounting for expected credit losses, paragraph 31.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

IFRS 9

Amount of allowances, both for individual and collective estimations, will be affected

by the assumption related with future events and macroeconomic factors, such as

the estimations of GDP, unemployment rate and collateral value. Those estimations

should consider all the relevant and supportable information, including forward

looking information. Entities should document all key assumptions, including

explanations for their adequacy.

Write-off

Entities are responsible for defining their NPL write-off policy based on internal and

external factors. Supervisors would expect that each bank, after taking into

consideration the principle of proportionality, would have a clearly defined NPL write-

off policy in place approved by the management body. This should be available to

the supervisor upon request.

Banks should ensure that measures are undertaken internally to avoid any arbitrage

of provision coverage calculation due to NPL write-off activities. In particular, write-

offs should take place when justified by the uncollectability of the exposure in

accordance with the internal write-off policy, as opposed to exposures being written

off only for the purpose of reaching a given level of gross NPLs or maintaining a

given level of coverage ratio.

6.7.2 Internal documentation

Provisioning

Banks should maintain internal supporting documentation, which may be made

available for review by the supervisory authority upon request. It should include:

• the criteria used to identify loans subject to an individual assessment;

• rules applied when grouping exposures with similar credit risk characteristics,

whether significant or not, including supporting evidence that the exposures

have similar characteristics;

• detailed information regarding the inputs, calculations and outputs in support of

each of the categories of assumptions made in relation to each group of loans;

• rationale applied to determine the considered assumptions in the impairment

calculation;

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

• results of testing of the assumptions against actual loss experience;

• policies and procedures which set out how the bank sets, monitors and

assesses the considered assumptions;

• findings and outcomes of collective allowances;

• supporting documentation for any factors considered that produce an impact on

the historical loss data;

• detailed information on the experienced judgment applied to adjust observable

data for a group of financial assets to reflect current circumstances

Write-offs

Banks should internally document and disclose their considered write-off policy,

including the indicators used to assess the expectations on recovery. Additionally,

detailed information on those financial assets that have been written-off but are still

subject to enforcement activity should be provided.

In the interests of full transparency of write-offs, banks should maintain detailed

records of all NPL write-offs on a portfolio-level basis and this information should be

readily available to supervisors upon request.

IT Database considerations

Banks should have databases complying with the following requirements.

• Depth and breadth, in that they cover all the significant risk factors. This should

allow, inter alia, exposures to be grouped together in terms of common factors,

such as the institutional sector to which the borrower belongs, the purpose of

the transaction and the geographical location of the borrower, so as to enable

aggregate analysis allowing identification of the entity’s exposure to these

significant risk factors.

• Accuracy, integrity, reliability and timeliness of data.

• Consistency. The data should be based on common sources of information and

uniform definitions of the concepts used for credit-risk control.

• Traceability, such that the source of information can be identified.

The entity’s internal control functions (such as the internal audit or risk control

departments) should verify that its databases comply at all times with the

characteristics required by the internal policies, and in particular with the

requirements set out above.

IAS 39, paragraph 62.

Guidance to banks on non-performing loans − NPL impairment measurement and write-offs

Banks should have procedures to ensure that the information collected in their

databases is integrated with management reporting, so as to make sure that reports

and other documentation (whether recurrent or ad hoc) of relevance to decision-

making at the various management levels, including that of the management body,

are based on timely, complete and consistent information.

Banks should establish and document the periodic procedures for comparing the

reliability and consistency of their database transaction classifications and the results

of their estimated allowances and provisions over the course of the various stages of

the credit-risk control cycle. They should periodically compare their allowance and

provision estimates by means of back-testing whereby they assess the accuracy of

said estimates by comparing them a posteriori with the effective real losses observed

on transactions.

The methods and assumptions used for estimating allowances and provisions should

be reviewed regularly to reduce any differences between loss estimates and the

actual loss experience. The entity’s management body should be responsible for

deciding if significant changes are to be made to the methods used to estimate

allowances and provisions.

As an additional support, the entity should periodically undertake:

• analyses of sensitivity to changes in the methods, assumptions, factors and

parameters used to estimate allowances and provisions;

• comparison and benchmarking exercises, using all the significant information

available both internally and externally.

6.8 Supervisory reporting and public disclosures

Supervisory reporting

Upon request by supervisors, banks should, at a minimum, be able to provide them

with data regarding the models they use to calculate impairment allowances for

NPLs on a collective basis as per table 7 in Annex 7.

Public disclosure

To give users of financial statements a better understanding of loan portfolio quality

and credit risk control practices, banks are expected to disclose the detailed set of

quantitative and qualitative disclosures as outlined in Annex 7.

Guidance to banks on non-performing loans − Collateral valuation for immovable property

7 Collateral valuation for immovable

property

7.1 Purpose and overview

Findings of supervisory activities including the Comprehensive Assessment/AQR but

also onsite inspections have highlighted deficiencies in the approaches employed by

banks in relation to the completeness and accuracy of immovable property valuation.

In the past, banks have often failed to obtain periodic financial information from

borrowers or updated real estate valuations in order to assess the quality of loans on

their balance sheets and the adequacy of collateral. Consequently, the banks failed

to recognise early warning signs that asset quality was declining, which resulted in

an understatement of balance sheet loan loss provisions.

Scope of chapter

This chapter sets out supervisory expectations and provides best guidance regarding

the policies, procedures and disclosures which banks should adopt when valuing

immovable property held as collateral for NPLs.

Under the SSM, banks are expected to adhere to the principles presented in this

chapter and incorporate these principles into their policies, procedures and controls.

For the purposes of the guidance set out in this chapter, all types of immoveable

property collateral are eligible regardless of CRR eligibility.

Articles 208 and 229 of Regulation (EU) No 575/2013 apply.

This chapter begins by outlining general governance expectations (section 7.2)

covering aspects of policies, procedure, monitoring and controls as well as

expectations with regard to appraisers. It then provides guidance on the frequency of

valuations (section 7.3) and on valuation methodology (section 7.4). Finally, it also

touches on the valuation of foreclosed assets (section 7.5).

In particular, paragraph 3 of Article 208 states: “The following requirements on monitoring of property

values and on property valuation shall be met: (a) institutions monitor the value of the property on a

frequent basis and at a minimum once every year for commercial immovable property and once every

three years for residential property. Institutions carry out more frequent monitoring where the market is

subject to significant changes in conditions; (b) the property valuation is reviewed when information

available to institutions indicates that the value of the property may have declined materially relative to

general market prices and that review is carried out by an appraiser who possesses the necessary

qualifications, ability and experience to execute a valuation and who is independent from the credit

decision process. For loans exceeding EUR 3 million or 5 % of the own funds of an institution, the

property valuation shall be reviewed by such appraiser at least every three years.”

Guidance to banks on non-performing loans − Collateral valuation for immovable property

7.2 Governance, procedures and controls

7.2.1 General policies and procedures

The bank should have written policies and procedures in place, approved by the

management body and complying with the criteria established herein, governing the

valuation of immovable property collateral.

The policy and procedures documents should have defined owners with

responsibility for reviewing them and ensuring that material changes are submitted to

the management body for approval.

Banks’ written collateral valuation policies and procedures should be reviewed at

least on an annual basis. Banks should ensure that any knowledge gaps are

identified during the review process and remediation plans are implemented in a

timely manner to close any such gaps.

Policies and procedures should be fully aligned with the bank’s risk appetite

statement (RAS).

7.2.2 Monitoring and controls

Banks are expected to monitor and review the valuations performed by appraisers

on a regular basis as set out in this chapter.

Banks should develop and implement a robust internal quality assurance policy and

procedures for challenging valuations completed internally and externally. This

process may have different forms depending on banks’ size and business model but

the general principles are:

• the quality assurance process should be carried out by a risk control unit that is

independent of the loan processing, loan monitoring and underwriting process;

• the independence of the external appraiser selection process should be tested

on a regular basis as part of the quality assurance process;

• an appropriate similar sample of internal and external valuations should be

compared against market observations on a regular basis;

• back-testing of both internal and external collateral valuations should be carried

out on a regular basis;

• the quality assurance process should be based on an appropriate sample size.

Additionally, the internal audit department should regularly review the consistency

and quality of the immovable property valuation policies and procedures, the

independence of the appraiser selection process and the appropriateness of the

valuations carried out by both external and internal appraisers.

Guidance to banks on non-performing loans − Collateral valuation for immovable property

Banks should ensure adequate diversification among the valuations assigned to

appraisers. After two sequential updated individual valuations (as defined in the next

section) of the same immovable property, the appraiser should rotate (either to a

different internal valuer or to a different external appraisal provider).

While sections 7.2.1 and 7.2.2 above relate to collateral securing NPLs, supervisors

would also consider these sections to represent best practice for the governance,

monitoring and control of performing exposures.

7.2.3 Individual versus indexed valuations

Individual valuations

For the purposes of this guidance, banks should use at a minimum the following

procedures to update the valuation of immoveable property collateral as follows:

• Banks should monitor the value of immovable property collateral on a frequent

basis and at a minimum as prescribed in Article 208(3) of Regulation (EU) No

575/2013.

• Individual property valuations (including updated individual property valuations)

are defined as property-specific appraisals, which are performed by an

appraiser on a specific property basis and are not based on indexation or any

other automated process. Individual property valuations should be performed in

line with the expectations of this chapter.

Indexed valuations

Valuations derived from indexation or any other automated processes are defined as

indexed valuations and do not constitute a revaluation or an individual property

valuation. However, they may be used to update the valuation for non-performing

loans of less than 300,000 euro in gross value, which are secured by immovable

property collateral provided that the collateral to be valued is susceptible to

measurement by such methods.

The minimum requirements of Article 208(3) of the CRR will continue to apply

notwithstanding the existence of the stated exception threshold.

Furthermore, the threshold for indexation does not supersede any national

jurisdictional requirement specifying a more conservative threshold requirement for

individual valuations.

The indices used to carry out this indexation may be internal or external as long as

they are:

Guidance to banks on non-performing loans − Collateral valuation for immovable property

• Reviewed regularly and the results of this review are documented and are

readily available. The review cycle and governance requirements should be

clearly defined in a management body approved policy document.

• Sufficiently granular and the methodology should be adequate and appropriate

for the asset class in question.

• Based on a sufficient time series of observed empirical evidence (actual

property transactions).

