Deal solutions for forborne exposures
The key objectives of forbearance measures are to pave the way for non-performing borrowers to exit their non-performing status as well as to prevent performing borrowers from reaching a non-performing status. However, with the introduction of IFRS 9, the provisioning requirements related to forborne/restructured exposures (when classified as so-called Stage 2 exposures) increased considerably, posing a trade-off for banks: to keep under-performing exposures and bear the related costs or dispose (either fully or only economically) of the assets and improve their risk profiles and financial performances.
The current low-growth macroeconomic environment, accompanied by expansionary monetary policy and the looming geopolitical tensions, poses a major risk on the European real economy, in particular on asset quality, and therefore creates an unstable setting for the entire banking sector.
The aim of the European Banking Authority (EBA) is to prevent another downturn via promoting sound credit risk management practices and appropriate implementation of accounting standards regarding financial assets. One of this initiative’s key pillars is the Basel Committee’s work on problem assets classification and valuation. That initiative translates into the release of harmonised definitions of “forbearance” and “non-performing exposures” (NPEs) applicable across EU countries to create more consistent and transparent risk management for the banking sector.
Forbearance: definition and objective
As per EBA guidelines, forbearance measures are concessions (e.g. refinancing or restructuring of the loan contract terms) granted towards a debtor facing – or about to face – financial difficulties. This definition is applicable to all credit exposures from the banking book, including debt securities (e.g. bonds).
These concessions may focus on different components of the loan contract:
- Interests – reduction of margin, deferral of interest, capitalisation offer (e.g. PIK)
- Repayments – debt waiver, prolongation, fixed repayment to cash sweep
- Covenants – waive of right of termination due to breach of covenants, covenant modification
- Takeover of payments from the debtor through a bank – takeover of overdue tax demand and insurance rates
- Other contract modifications – security approval, exchange of collateral, postponement of priority
Overall, the key objectives of forbearance measures are to pave the way for non-performing borrowers to exit their non-performing status as well as to prevent performing borrowers from reaching a non-performing status. Concisely, forbearance measures should always aim to return the exposure to a situation of sustainable repayment.
The EBA set out a clear path regarding how exposure would shift from performing to forborne and to NPE, and vice versa. Whereas it can be a quick transfer from performing exposure to NPE, the road back takes at least 2 years and the debtor has to comply with several regulatory restrictions.
Forbearance: accounting treatment and IFRS 9
On the accounting front, there were significant changes in 2018 with the implementation of IFRS 9. As regards provisioning methodologies, banks had to switch from IAS 39 (incurred credit-loss approach) to IFRS 9 (forward-looking expected credit loss – ECL). Under the new standards, provisions are calculated with the 12-month ECL for Stage 1 (“performing”) exposures, while Stage 2 (“under-performing”) and Stage 3 (“non-performing”) exposures must use the lifetime ECL.
The primary difference is that under IAS 39 granting forbearance measures to performing exposures (that remained performing) had no impact on provisions and therefore on banks’ financials. With IFRS 9, granting forbearance will often lead to a change of categorisation to Stage 2 and therefore from a 12-month ECL to a lifetime ECL provision calculation approach, the latter leading to increased provisions.
Implications for banks
Even though regulations and accounting principles aim to be neutral, they can still generate pressure on decision makers – in the case of the new regulatory treatment of forborne exposures, this imposes a trade-off to bankers.
On the one hand, banks can decide to bear the increased costs in relation to forborne exposures and aim to maximise their recovery via granting a ‘second opportunity’ to ‘heal’ the debtor. While this can be the proper approach for some cases, it has limited upside benefits and goes along with the possibility of risking the growth of troubled exposures. In addition, it freezes large amounts of capital.
On the other hand, institutions can decide not to suffer from the downside risk and set up a disposal process for forborne assets. Besides traditional portfolio sales, the disposal of a pool of single tickets or various forms of asset securitisation are becoming solutions that are more attractive. These options can provide immediate cash inflow and regulatory capital relief to banks.
Solutions we offer
PwC European Portfolio Advisory Group has an unparalleled market track record both on sell- and buy-side of loan portfolio disposals across the CEE region with demonstrated strong access to investors and execution certainty and has successfully advised on over €25bn transaction volume during the past 5 years.
In order to support banking professionals in their process to form strategic portfolio decisions, whether to keep or sell portfolios, we have developed an advanced analytical portfolio optimisation methodology. With this approach, we contrast risks and rewards – from keeping a portfolio on the banking book to the expected proceeds from a transfer of loans to a third-party market participant. Thus, we compare the internal and external views on a portfolio’s value, reflected in the bank’s internal reserve price and an investor’s market price, respectively, in order to support bank management’s strategic decision-making over time.
This comparison is an ideal decision-making tool when searching for a well-balanced and optimised portfolio and helps banks define the optimal portfolio strategy.
Tailor-made disposal of a pool of single tickets
We refer to single tickets as claims towards mid-sized or large corporate debtors / debtor groups. The disposal of a pool of single tickets represents an innovative sale structure capturing advantages of both traditional single-ticket sales and portfolio sales. In addition, key benefits of the disposal of a pool of single tickets include a high degree of flexibility in perimeter composition and tailor-made deal structure on an individual object level. Moreover, the seller can look to optimise overall pricing across the pool by focusing bidder interest on assets where most competitive, while also taking into account preferred potential structures. At the same time, there is significant flexibility for the buyer as well.
Structured finance solutions
Securitisation transactions are efficient solutions in bankers’ tool-kit to handle changing regulation and to meet shareholders expectations.
Synthetic securitisation – where legal ownership is retained, similar to a credit risk insurance – is a solution to hedge credit risk borne on the balance sheet and to relieve regulatory capital. Such an arrangement is particularly well fitted for situations where keeping the client relationship is desirable.
True-sale securitisation – where assets are transferred to a dedicated SPV – provides cash funding to the issuer (i.e. banks) and a large array of structuring options to fit specific business and strategic needs.
We expect the European securitisation market to be lifted by the recent introduction of a new regulatory framework standardising and supporting securitisation transactions for issuers and investors alike.
EBA Final ITS 2013/03 (July 2014) – Final draft Implementing Technical Standards on Supervisory reporting on forbearance and non-performing exposures under article 99(4) of Regulation (EU) No 575/2013
EBA Guidelines 2018/06 (November 2018) – Final Report: Guidelines on management of non-performing and forborne exposure
PwC In depth (December 2017) – IFRS 9 impairment: significant increase in credit risk
For more information please contact:
Consultant PwC Austria, FS Deals
Senior Consultant, PwC Austria, FS Deals