7.2.4 Appraisers

All valuations (including updated valuations) should be performed by independent

qualified appraisers, internal or external, who possess the necessary qualifications,

ability and experience to execute a valuation, as provided for in Article 208(3)(b) of

Regulation (EU) No 575/2013.

Banks should have a properly approved panel of independent and qualified

appraisers, internal or external, based on the criteria below. They should assess

appraisers’ performance on an on-going basis and decide whether an appraiser may

remain in the panel, or not.

Banks should ensure that external appraisers have an appropriate level of

professional indemnity insurance and should review this insurance on an annual

basis to ensure that it is adequate and valid.

Banks should ensure that all appraisers and their first grade relatives, both internal

and external, meet the requirements of independence as follows:

• appraiser is not involved in the loan processing, loan decision and credit

underwriting process;

• appraiser is not guided or influenced by the debtor’s creditworthiness;

• appraiser does not have an actual or potential, current or prospective conflict of

interest regarding the result of the valuation;

• appraiser does not have an interest in the property;

• appraiser is not a connected person to either the buyer or the seller of the

property;

• appraiser provides an impartial, clear, transparent and objective valuation

report;

• appraiser should not receive a fee linked to the result of the valuation.

A qualified appraiser should:

Guidance to banks on non-performing loans − Collateral valuation for immovable property

• be professionally competent and have at least the minimum educational level

that meets any national requirements to carry out such valuations;

• have appropriate technical skills and experience to perform the assignment;

• be familiar with and be able to demonstrate ability to comply with any laws,

regulations and real estate valuation standards that apply to the appraiser and

the assignment;

• have the necessary knowledge of the subject of the valuation, the real estate

market in which it would trade and the purpose of the valuation.

A panel of appraisers should contain expertise in various areas of the property sector

appropriate to the lending business of the bank and the location of lending.

7.3 Frequency of valuations

For the purposes of this guidance, banks should use the procedures described

below to review and monitor the valuation of immoveable property collateral.

Notwithstanding the provisions of section 7.2, banks should update individual

valuations for the collateral of all exposures on a frequent basis and at a minimum

every year for commercial immovable property and every three years for residential

immoveable property.

The valuation of the immovable property collateral should be updated on an

individual basis at the time the loan is classified as a non-performing exposure and

at least annually while it continues to be classified as such. This applies to all loans

classified as non-performing as per chapter 5 of this guidance. The only exception to

this individual updated valuation requirement is that below specific exposure

thresholds (see section 7.2.3) updated individual valuations may be carried out by

indexation provided that the collateral to be valued is susceptible to be measured

with such methods.

For properties with an updated individual valuation that has taken place within the

past 12 months (in line with all applicable principles and requirements as set out in

this chapter), the property value may be indexed up to the period of the impairment

review.

Banks should carry out more frequent valuations where the market is subject to

significant negative changes and/or where there are signs of significant decline in the

value of the individual collateral.

Therefore, banks should define criteria in their collateral valuation policies and

procedures for determining that a significant decline in collateral value has taken

place. These will include quantitative thresholds for each type of collateral

established, based on the observed empirical data and any relevant qualitative bank

experience, bearing in mind relevant factors such as market price trends or the

opinion of independent appraisers.

Guidance to banks on non-performing loans − Collateral valuation for immovable property

Banks should have appropriate IT processes and systems in place to flag out-dated

valuations and to trigger valuation reports.

7.4 Valuation methodology

7.4.1 General approach

Banks should have defined collateral valuation approaches per collateral product

type which are adequate and appropriate for the asset class in question.

All immovable property collateral should be valued on the basis of market value or

mortgage lending value as allowable under Article 229 of the CRR. Market value is

the estimated amount for which an asset or liability should be exchanged on the

valuation date between a willing buyer and a willing seller in an arm’s length

transaction after proper marketing and where the parties had each acted

knowledgeably, prudently and without compulsion.

Overall valuations based only on the discounted replacement cost should not be

used.

For income-generating immovable properties a market comparable or discounted

cash-flow approach can be used.

Immovable property collateral should be valued, adhering to European and

international standards

. National standards can also be accepted if they follow

similar principles.

7.4.2 Expected future cash flows

In accordance with the principles in chapter 6 on NPL measurement, individual

estimations of provision allowances by discounting future cash flows can be carried

out using two broad approaches:

• “going concern” scenario, where the operating cash flows of the debtor continue

and can be used to repay the financial debt and collateral may be exercised to

the extent it does not influence operating cash flows;

• ''gone concern'' scenario, where the operating cash flows of the debtor cease

and collateral is exercised.

In a going concern scenario, since estimation of allowance is based on the

assumption of operating cash flows of the debtor including cash flows being received

from the collateral, updated and reliable information on cash flows is a requisite for

These include the European Valuation Standards EVS-2016 (Blue Book) and the Royal Institute of

Chartered Surveyors (RICS) standards.

Guidance to banks on non-performing loans − Collateral valuation for immovable property

such estimation. Please refer to chapter 6, NPL Measurement, which includes further

reference to a going concern scenario.

7.4.3 Gone concern approach

In a gone concern scenario, the future sale proceeds from collateral execution

should be adjusted taking into account the appropriate liquidation costs and market

price discount to the open market value (OMV).

Liquidation/selling costs

Liquidation costs are defined as the cash outflows incurred during collateral

execution and the sales process and include:

• all applicable legal costs;

• selling costs, taxes and other expenses;

• any additional maintenance costs to be incurred by the bank in relation to the

repossession and disposal of the collateral;

• any cash inflows up to the date of liquidation.

In addition to the above liquidation costs, a market price discount, if appropriate,

should be applied to the updated valuation as outlined below.

The property price (i.e. OMV) at the time of liquidation should take into account

current and expected market conditions.

Time-to-sale considerations based on the underlying national legal framework on the

disposal of mortgaged properties should also be included if applicable, especially

when the legal procedures are lengthy.

The execution of collateral can include both consensual and non-consensual (forced)

liquidation strategies.

The extent/size of the liquidation costs as outlined above should be directly related to

the manner of collateral execution i.e. whether it is consensual or non-consensual.

Market price discount

Market price discounts applied to the property price (OMV at the time of liquidation)

or to fair values derived from fair value models are relevant for the following

economic reason: empirical evidence and practical experience show that there is a

negative correlation between the frequency of defaults and the value of collateral.

Furthermore, market liquidity tends to decline if banks need to realise collateral in

numerous instances and in times of high default rates they often face capital

Guidance to banks on non-performing loans − Collateral valuation for immovable property

pressure to speed up the liquidation of collateral even if they need to sell at

unfavourable prices. Using a discount is not an expression of an arbitrary

conservative bias, but reflects the economic reality of forecasting cash flows. The

market price discount should thus reflect the liquidity of the market and the

liquidation strategy. It should not reflect fire sale conditions unless the anticipated

liquidation strategy actually involves a fire sale.

Supervisors expect banks to apply adequate market price discounts for the purposes

of IAS 39 and IFRS 9, for the calculation of regulatory capital and for risk control

purposes. A market price discount can be close to zero for highly liquid and non-

distressed collateral types, which are not affected by any significant correlation risks.

A minimum discount of 10% should be applied if the collateral is sold by auction.

All banks are expected to develop their own liquidation cost and market price

discount assumptions based on observed empirical evidence. If insufficient empirical

evidence is available, discount assumptions should be sufficiently conservative and

based on, at a minimum, liquidity, passage of time, and the quality/ageing of the

appraisal. If a bank faces the situation of a frozen real estate market and only a small

number of properties have been sold or the sales history has to be considered as not

sufficient, a more conservative market price discount should apply.

Example for the calculation of expected future cash flows

A worked example outlining how the liquidation/selling costs and market price

discount are applied is included below. It also shows that in addition to the market

price discount and liquidation cost, other aspects such as maintenance cost and

discounting (especially for long time-to-sale) can significantly impact the net present

value of the collateral.

Example

Market price discount of 10% applies

Time to liquidation/disposal: 5 years

Selling costs (including taxes and other expenses): 10%

Maintenance costs: 5%

Effective interest rate: 5%

T=0

T=1 T=2 T=3 T=4 T=5

Gross value of loan €300

Open market valuation of collateral

€200

Market price discount

-€20

Selling costs

-€18

Maintenance costs

-€10

Expected future cash flows

-€10 -€10

-€10

€152

Present value of collateral €84

Amount of impairment €216

Guidance to banks on non-performing loans − Collateral valuation for immovable property

Further considerations on estimating cash flows from property

collateral liquidation

In estimating cash flows from property collateral liquidation, banks should use

adequate and realistic assumptions. In addition, credit institutions should pay

attention to the requirements of valuing cash flows under IFRS 13 on fair value

measurements. In particular, financial institutions should comply with the following

requirements.

• Determine the assumed time of disposal taking into account current and

expected market conditions as well as the underlying national legal framework

regarding the disposal of mortgaged properties.

• Ensure that the property price used to determine the estimated market value of

property collateral at the point of liquidation is not more optimistic than

projections produced by international organisations, and therefore does not

result in an improvement on the current market conditions.

• Ensure that income from property collateral is not assumed to increase from the

current levels unless there is an existing contractual arrangement for such

increase. Moreover, current income from property should be adjusted when

calculating the cash flows in order to reflect the expected economic conditions.

For example, it may not be appropriate to project a flat rental income in a

recessionary environment where vacant properties are increasing, putting

downward pressure on rent levels.

• A “hold” strategy on immovable property is not acceptable. A hold strategy is

defined as holding the asset at above market value assuming that the asset will

be sold after the market recovers.

When using the value of collateral in assessing the recoverable amount of the

exposure, the following at least should be documented:

• how the value was determined, including the use of appraisals, valuation

assumptions, and calculations;

• the supporting rationale for adjustments to appraised values, if any;

• the determination of selling costs, if applicable;

• the expertise and independence of the appraiser;

• the assumed timeline to recover.

When the observable market price is used to assess the recoverable amount of the

exposure, the amount, source and date of the observable market price should also

be documented on file.

Banks should be able to substantiate the assumptions used by providing to the

competent authority, if requested, details on the property market value, the market

price discount, legal and selling expenses applied, and the term used for the time to

Guidance to banks on non-performing loans − Collateral valuation for immovable property

liquidation. Banks should be able to fully justify their assumptions, both qualitatively

and quantitatively, and explain the drivers of their expectations, taking past and

current experience into account.

Back-testing

Banks should demonstrate via sound back-testing that the assumptions used are

reasonable and grounded in observed experience. In this context, banks should

regularly back-test their valuation history (last valuation before the object was

classified as a NPL) vs. their sales history (net sales price of collateral). Depending

on the size and business model of the bank, it should differentiate between object

types (e.g. single family home, apartment, warehouse), valuation

models/approaches, type of sale (voluntary/forced) and regions for their back-testing

process. The back-testing results should be used to determine discounts on

collateral valuations supporting exposures remaining on the balance sheet.

Alternatively, banks using the A-IRB approach can use secured LGDs to determine

discounts.

IT database requirements in respect of collateral

Banks should have databases of transactions to enable the proper assessment,

monitoring and control of credit risk and the preparation of reports and other timely

and comprehensive documentation, both for management and to inform third parties

or respond to requests from supervisors. In particular, databases should comply with

the following requirements:

• depth and breadth, in that they cover all the significant risk factors;

• accuracy, integrity, reliability and timeliness of data;

• consistency – they should be based on common sources of information and

uniform definitions of the concepts used for credit-risk control;

• traceability, such that the source of information can be identified.

These databases should include all the relevant information on properties and other

collateral for the banks’ transactions and on the links between collateral and specific

transactions.

7.5 Valuation of foreclosed assets

Banks are strongly encouraged to classify foreclosed real estate assets as non-

current assets held for sale under IFRS 5

. This accounting treatment implies that

The definition of foreclosed assets applied in the context of this guidance is provided in Annex 1.

Guidance to banks on non-performing loans − Collateral valuation for immovable property

the management should approve an individual plan to sell the asset within a short

timeframe (normally one year) and that an active sales policy should be pursued

(IFRS 5.8); thus, it favours recoveries.

Given this premise, foreclosed assets received should be valued at the lower of:

• the amount of the financial assets applied, treating the asset foreclosed or

received in payment of debt as collateral;

• the fair value of the repossessed asset, less selling costs.

When fair value is not obtained by reference to an active market but is based on a

valuation technique (either level 2 or level 3), it may be necessary to make some

adjustments as a result of the following factors:

• The condition or location of the assets. Risk and uncertainties regarding the

asset should be incorporated in the fair value estimation.

• The volume or level of activity of the markets for these assets. The previous

experience of the entity in the realisations and the differences between the

valuation technique and the final amount obtained in the realisation should be

incorporated. Assumptions made in order to measure this adjustment may be

documented, and should be available to the supervisor on request. Illiquidity

discounts may be considered.

In rare cases, banks acquire buildings still under construction and decide to

complete construction before selling the building. In such cases, the bank should

demonstrate the merits of such a strategy and the cost should not exceed the fair

value less costs to complete and sell the asset considering adequate illiquidity

discounts as described above. Foreclosures of property are merely a consequence

of granting loans which later defaulted. Therefore, such foreclosures are not an

expression of a property investment business strategy as defined in IAS 40. Nor are

difficulties encountered by banks in selling foreclosed property evidence of such an

investment strategy. Banks are therefore strongly discouraged from applying IAS 40

in such cases and encouraged to apply IFRS 5 as indicated at the beginning of this

section.

Long maintenance periods for foreclosed assets are evidence of difficulties in

disposing of them, for example due to the illiquidity of the market. Therefore, when a

foreclosed asset has exceeded the average holding period of similar assets, for

which active sale policies are in place, banks should revise the illiquidity discount

applied in the valuation process mentioned above, and increase it accordingly. In

these circumstances, the bank should refrain from recognising write-backs/reversals

of existing accumulated impairment on the asset as its prolonged presence on the

balance sheet provides evidence that the bank is unable to sell the assets at an

increased valuation.

Under the IFRS framework, there are a number of approaches to value foreclosed assets (IAS 2, IAS

16, IAS 40 and IFRS 5). However, supervisors strongly encourage banks to use IFRS 5 for the reasons

outlined above.

Guidance to banks on non-performing loans − Collateral valuation for immovable property

The frequency of valuation of foreclosed assets and the applicable procedures are

aligned to the treatment of immoveable property as set out in section 7.3 and 7.2.2.

7.6 Supervisory reporting and public disclosures

Annex 7 sets out supervisory expectations on public disclosures relating to collateral.

Guidance to banks on non-performing loans − Annex 1

Glossary

Annex 1

Glossary

Abbreviation/Term Definition Reference

AMC (asset management

company)

A special-purpose vehicle for cleansing bank balance sheets. A credit institution can transfer

non-performing assets (NPA) to an AMC, subject to certain requirements and conditions

being met. AMCs are often referred to as “bad banks”.

AQR (asset quality review) Assessment conducted by supervisors to enhance the transparency of bank exposures,

including the adequacy of asset and collateral valuation and related provisions.

ECB 2014 and 2015 AQR results

BCBS (Basel Committee on

Banking Supervision)

Committee of the Bank for International Settlements which provides a forum for regular

cooperation on banking supervisory matters. Its objective is to enhance understanding of key

supervisory issues and improve the quality of banking supervision worldwide.

The most important regulatory frameworks are known as Basel II and Basel III.

Representatives of central banks and supervisory authorities from different countries are

members of the BCBS.

https://www.bis.org/bcbs

CRR (Capital Requirements

Regulation)

Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June

2013 on prudential requirements for credit institutions and investment firms and amending

Regulation (EU) No 648/2012.Text with European Economic area relevance.

Official text of CRR

CRD IV (Capital

Requirements Directive)

Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on

access to the activity of credit institutions and the prudential supervision of credit institutions

and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC

and 2006/49/EC. Text with EEA relevance.

Official text of CRD IV

Cure rate

The percentage of loans that previously presented arrears and, post restructuring, present no

arrears.

Denounced loans Denounced loan, as used, for example, in the Greek NPL context, means that the loan

contract has been terminated by the lender and such termination has been notified to the

borrower.

EBITDA (earnings before

interest, taxes, depreciation

and amortisation)

Useful metric for comparing the income of companies with different capital structures.

Companies with significant fixed assets, such as manufacturing companies, or companies

which incur large depreciation charges or which have significant intangible assets which

result in large amortisation charges, can easily be compared. It is also a useful measure for a

company's creditors as it shows the income available for interest payments.

EL (expected loss) “Expected loss” or “EL” means the ratio of the amount expected to be lost on an exposure

from a potential default of a counterparty or dilution over a one-year period to the amount

outstanding at default.

“Exposure” means an asset or off-balance-sheet item.

“Loss” means economic loss, including material discount effects, and material direct and

indirect costs associated with collecting on the instrument.

Regulation (EU) 575/2013 Art 5(3)

EWI (early warning indicators) Quantitative or qualitative indicators, based on asset quality, capital, liquidity, profitability,

market and macroeconomic metrics. In the context of the risk control framework, an

institution can use progressive metrics (“traffic light approach”) or EWI to inform the

institution’s management that a stress situation (“red triggers”) could potentially be reached.

Foreclosed assets For the purposes of this guidance, foreclosed assets are defined as assets held on the

balance sheet of a credit institution obtained by taking possession of collateral, or by calling

on similar credit enhancements. Those assets can be obtained through judicial procedures

(“foreclosed” in the strict sense), through bilateral agreement with the debtor (swap or sale)

or other types of collateral transfer from debtor to creditor. Foreclosed assets comprise both

financial assets and non-financial assets. Foreclosed assets include all collateral obtained

irrespective of their classification for accounting purposes (e.g. including assets for own use

and for sale).

FTE (full time

equivalent/employee)

A unit obtained by comparing an employee’s average number of hours worked to the average

number of hours of a full-time worker. A full-time person is therefore counted as one FTE,

while a part-time worker gets a score in proportion to the hours he or she works.

http://ec.europa.eu/eurostat/statistics-

explained/index.php/Glossary:Full-

time_equivalent_(FTE)

GDP (gross domestic product) The standard measure of the value of final goods and services produced by a country during

a period minus the value of imports.

https://data.oecd.org/gdp/gross-domestic-product-

gdp.htm

IAS (International Accounting

Standards)

Rules set by the International Accounting Standards Board (IASB) – an independent body of

international accounting experts. The main purpose of the standards is to promote the

quality, transparency and comparability – at an international level, too – of financial

statements drawn up by various enterprises or by one enterprise for various periods. Publicly

traded enterprises domiciled in the EU are required by Regulation (EU) 1606/2002 to prepare

http://www.ifrs.org/Pages/default.aspx

Guidance to banks on non-performing loans − Annex 1

Glossary

consolidated financial statements in accordance with International Accounting Standards. As

the IASB is an international association under private law, its standards cannot be

immediately legally binding. Each standard has to undergo a recognition procedure in order

to become legally binding at EU level or in other countries. Prior to 1 April 2001, the body

was called the International Accounting Standards Committee (IASC) and the rules that it

issued were called International Accounting Standards (IAS). These rules are still valid and

still bear the same name. Any rules published after this date are called International Financial

Reporting Standards (IFRS).

ICAAP (internal capital

adequacy assessment

process)

Strategies and processes to assess and maintain on an ongoing basis the amounts, types

and distribution of internal capital that banks consider adequate to cover the nature and level

of the risks to which they are or might be exposed. These strategies and processes are

subject to regular internal review to ensure that they remain comprehensive and

proportionate to the nature, scale and complexity of the activities of the institution concerned.

See also Article 73 of Directive 2013/36/EU, which requires institutions to have in place a

sound, effective and comprehensive ICAAP.

Official text of Directive 2013/36/EU – CRD IV

IFRS (International Financial

Reporting

Standards)

Set of international accounting standards stating how particular types of transactions and

other events should be reported in financial statements. See also IAS (International

Accounting Standards) above.

http://www.ifrs.org/Pages/default.aspx

IMF (International Monetary

Fund)

International organisation of which the primary purpose is to ensure the stability of the

international monetary system – the system of exchange rates and international payments

that enables countries (and their citizens) to transact with each other. The Fund’s mandate

was updated in 2012 to include all macroeconomic and financial sector issues that have a

bearing on global stability. It has 186 member countries.

http://www.imf.org

KPI (key performance

indicator)

Indicators through which a bank’s management or supervisor can assess the performance of

the institution.

LGD (loss given default) “Loss given default” or “LGD” means the ratio of the loss on an exposure due to the default of

a counterparty to the amount outstanding at default.

“Loss” means economic loss, including material discount effects, and material direct and

indirect costs associated with collecting on the instrument.

Regulation (EU) 575/2013, Art 4(1)(55) and Art 5(2)

LLP (loan loss provision) Reduction in the carrying amount of an asset to reflect its decrease in creditworthiness.

LTV (loan to value)

Ratio used in the context of mortgage lending expressing the value of a loan compared to the

appraised value of the underlying real estate.

MIS (management information

systems)

Risk-management information systems to gather and report relevant data at a business and

bank-wide level.

See BIS Principles for effective risk data

aggregation and risk reporting

NPA (non-performing assets) NPEs plus foreclosed assets

NPE (non-performing

exposures)

Exposures (loans, debt securities, off-balance-sheet items) other than held for trading that

satisfy either or both of the following criteria:

(a) material exposures which are more than 90 days past-due;

(b) the debtor is assessed as unlikely to pay its credit obligations in full without realisation of

collateral, regardless of the existence of any past-due amount or the number of days past

due.

Non-performing exposures include the defaulted and impaired exposures. The total NPE is

given by the sum of non-performing loans, non-performing debt securities and non-

performing off-balance-

sheet items. See also EBA Implementing Technical Standard (ITS) on

Supervisory Reporting (Forbearance and non-performing exposures).

EBA Implementing Technical Standard (ITS) on

Supervisory Reporting (Forbearance and non-

performing exposures)

NPL (non-performing loans) Loans other than held for trading that satisfy either or both of the following criteria:

(a) material loans which are more than 90 days past-due;

(b) the debtor is assessed as unlikely to pay its credit obligations in full without realisation of

collateral, regardless of the existence of any past-due amount or of the number of days past

due.

Non-performing loans include defaulted and impaired loans. NPLs are part of NPEs. See also

EBA Implementing Technical Standard (ITS) on Supervisory Reporting (Forbearance and

non-performing exposures).

However, it should be noted that this Guidance document generally refers to “NPLs” as this is

an established term in daily interactions between banks and supervisors. In technical terms,

the guidance addresses all Non-Performing Exposures (NPEs) following the EBA definition,

as well as foreclosed assets. In parts it also touches on performing exposures with an

elevated risk of turning non-performing, such as watch-list exposures and performing

forborne exposures.

EBA Implementing Technical Standard (ITS) on

Supervisory Reporting (Forbearance and non-

performing exposures)

NPL WUs (Workout Units) Dedicated and separate organisational units within the bank solely occupied with NPL

workout processes; those units can also comprise early arrears activities (i.e. exposures not

yet classified as NPLs) or foreclosed assets.

NPV (net present value) The nominal amount outstanding minus the sum of all future debt-service obligations (interest

and principal) on existing debt discounted at an interest rate different from the contracted

rate.

OMV (open market valuation) The price at which an asset would trade in a competitive auction setting. OMV is used

interchangeably with Market Value.

https://www.ivsc.org/

PD (probability of default) “Probability of default” or “PD” means the probability of default of a counterparty over a one-

year period.

Regulation (EU) 575/2013, Art 4(1)(54)

Guidance to banks on non-performing loans − Annex 1

Glossary

100

PE (performing exposure) Exposures not covered by the NPE criteria as defined above.

RAF (risk appetite framework)

The overall approach, including policies, processes, controls, and systems through which risk

appetite is established, communicated and monitored. It includes a risk appetite statement,

risk limits, and an outline of the roles and responsibilities of those overseeing the

implementation and monitoring of the RAF. The RAF should consider material risks to the

financial institution, as well as to the institution’s reputation vis-à-vis policyholders,

depositors, investors and customers. The RAF aligns with the institution's strategy.

Financial Stability Board publication Principles for

An Effective Risk Appetite Framework

RAS (risk appetite statement) The articulation in written form of the aggregate level and types of risk that a financial

institution is willing to accept, or to avoid, in order to achieve its business objectives. It

includes qualitative statements as well as quantitative measures expressed relative to

earnings, capital, risk measures, liquidity and other relevant measures as appropriate. It

should also address more difficult to quantify risks such as reputation and conduct risks as

well as money laundering and unethical practices.

Financial Stability Board publication Principles for

An Effective Risk Appetite Framework

Recovery plan Document drafted by credit institutions and investment firms containing the measures to be

taken in order to restore their financial position following a significant deterioration of their

financial situation, as required by the new Union-wide framework for crisis prevention, crisis

management and resolution.

See Article 5(10) of Directive 2014/59/EU and EBA

final draft Regulatory Technical Standards on the

content of recovery plans.

SI (significant institution) In Single Supervisory Mechanism (SSM) terms, a significant institution is a bank to which

such importance is attached that it is directly overseen by the European Central Bank (ECB).

The following are considered “significant”: the three largest banks in a participating member

state, banks in receipt of direct European Financial Stability Facility/European Stability

Mechanism (EFSF/ESM) assistance and banks with total assets in excess of €30 billion or

20% of national gross domestic product (with a balance sheet total of at least €5 billion). In

exceptional cases, the ECB can declare significant a bank operating across national borders.

Overall, as of 1 January 2016 the ECB has defined around 129 banks, which together have

banking assets amounting to over 80% of the total assets on the aggregated balance sheets

of all supervised credit institutions, as significant. Direct supervision is microprudential, i.e.

institution-specific, in nature, while “systemically important financial institutions” are subject to

macroprudential, i.e. system-specific, oversight.

https://www.bankingsupervision.europa.eu

SSM (Single Supervisory

Mechanism)

The pillar of the EU banking union that is responsible for banking supervision. It comprises

the ECB and the national supervisory authorities of the participating countries. Its main aims

are to: (i) ensure the safety and soundness of the European banking system, (ii) increase

financial integration and stability, (iii) ensure consistent supervision.

https://www.bankingsupervision.europa.eu

ST (stress test) Stress test exercises conducted by supervisory authorities in order to provide supervisors,

banks and other market participants with a common analytical framework to consistently

compare and assess the resilience of banks to economic shocks.

EBA 2016 EU-wide stress test exercise

ECB 2016 stress test – press release

Texas ratio The Texas ratio is generally calculated by dividing the gross value of a bank’s non-performing

assets by the sum of its tangible common equity capital and loan loss reserves.

UTP (unlikeliness to pay) See article 178(3) of Regulation (EU) 575/2013 for the elements to be taken as indications of

unlikeliness to pay.

http://eur-lex.europa.eu/legal-

content/EN/TXT/?uri=celex%3A32013R0575

Watch-list exposures Exposures that have displayed characteristics of a recent increase in credit risk which are

subject to enhanced monitoring and review by the bank.

Guidance to banks on non-performing loans − Annex 2

Sample of NPL segmentation criteria in retail

101

Annex 2

Sample of NPL segmentation criteria in

retail

1. Natural or legal person

(a) Retail client

(b) Sole trader

(d) Small and medium-sized enterprises (SMEs) (overlap with corporates)

2. Arrears bucket/days past due (the higher the level of arrears the narrower the

range of possible solutions)

(a) Early arrears (>1 dpd and ≤90 dpd)

(b) Late arrears of (>90 dpd and <180dpd)

which legal actions have taken place or are in progress)

3. Re-restructured cases (restructured loans with arrears, indicative of persistence

of repayment problems and/or failure of restructuring solution offered)

(a) Number of previous restructurings

4. Exposure balance

(a) High value

(b) Low value

5. Level of risk (based on bank’s assessment / behaviour scoring / internal

behaviour data / transaction history / credit rating). Clients with better payment

histories are more likely to respond positively to restructuring offers.

(a) very high

(b) high

(d) low

Guidance to banks on non-performing loans − Annex 2

Sample of NPL segmentation criteria in retail

102

6. Based on borrower's behaviour

(a) seasonal repayments

(b) cooperative vs. non cooperative (customers unwilling to cooperate should

be sent to debt recoveries)

(i) number of promises kept/not kept

(ii) number of unsuccessful call attempts

(iii) date of last successful contact

7. Purpose of credit facility (by product)

(a) principal private residence loan

(b) secondary home/holiday home loan

(d) personal loan

(e) overdraft account

(f) leased asset

(g) credit card

(h) sole traders, micro businesses, small and medium-sized business loan

(i) for the setup of the business: premises; infrastructure, machinery;

renovations

(ii) working capital

8. Loan currency (euro, Swiss franc, dollar etc.)

9. Loan interest rate (interest rate reduction consideration for loans burdened by

high interest rates, if possible)

10. Customer outlook (borrower’s age, health, employment type and history,

employment prospects, professional skills, industry).

11. Country of residence/incorporation

(a) residents

(b) non-residents

12. Location of the underlying collateral

(a) rural vs. urban

(b) prime location, city centre, outskirts etc.

Guidance to banks on non-performing loans − Annex 2

Sample of NPL segmentation criteria in retail

103

13. Type of underlying collateral

(a) land

(i) building plot

(ii) agriculture land

(b) building

(i) house

(ii) shop

(iii) factory

14. Based on the LTV

(a) For low LTV loans, sale of underlying collateral may be the preferred

option, as opposed to high LTV loans

15. Hardship cases (health problems, separations, divorce)

16. Borrower’s affordability assessment

(a) can afford loan repayment vs. cannot afford

(b) income less expenditure vs. reasonable living expenses vs. loan

instalment

17. Borrower’s viability (e.g. viable vs. non-viable borrower)

Guidance to banks on non-performing loans − Annex 3

Benchmark for NPL monitoring metrics

104

Annex 3

Benchmark for NPL monitoring metrics

Banks should establish a robust set of metrics to measure progress in the

implementation of their strategy for non-performing loans and foreclosed assets. The

table below provides an indicative and not exhaustive list of such metrics and

includes key elements described in section 3.5 of this guidance.

High-Level NPL Metrics

NPE level and flows NPE stock / Total volume of exposures

NPE stock + foreclosed assets + performing forborne / Total volume of exposures + foreclosed assets

Quarterly flow of NPEs (+/-) / Total NPE stock

Quarterly flow from PE to NPE

Quarterly flow from performing forborne to NPE

Quarterly flow from NPE to PE

Quarterly flow from NPE to performing forborne

Quarterly flow from performing forborne to PE

Quarterly flow from PE to performing forborne

Provisions Quarterly increase in provision stock

Quarterly level of provision write-backs

Quarterly change in provision stock (+/-) / Total NPE Stock

Accumulated total provisions / Total NPE Stock

By cohort (e.g. number of years since NPL classification, secured/unsecured)

Loss budget Total loss as a result of forbearance activity

Total loss versus budget

Collection Activity

Staff activity Number of customer engagements per quarter versus plan

Number of customer engagements leading to forbearance agreement

Number of customer engagements leading to cash recovery

Cash recovery Quarterly cash recovery from NPE / Total NPE stock

Quarterly cash recovery from interest on NPE / Total NPE stock

Quarterly cash recovery from capital & fees on NPE / Total NPE stock

Quarterly cash recovery from property related liquidations; also as a percentage of Total NPE stock

Quarterly cash recovery from non-property related liquidations; also as a percentage of Total NPE

Stock

Quarterly cash recovery from sales of NPEs; also as a percentage of Total NPE Stock

Quarterly cash recovery from NPE; also as a percentage of Total NPE Stock

Forbearance Activity

Debt forgiveness Quarterly debt forgiveness

Quarterly debt forgiveness / Specific assigned provisions

Quarterly debt forgiveness / Total NPE stock

Accounting write-offs Quarterly accounting write-offs (full and partial)

Quarterly accounting write-offs (full and partial) / Specific assigned provisions

Quarterly accounting write-offs (full and partial) / Total NPE stock

Forbearance activity Value of NPE currently in short-term forbearance

Value of NPE currently in long-term forbearance

Value of recently agreed forbearance solutions by characteristics (e.g. payment holiday > 12 months)

Guidance to banks on non-performing loans − Annex 3

Benchmark for NPL monitoring metrics

105

Value of loans currently in forbearance / Total NPE stock

Value of PE currently in forbearance

Quarterly non-performing forborne / Total NPE stock

Total non-performing forborne / Total NPE stock

Value of non-performing forborne currently experiencing financial difficulties

Re-default rate Re-default rate on non-performing forborne

Re-default rate on performing forborne

Debt/asset swap Quarterly debt to equity swaps; also as a percentage of total NPE stock

Quarterly debt to asset swap; also as a percentage of total NPE stock

Legal activity

Legal activity Value and count of loans currently in legal activity

Value and count of assets recently foreclosed

Quarterly value and count of new loans entering legal activity

Quarterly value and count of loans exiting legal activity

Average length of legal procedures recently closed

Average recovery amounts from legal procedures recently closed (including total costs)

Loss rate on loans exiting legal activity

P&L items stemming from NPLs

Interest from NPLs Interest payments recognised on NPLs in the P&L

Percentage of recognised interest payments from NPLs actually received

Guidance to banks on non-performing loans − Annex 4

Samples of early warning indicators

106

Annex 4

Samples of early warning indicators

EWI at a borrower level from external sources

External sources Debt and collateral increase in other banks

Past-due or other NP classifications in other banks

Guarantor default

Debt in private central register (if any)

Legal proceeding

Bankruptcy

Changes in the company structure (e.g. merger, capital reduction)

External rating assigned and trends

Other negative information regarding major clients/counterparties of the debtor/suppliers

EWI at a borrower level from internal sources

Companies Negative trend in internal rating

Unpaid cheques

Significant change in liquidity profile

Liabilities leverage (e.g. equity/total < 5% or 10%)

Number of days past due

Number of months with any overdraft/overdraft exceeded

Profit before taxes/revenue (e.g. ratio < -1%)

Continued losses

Continued excess in commercial paper discount

Negative own funds

Payments delay

Decrease of turnover

Reduction in credit lines related to trade receivables (e.g. year-on-year variation, 3m average/1y

average)

Unexpected reduction in undrawn credit lines (e.g. undrawn amount/total credit line)

Negative trend in behavioural scoring

Negative trend in probability of default and/or internal rating

Individuals Mortgage loan instalment > x time credit balance

Mortgage and consumer credit days past due

Decrease in the credit balance > 95% in the last 6 months

Average total credit balance < 0.05% of total debt balance

Forborne

Nationality and related historic loss rates

Decrease of payroll in the last 3 months

Unemployment

Early arrears (e.g. 5-30 days of past due, depending on portfolio/client types)

Reduction in bank transfers in current accounts

Increase of loan instalment over the payroll ratio

Number of months with any overdraft, exceeded

Negative trend in behavioural scoring

Negative trend in probability of default and/or internal rating

EWI at a portfolio/segment

level

Portfolio distribution

Guidance to banks on non-performing loans − Annex 4

Samples of early warning indicators

107

Size distribution and concentration level

Top X (e.g. 10) groups of connected clients and related risk indicators

Asset class distribution

Breakdown by industry, sector, collateral types, countries, maturities, etc.

Risk parameters PD/LGD evolution (overall and per segment)

PD/LGD forecasts and projections

Overall EL

Default exposure

LLP data LLP stocks and flows (overall and per segment)

Volumes and trends of significant risk provisions on individual level

NPL/forbearance

status/foreclosure

NPL volume by category (>90 past due, LLP, etc.)

NPL/forbearance

status/foreclosure

Forbearance volume and segmentation (restructuring, workout, forced prolongation, other

modifications, deferrals, >90 past due, LLP)

Foreclosed assets on total exposures

NPL ratio without foreclosed assets

NPL ratio with foreclosed assets

NPL coverage (LLPs, collateral, other guarantees)

EWI by specific type of customers/sectors

General Customisable index data (GDP, stock markets, commodity prices, CDS prices, etc.)

Shipping Shipping market indexes (e.g. Baltic Dry Index)

Debt service coverage ratio (DSCR) and LTV scores

Aviation Airline-specific indicators (passenger load, revenue per passenger, etc.)

Real estate Real estate-related indexes (segment, region, cities, rural areas, etc.)

Rental market scores and expected market value changes

Energy Index data on regional alternative energy sources (e.g. wind quantities, etc.)

Information-gathering system on potential technical or political risks on energy

Infrastructure/airports Airport passenger data

Guidance to banks on non-performing loans − Annex 5

Common NPL-related policies

108

Annex 5

Common NPL-related policies

Banks should develop, regularly review and monitor their adherence to policies

related to the NPL management framework. For high NPL banks, the management

body should review these policies and processes at least annually and proceed with

any necessary amendments.

Having regard to the strategy of the bank (including its NPL strategy and operational

plan where relevant) and the principle of proportionality, the following policies are

expected to be established.

Arrears management policy

The purpose of this policy is to prescribe the bank’s NPL operating model (see

section 3.3), including at least the following elements:

• The structure and responsibilities of the NPL WUs as well as other units

involved in the management of arrears (including NPLs), also defining clear

hand-over triggers and link to portfolio segmentation;

• the procedure to be followed by the functions involved to include at a

minimum:

• the procedure and handover criteria to be followed for each stage of

arrears, i.e. pre-arrears, early arrears and late arrears.

• the procedure to be followed in cases where a borrower is classified

as non-cooperating and/or non-viable and the criteria for the borrower

to be classified as such;

• the communication

with the borrower at each step;

• the tools and methods to be applied;

• the human and technical resource requirements;

• the minimum level of MI reports to be produced internally for monitoring

purposes and regular updates to the management body.

Communication with the borrower should be aligned with the legislative framework (e.g. code of

conduct) of the country of operations.

Guidance to banks on non-performing loans − Annex 5

Common NPL-related policies

109

Forbearance policy

The purpose of this policy is to outline the framework within which the bank may

grant forbearance measures to borrowers that face or in the future may face financial

difficulties (see chapter 4).

Indicatively, the policy should prescribe at least:

1. The necessary financial and non-financial documentation to be requested and

provided by the borrowers

in order for the responsible credit officer to

demonstrate repayment capacity on a principal and interest basis.

2. The minimum key financial repayment capacity metrics and ratios to be applied

by the credit officer, detailed on a portfolio/product-specific basis in order to fully

assess the borrower’s repayment capacity.

3. The process to be followed in determining and implementing the most

appropriate forbearance solution for a borrower:

(a) For retail customers, it is expected that this should be illustrated by a

decision tree similar to the one presented in the dedicated chapter on

forbearance. For non-retail borrowers a decision tree approach may not be

appropriate but the policy should provide clear instructions to the credit

officer on how to assess the suitability of a forbearance treatment for a

non-retail borrower.

(b) In the case of borrowers for whom no solution can be reached (either non-

viable and/or non-cooperating borrowers), the time-bound process and

procedures for the transfer of these borrowers to the NPL WU responsible

for liquidation.

4. A toolkit of short-term and long-term solutions as outlined in chapter 4.

(a) Any forbearance solution should effectively involve a re-underwrite of the

borrower to establish a sustainable debt structure and demonstrate

repayment capacity on a principal and interest basis.

5. Clear instructions to the credit officer regarding the requirements for revaluation

of collateral in line with chapter 7.

6. The decision-making process, approval levels and procedures for each type of

forbearance solution and exposure levels up to management body level.

7. The process and procedure for the monitoring of the forbearance solutions

awarded and borrower performance following the completion of a restructuring.

Depending on the type of borrower, i.e. physical persons or legal entities, the required documentation

is expected to differ.

Guidance to banks on non-performing loans − Annex 5

Common NPL-related policies

110

(a) These processes and procedures should clearly articulate the frequency of

review of the borrower, what constitutes a re-default, process for

reassessment and requirements for the reporting of re-defaults.

8. The range of pricing in accordance with the proposed solution and the type of

borrower.

For item 2 above, banks should develop sector-specific (at a minimum regulatory

reporting exposure classes) guidelines which establish the key financial metrics and

ratios on a sector-specific basis (SMEs & corporates). For example, in the hotel

sector the assessment may include average room rates, revenue per available room,

occupancy, cash conversion, fixed costs as a percentage of total costs, variable

costs as a percentage of total costs, maintenance capital expenditure, etc.

Debt recovery/enforcement policy

The NPL WUs responsible for debt recovery should take the most appropriate

actions in a timely manner to improve debt collection and maximise debt

recovery/minimise loss. Related processes and procedures should be defined in

accordance with the NPL strategy in a debt recovery policy, which should address, at

a minimum:

• The range of available options to resolve the case. Indicatively, the available

options of a debt recovery unit are the following (not in any prescribed order):

• voluntary asset sale (borrower re-engages and agrees to sell the asset)

• forced asset sale via receivers/court proceedings (assets are not held on

the balance sheet of a credit institution )

• foreclosure of asset (assets are held on the balance sheet of a credit

institution)

• debt collection (internal or external)

• debt to asset/equity swap;

• sale of loan/loan portfolio to a third party.

• The procedure to be followed to decide the most appropriate recovery option

and the team of experts to be involved (e.g. credit officer, lawyers, real estate

experts, risk control) to assist in taking the decision.

• The recovery option should take into account the existence of collateral, type of

legal documentation, type of borrower, local market conditions and

macroeconomic outlook, the legislative framework in place and potential

historical recovery rates per option vs. the costs involved per option.

• A clear definition of non-cooperating borrowers or link to related policies

including such definition.

Guidance to banks on non-performing loans − Annex 5

Common NPL-related policies

111

• A clearly defined approval process for each stage of the debt recovery process

for the different recovery options available to the bank.

• The role of risk control and internal audit departments in the procedure and in

the monitoring process.

With respect to the liquidation of collateral, the following should be defined in a

policy.

• The valuation approach to be followed in respect of the asset (in line with

chapter 7) including the liquidation costs to be applied both in a consensual and

non-consensual sale scenario. The liquidation costs should be in line with

requirements as set out in section 7.4.3.

• Involvement of internal or external experts.

• Potential limits to the amount of repossessed or foreclosed assets that will be

acquired by the bank within a certain time period and potential limits to the

amount of assets that could be held by the bank at any point of time.

• The procedure to be followed post repossession or foreclosure to develop and

implement a sale strategy, and the responsible unit within the bank to undertake

the management of the assets concerned (may also be defined in a separate

foreclosed/repossessed asset policy).

NPL classification and provisioning policy

Banks should adopt, document and adhere to sound methodologies that address

policies, procedures and controls for assessing and measuring allowances on non-

performing loans.

• These methodologies should be reviewed at a minimum on an annual basis.

• Methodologies should clearly document the key terms, judgements,

assumptions and estimates related to the assessment and measurement of

allowances for non-performing loans (e.g. migration rates, loss events,

collateral liquidation costs).

They should encompass appropriate

conservatism and be supported by observed empirical evidence.

• Clear guidance on the timeliness of provisions by type of regulatory exposure

classes if relevant (see section 6.6).

• Banks should adopt and adhere to written policies and procedures detailing the

credit risk systems and controls used in their credit risk methodologies.

To take into account industry concentration risk, e.g. in the real estate sector.

BCBS Guidance on credit risk and accounting for expected credit losses, principle 2.

BCBS Guidance on credit risk and accounting for expected credit losses, paragraph 29.

BCBS Guidance on credit risk and accounting for expected credit losses, paragraph 31.

Guidance to banks on non-performing loans − Annex 5

Common NPL-related policies

112

• Management judgements, estimates, considered assumptions and related

sensitivity analysis should be subject to appropriate disclosures.

• Banks should, as a matter of best practice, back-test their loss rates on a

regular basis. The supervisory expectation is that this should occur at a

minimum every 6 months.

• In addition, banks should be sufficiently prudent when considering the write-

back/reduction of existing provisions and ensure that the revised estimates and

assumptions reflect the current economic condition and the current view of the

expected economic outlook.

• Banks should also consider the contractual obligation of expected cash flows

before considering including them in discounted cash flows

Write-off policy

As outlined in section 6.6, all banks should have a defined write-off policy to ensure

the ‘recoverability’ of NPLs is assessed in a timely manner.

Considering the potential impact on banks’ capital and the moral hazard that write-

offs may cause, specific and clear rules should be put in place to ensure that their

application is aligned with the bank’s strategic planning, while an ongoing control

mechanism should be established to identify their proper and prudent

implementation.

The write-off policy/procedure documents should address at a minimum the

following:

• the write-off approach to be taken on a specific portfolio/exposure class basis,

i.e. under what conditions/circumstances write-offs are to be performed;

• whether a case-by-case approach is allowable and the procedures to be

followed;

• the supporting documentation required to support a write-off credit decision;

• whether there will be a maximum amount of write-offs allowable on a borrower

(connection)-level basis and on a portfolio-level basis;

• the credit approval limits relating to write-offs.

It is also recommended that appropriate authority limits be established regarding the

implementation of debt write-off and debt forgiveness arrangements, given the

significant financial and reputational implications associated with incorrect decisions.

Guidance to banks on non-performing loans − Annex 5

Common NPL-related policies

113

Multi-bank distressed debt policy

Banks should also consider the interaction with other creditors for NPL borrowers

with multiple creditors, usually corporate borrowers. Therefore, banks should put in

place a clear procedure for negotiating and interacting with other financial institutions

(or other third parties) with whom the borrower is indebted.

Collateral policies

Given the importance of credit risk mitigation in the NPL work-out process banks

should develop clear and consistent collateral policies. These policies should

comprehensively cover the management, valuation and reporting of all collateral

types held as security for NPLs. Given the complexity and specialisation of some

collateral items, banks should seek external expertise in drafting and reviewing these

policies. By developing these collateral policies, banks will ensure a consistency of

approach to managing and valuing similar collateral across the portfolio as per

chapter 7 of this guidance.

Early warning/watch-list policy

A dedicated policy should be established specifying, amongst other things:

• the types of actions required in response to the different types of early warning

alerts – relationship managers should not be able to suppress early warning

triggers unless a suitable action has been taken and documented;

• escalation procedures;

• key elements, frequency and recipients of the reporting;

• hand-over criteria/link to NPL procedures.

Outsourcing/NPL servicing policy

A dedicated policy should be established for the outsourcing of services to third

parties if this is relevant. This needs to include the required procedures for the

selection of outsourcing partners, the required legal contract content and the

decision-making process for outsourcing agreements as well as the monitoring of

those agreements.

Guidance to banks on non-performing loans − Annex 6

Affordability assessment for retail and corporate borrowers

114

Annex 6

Affordability assessment for retail and

corporate borrowers

Retail borrowers

In cases where the borrower has different categories of credit facilities with the bank

(e.g. housing loan, credit card, consumer loan, etc.), the bank should look at

“unbundling” the various credit facilities, constituent collateral and/or earnings

streams. In its assessment the bank should look at these categories separately as

well as in total to determine the most appropriate overall restructuring solution(s).

The following aspects should also be addressed.

• Consideration of the borrower’s personal financial and non-financial information.

• Consideration of the borrower’s overall indebtedness, especially as regards

unsecured debt repayment commitments and the consequences of non-

payment.

• Agreed programme of loan repayments should be equal to or less than the

remaining available income after deducting all expenses and commitments.

• Analysis/assessment of historic data to trace the timing and reasons of the

borrower’s financial difficulties and provide an indication of the viability of the

restructuring solution offered.

• Assessment of borrower expenditure levels should take account of likely future

expenditure increases. At a minimum banks should be able to demonstrate that

increases in line with inflation have been considered but they should also be

able to demonstrate that increases specific to the borrower and their unique

circumstances have been taken into account (for example an increase in

dependents or future education costs etc.).

• Where future and specific expenditure decreases are being taken into account

(dependents exiting education and entering the workforce, for example) banks

should be able to demonstrate that a conservative approach has been taken in

considering these decreases, that they are plausible and practical over the life

of the revised solution and that they will not place an unreasonable burden on

the borrower.

• Assessment of whether proposed restructuring solution would be in line with the

borrower’s individual needs to maintain a certain living standard.

• Assessment of the borrower’s current and future repayment ability.

Guidance to banks on non-performing loans − Annex 6

Affordability assessment for retail and corporate borrowers

115

For the current repayment ability, indicatively the following should be taken into

account:

• personal financial and non-financial information (e.g. dependants, household

needs, occupation, income, expenditure, etc.);

• overall indebtedness;

• current repayment capacity;

• previous repayment history;

• reasons for arrears (e.g. salary reductions, job loss, etc.);

• age and level of arrears;

• appropriateness of the property size to the borrower’s accommodation needs.

For the future repayment ability, indicatively the following should also be taken into

account:

• income;

• years to retirement vis-à-vis duration of loan;

• life cycle stage;

• dependents and their age;

• employment status/prospects;

• industry sector;

• savings and assets;

• loans and other obligations;

• future repayment capacity;

• minimum living standard;

• relevant labour market indicators;

• known future changes to the borrower’s circumstances.

In addition, the following should apply:

• For the capitalisation of arrears, the bank should assess and be able to provide

evidence that the borrower’s verified income and expenditure levels are

sufficient to enable them to service the revised loan repayment on an affordable

basis for the duration of the revised repayment schedule and the borrower has

been performing against the revised arrangement for 6 months before arrears

are capitalised.

Guidance to banks on non-performing loans − Annex 6

Affordability assessment for retail and corporate borrowers

116

• For a term extension, the borrower’s age should be taken into account. In this

regard, if the borrower is subject to a compulsory retirement age, for a

mortgage extension beyond that term such extension will only be considered

sustainable where the bank has assessed and can demonstrate and provide

evidence that the borrower can, through a pension or other sources of verified

income, service the revised loan repayments to maturity on an affordable basis.

• Affordability assessment of guarantors (if applicable).

Types of documentation

As a minimum, the following information should be obtained when restructuring a

retail loan:

• personal financial and non-financial information of borrower (e.g. dependants,

household needs, occupation, income, expenditure, etc.);

• overall indebtedness;

• latest independent valuation report of any mortgaged immovable properties

securing the underlying facility;

• information on any other collateral securing the underlying loan facilities (e.g.

fixed charge, life insurance, third party guarantees);

• latest valuations of any other collateral securing the underlying loan facilities;

• verification of variable elements of current income;

• assumptions used for the discounting of variable elements;

• relevant labour market indicators.

Corporate borrowers

• In cases where the borrower has different categories of credit facilities with the

bank (e.g. SME loan, CRE loan etc.), the bank should look at “unbundling” the

various credit facilities, constituent collateral and/or earnings streams. In its

assessment the bank should look at these categories separately as well as in

total to determine the most appropriate overall restructuring solution(s).

• Consideration of the overall indebtedness of the borrower as prescribed in the

national credit register bureau, especially for the borrower’s unsecured debt

repayment commitments and the consequences of non-payment.

• Analysis/assessment of historic data to trace the timing and reasons of the

borrower’s financial difficulties and provide an indication as to the viability of its

business model

Guidance to banks on non-performing loans − Annex 6

Affordability assessment for retail and corporate borrowers

117

• Analysis/assessment:

• of the company’s business plan (e.g. SWOT analysis, projected financial

ratio analysis, industry sector analysis);

• of the company’s historic financial data, which may help trace the trigger

event of the company experiencing difficulties and may provide an

indication as to the viability of its business model.

• Review of the cash-flow forecast provided by the borrower, taking into account:

• the cash-flow forecast, which should cover all recurring items in

appropriate detail to ensure a maximum coverage;

• the business model/business activity of the borrower or the economic

environment both past and future;

• scrutiny and assessment for reasonableness of projections and

assumptions;

• borrower’s facilities with other banks, major expenses, capital expenditure,

disposals, equity contribution, other amounts due (fines, taxes, social

insurance, insurance, pension funds) etc.

• Cash-flow ratio analysis:

• based on the latest financial statements (audited or management);

• based on the cash-flow forecast.

• Agreed programme of loan repayments is equal to or less than the projected

available free cash flows according to the cash-flow forecast.

• Affordability assessment of guarantors (if applicable).

Types of documentation

As a minimum, the following information should be obtained when restructuring a

non-retail loan:

• latest audited financial statements and/or latest management accounts;

• verification of variable elements of current income;

• assumptions used for the discounting of variable elements;

• overall indebtedness;

• business plan and/or cash-flow forecast, depending on the size of the borrower

and the maturity of the loan;

Guidance to banks on non-performing loans − Annex 6

Affordability assessment for retail and corporate borrowers

118

• latest independent valuation report of any mortgaged immovable properties

securing the underlying facility;

• information on any other collateral securing the underlying loan facilities (e.g.

fixed charge, life insurance);

• latest valuations of any other collateral securing the underlying loan facilities;

• historical financial data;

• relevant market indicators (unemployment rate, GDP, inflation, etc.).

Guidance to banks on non-performing loans − Annex 7

Summary of supervisory reporting and disclosures related to NPLs

119

Annex 7

Summary of supervisory reporting and

disclosures related to NPLs

The process of balance sheet repairs requires proper identification and management

of NPLs. Transparency is an important building block of this proper management.

Specific disclosures on relevant aspects of the identification, impairment and

payment of NPLs should improve stakeholders’ confidence in banks’ balance sheets

and ultimately increase the willingness of markets to play a role in the management

of NPLs for which high quality information has become available.

In order for banks to convey their risk profiles comprehensively to market

participants, the ECB recommends, therefore, that they disclose additional NPL-

related information to that required under Part Eight of the CRR (Article 431). A

summary of additional supervisory reporting and disclosure items related to NPLs is

provided below.

Guidance to banks on non-performing loans − Annex 7

Summary of supervisory reporting and disclosures related to NPLs

120

Chapter 2: NPL strategy

Example/extract of NPE and foreclosed asset strategy template

Credit institution:

Actual

Projections

xxxx

Operational TARGETS and KPIs

2016

2017 1H

2017

2018

2019

2020

2021

Line

PART A: Stocks & Flows

NPE Volume (Gross)

of which: Past due > 90 days

of which unlikely to pay

NPE Volume (Net)

of which: Past due > 90 days

of which unlikely to pay

Total loans (Gross)

8=1/7

NPE Ratio

9=2/7

90 dpd ratio

10=3/7

unlikely to pay ratio

11=12+19

NPE Flows (Gross)

12=13+16

NPE transitions (+/-)

13=14+15

From performing to non-performing(+)

of which: from non-forborne performing to NPE

of which: from forborne performing to NPE

16=17+18

From non-performing to performing(-)

of which: from NPE to non-forborne performing

of which: from NPE to forborne performing

19=20+29

NPE reduction/increase

20=21+22+23+24+25+26+27+28

Sources of NPE balance sheetreductions (-)

Cash recoveries

Sales of NPEs (Gross)

Write-offs

Collateral liquidations (cash)

Foreclosure

Debt to equity swaps

Significant risk transfer

Other adjustments

29=30+31+32

Other sources of NPE increase (+)

Purchase of loans

Additional disbursements to customers with NPE

Arrears capitalisation

33=34+37+38+39

Cash recoveries from NPEs

34=35+36

Cash recoveries from collections of NPEs

Banks will receive the relevant template(s) from their Joint Supervisory Teams. The above is a

sample/extract only. The actual template will probably incorporate additional tables, including

foreclosed assets, macro assumptions and vintage information.

Guidance to banks on non-performing loans − Annex 7

Summary of supervisory reporting and disclosures related to NPLs

121

Credit institution:

Actual

Projections

xxxx

Operational TARGETS and KPIs

2016

2017 1H

2017

2018

2019

2020

2021

Line

of which:principal amount

of which:Interest amount

Cash recoveries from liquidations of NPEs

Cash recoveries from sales of NPEs

Other cash collections

40=41+42+43

Loss budget

Envisaged use of impairment allowance

Envisaged use of capital (amount not covered by impairment allowance)

Associated tax impact

Estimated CET1 amount impact from implementation of NPE strategy

Estimated RWA impact from implementation of NPE strategy

46=47+48

Forborne exposures (Gross)

of which: Forborne non-performing exposures

of which: Forborne performing exposures

NPE (gross) where an independent servicer has been contracted

Total denounced loans (gross)

Denounced loans for which legal action has been initiated (gross)

NPL strategy documentation, including related templates, should be submitted to the

supervisor with no expectation for it to be disclosed.

Chapter 4: Forbearance

Public disclosures – forbearance

In order for banks to convey their risk profiles comprehensively to market

participants, the ECB recommends that they disclose the following quantitative

information in addition to that required pursuant to Part Eight of the CRR (Article

431):

• Credit quality of forborne exposures: with the separate identification of forborne

exposures which, at the disclosure date, are performing, non-performing,

defaulted, and impaired, with the associated amount of impairment raised

separately for performing and non-performing exposures. Where relevant, the

identification by credit quality can be broken down at the level of exposure

classes, using either the regulatory exposure classes in Regulation (EU)

575/2013 or other appropriate exposure classes. Non-financial corporates

should be further broken down by sector and geography and households should

Guidance to banks on non-performing loans − Annex 7

Summary of supervisory reporting and disclosures related to NPLs

122

be further broken down by business line and geography if specific

concentrations exist.

• Quality of forbearance: including forborne exposures by number of forbearance

measures granted in the past and redefaults having occurred in the past 12

months (using 12-month cure period as outlined in section 3.5.3).

• Ageing of forborne exposures: time since the granting of forbearance

measures, across a sufficient number of time brackets (<3 months, 3-6 months,

etc.).

• Net present value impact of forbearance measures granted in the past 6/12/24

months.

To facilitate consistent disclosures across banks, example tables are included below

for guidance to banks.

The templates below are designed to offer guidance to institutions on the

implementation of the above-listed items. While institutions remain free to use a

different format for the disclosure of the above-listed items, this different format

should provide at least a similar granularity of these disclosures for elements that are

applicable and material – materiality being assessed in accordance with the relevant

EBA Guidelines.

Guidance to banks on non-performing loans − Annex 7

Summary of supervisory reporting and disclosures related to NPLs

123

Table 5

Public disclosure example tables for forbearance

a. Credit quality of forborne exposures

All forborne exposures (million €)

Impairment, provisions and value

adjustments

Collateral and

financial

guarantees

received on

forborne

exposures

of which:

performing

past-due

of which

non-

performing

of which:

impaired

of which:

defaulted

Performing

forborne exposures

Non-performing

forborne exposures

of which:

value

adjustments

of which:

value

adjustments

Debt securities (including at

amortised cost and fair value)

Central banks

General governments

Credit institutions

Other financial corporations

Non-financial corporations

Loans and advances (including

at amortised cost and fair value)

Central banks

General governments

Credit institutions

Other financial corporations

Non-financial corporations

(consider breakdown)

Households (consider breakdown)

DEBT INSTRUMENTS other than

HFT

LOAN COMMITMENTS GIVEN

TOTAL EXPOSURES WITH

FORBEARANCE MEASURES

b. Quality of forbearance

Forborne exposures (million €)

Having been forborne more than once

Having been forborne more than twice

Having re-defaulted in the past 12 months

c. Forborne exposures by credit category

< 3 months 3-6 months 6-12 months > 12 months

TOTAL EXPOSURES WITH FORBEARANCE MEASURES

of which: performing exposures

of which: non-performing exposures

d. NPV impact of exposures forborne in the past 6/12/24 months

Past 6 months Past 12 months Past 24 months

Net present value of original contract cash flows

Net present value of forborne contract cash flows

Description of discounting approach applied by the bank

Supervisory reporting – forbearance

A breakdown of forborne exposures by major types of forbearance option, separately

for short-term and long-term forbearance measures (where relevant if forbearance

affects some exposure classes more than the others, a breakdown can be made at

Guidance to banks on non-performing loans − Annex 7

Summary of supervisory reporting and disclosures related to NPLs

124

the level of exposure classes, or exposure classes can be identified separately),

should be provided to supervisors at least on an annual basis (unless requested

more frequently by the supervisor) as indicated in the table below.

Table 6

Additional supervisory reporting on the use of different types of forbearance options

For forbearance options multiple options can apply for a single exposure and amounts should be included for each relevant option; thus “Total” is not expected to be the sum of all

options granted

Year t Year t-1

All forborne exposures

(million €)

All forborne exposures

(million €)

of which non-performing of which non-performing

Short-term options granted

of which Interest only

Reduced payments

Grace period/payment moratorium

Arrears/interest capitalisation

Other (providing detail if significant)

Long-term options granted

of which Interest rate reduction

Term extension

Additional security

Rescheduled payments

Debt forgiveness

Voluntary sale

Other (providing detail if significant)

Total

Chapters 5 and 6: NPEs, impairment and write-off

Public disclosures

ESMA has encouraged financial institutions to use the definitions of NPE and

forbearance in Commission Implementing Regulation (EU) No 680/2014 for their

financial statement disclosures and to explain the relationship between NPLs,

defaulted and impaired loans applied in the institution.

On disclosures, banks

should consider the EBA ITS supervisory reporting requirements as established in

Commission Implementing Regulation (EU) No 680/2014 as a benchmark.

Information that banks are expected to disclose in accordance with Part Eight CRR

and with appropriate cross-reference to their financial statements are as follows:

• The assumptions underlying the definition of non-performing exposures and

how they compare with the assumptions used for identifying impaired financial

assets and defaulted exposures, including:

See ESMA PS and ESMA, Review of Accounting Practices – Comparability of IFRS Financial

Statements of Financial Institutions in Europe (2013).

Guidance to banks on non-performing loans − Annex 7

Summary of supervisory reporting and disclosures related to NPLs

125

• materiality thresholds for the identification of non-performing exposures on

the basis of the 90 days past due criterion;

• methods used for days past due counting;

• indicators of unlikeliness to pay used;

• effective average duration of the cure period and probation period;

• the impairment policy for non-performing exposures:

• impairment triggers and thresholds considered when assessing

whether a loss event has occurred;

• key management judgements, estimates and assumptions used in

the determination of collective provisions;

• policy on the reversal of impairment;

• sensitivity analysis on changes to key assumptions.

• Information on whether collective and individual impairment on performing and

non-performing exposures are treated as specific credit risk adjustments or as

general credit risk adjustments.

• A reconciliation of the definitions of non-performing, impaired, defaulted,

restructured/modified assets and forborne exposures. This reconciliation should

comprise both a conceptual explanation of the differences and quantitative

information on the effects of these conceptual differences.

• Performing, performing past due, and non-performing exposures, with separate

identification of exposures more than 90 days past due, exposures unlikely to

pay, impaired and defaulted exposures by exposure classes.

• Ageing of performing and non-performing exposures that are past due.

• The individual and collective impairment allowance raised against performing

and non-performing exposures by exposure class, sector and geography,

where relevant distinguishing between impairment that qualifies as specific

credit risk adjustment and as general credit risk adjustments.

• The individual and collective impairment charges recognised on performing and

non-performing exposures by exposure class, sector and geography.

• When the accounting standards recognise impairment on all assets based on

an expected loss model, a breakdown of performing and non-performing

exposures as well as their associated accumulated impairment and impairment

charges by stages, where relevant distinguishing between impairment that

qualifies as specific credit risk adjustment and as general credit risk

adjustments. The breakdown by stages should be performed by exposure

class, sectors and geography.

Guidance to banks on non-performing loans − Annex 7

Summary of supervisory reporting and disclosures related to NPLs

126

Write-offs

• The amount of accumulated written-off NPEs, as well as the amount of NPEs

written off during the reporting period, with the impact of these write-offs on the

amount of impairment and the P&L by exposure class, sector and geography.

The amount of NPEs written off during the reporting period should

simultaneously be broken down by ageing.

Cash collections

• Payments collected on NPEs and their attribution to P&L:

• cash collected on non-performing exposures, separately for cash

stemming from repayments by the borrower and cash stemming from

collateral recoveries (sale of repossessed collateral);

• the split of cash payments between amounts allocated to the repayment of

interest and amounts allocated to the repayment of principal;

• the amount of interest accrued on non-performing exposures;

• a comparison between the amount of interest accrued and the amount of

cash collected on non-performing exposures.

• A breakdown of the payments received and accounted for into exposure

classes, credit segments, sectors or geography may be useful in the case of a

particular concentration of asset quality issues.

Supervisory reporting

In relation to the estimation of allowances on a collective basis, banks should, at a

minimum, be able to provide the data in Table 7 on the models they use to calculate

impairment allowances for NPEs on a collective basis. The data should be provided

on an annual basis or more regularly if requested by supervisors. Elements in

columns C, D and E should be reported at the level of the segments described in

column B (further details below).

Table 7

Supervisory reporting on the estimation of allowances on a collective basis

A. Portfolio B. Segment C. LGD D. Cure rate

E. NPE

exposure at

default

A.1 Sector

of the

counter-

party

A.2

Residence

of the

counter-

party

C.1

Rate in %

C.2

Calibration

period

C.3

Adj. for

current

conditions

C.4

Alt.

approach

applied

D.1 Rate in

D.2

Calibration

period

D.3

Adj. for

current

conditions

D.4 Alt.

approach

applied

Explanation of table content:

A. Description of the NPE portfolios to which the segments described in B pertain to:

Guidance to banks on non-performing loans − Annex 7

Summary of supervisory reporting and disclosures related to NPLs

127

• A.1 Sector of the counterparty as per FINREP 20.4;

• A.2 Country of residence of the counterparty.

B. Description of each granular group of exposures with shared credit risk

characteristics created for the purpose of the collective estimation of provisions. This

should specify the segmentation criteria (e.g. product type, collateralisation, client

segment, etc.) applied.

C. Description of loss given default as applied at the level of the segment described

in B:

• C.1 LGD applied in %;

• C.2 Calibration period for historical data used (e.g. “2010-2015”) to estimate

C.1;

• C.3 If applicable, description of adjustments made to historical data used in

estimation (e.g. to reflect current conditions);

• C.4 If C.1 has not been estimated based on historical data (i.e. C.2/C.3 are not

applicable), description of the alternative approach applied.

D. Cure rate for NPLs as applied at the level of the segment described in B:

• D.1 Cure rate applied in %;

• D.2 Calibration period for historical data used (e.g. “2010-2015”) to estimate D.1

• D.3 If applicable, description of adjustments made to historical data used in

estimation (e.g. to reflect current conditions);

• D.3 If D.1 has not been estimated based on historical data (i.e. D.2/D.3 are not

applicable), description of the alternative approach applied.

E. Aggregated NPE exposure at default in € million at the level of the segment

described in B

Interest Accrued – NPLs

Regarding the interest accrued on NPLs, on an annual basis or more regularly if

requested by supervisors banks should, at a minimum, be able to provide the data in

Table 8 below in respect of interest accrued on NPLs.

Guidance to banks on non-performing loans − Annex 7

Summary of supervisory reporting and disclosures related to NPLs

128

Table 8

Supervisory reporting on interest accrued on NPEs

€m

Original effective interest income

in Profit & Loss

(before impairment)

Accrued effective interest income

after consideration of impairment

and unwinding

Cash collected

(only Interest-related)

Total loans

Performing loans

Specifically/individually assessed NPLs, of which

- impaired

- not impaired

- forborne

Restructured unimpaired NPLs

≤90 dpd

>90 dpd

Non-restructured unimpaired NPLs

≤90 dpd

>90 dpd

Collectively assessed NPLs

Impaired NPLs

Unimpaired NPLs

Restructured unimpaired NPLs

≤90 dpd

>90 dpd

Non-restructured unimpaired NPLs

≤90 dpd

>90 dpd

Chapter 7: Collateral valuation

As part of their public disclosures, institutions should provide, ideally by cross

reference to the disclosures in their financial statements, quantitative information on

the following:

1. The collateral and guarantees held against performing and non-performing

exposures by exposure class, sector and geography.

2. For the most relevant collateralised NPE portfolios and for total NPEs, a

breakdown of collateral (latest updated valuation (in accordance with chapter

7)), NPV expected taking into account the disposal time and costs until disposal

as well as provisions by type of asset and different NPE vintages (i.e. time since

NPE classification in years).

3. Foreclosed asset values by type of assets and vintage as well as related

provisions. A breakdown of regulatory exposure classes into credit segments

may be useful to present meaningful results.

Annex 8

Risk transfer of NPLs

When securitising or otherwise transferring their NPLs in a un-tranched form, it is

essential that banks pay attention to the following elements:

• a realistic estimation of cash flows used to repay the resulting securitisation

liabilities, which in the case of NPLs are generally not regular;

• the valuation of associated collateral securing the NPLs (in line with chapter 7

of this guidance);

• all structuring costs involved in the transaction;

• the associated regulatory requirements.

Securitisation transactions require a significant risk transfer assessment, additional

reporting and disclosures, and a retention of at least 5% of the economic interest.

The junior tranches, at least, generally have an associated risk weight of 1250%. In

addition, the institution should reflect the securitisation in its ICAAP and ILAAP, and

should also consider operational risk (e.g. legal risk associated with the transfer of

the NPLs), reputational and other risks which might increase with the transaction.

The significant risk transfer should be approached in accordance with the ECB

Public Guidance on the recognition of significant credit risk transfer of 24 March

2016

Risk weights for specialised lending might be applicable in some cases to risk-

transfer transactions (for instance those transactions where the underlying

exposures are physical assets over which the lender has substantial control,

provided that the conditions listed in Article 147(8) of the CRR are met). Therefore

the prudential treatment of transactions should always be determined on a case-by-

case basis.

Risk transfers not classified as prudential securitisations

might also require

authorisation by the competent authorities or other bodies, depending on national

law (for instance for the divestment of assets or for substantial changes in a bank’s

risk profile).

Although a significant risk transfer cannot be achieved in such cases, NPL risk

transfers other than securitisations can still lead to derecognition and

deconsolidation from a regulatory point of view under certain conditions. These are

generally linked to the accounting treatment of the transactions. In this context, it

https://www.bankingsupervision.europa.eu/ecb/pub/pdf/guidance_significant_risk_transfer.en.pdf

As defined in Article 4(1)(61) of the CRR, i.e. involving credit risk tranching, repayments being

performance linked to the underlying exposures, and an allocation of losses during the life of the

transaction

Guidance to banks on non-performing loans − Annex 8

Risk transfer of NPLs

129

Guidance to banks on non-performing loans − Annex 8

Risk transfer of NPLs

130

should be noted that the ECB expects to be consulted on all risk transfer

transactions at an early stage.

When assessing whether such NPL risk transfer transactions (other than

securitisations) meet the conditions for regulatory deconsolidation/derecognition, the

ECB will consider whether the residual risks retained are appropriately covered. If

not, the regulatory treatment it adopts for the transactions could deviate from the

accounting treatment and lead to additional capital charges being imposed. This

could apply, for example, if the originating bank is also providing funding in any form

to the investing vehicle, resulting in a potential delay of loss recognition for the

transferring bank, or if the transferring bank is expected to provide support, beyond

its contractual obligations, to the risk transfer transaction.

Postal address 60640 Frankfurt am Main, Germany

Telephone +49 69 1344 0

Website www.bankingsupervision.europa.eu