The exposure value (EV) of a loan, according to Article 111 CRR “... shall be its accounting value remaining after specific credit risk adjustments”.
Furthermore, Article 127(1) CRR, in accordance with Article 178 CRR, assigns the following risk weights to the unsecured part of a defaulted exposure: “(a) 150% where specific credit risk adjustments are less than 20% [of GBV] of the unsecured part of the exposure value if these specific credit risk adjustments were not applied; (b) 100% where specific credit risk adjustments are no less than 20% [of GBV] of the unsecured part of the exposure value if these specific credit risk adjustments were not applied”.
In general, in the case of defaulted exposures (as per Article 178 of CRR) a bank records both the original GBV and the specific credit risk adjustments computed in accordance with the relevant accounting rules (IAS 39 in the case of loans and receivables); it is therefore straightforward to check whether specific credit risk adjustments exceed 20% of the GBV.
However, in the case of an asset management company (“bad bank”) buying defaulted exposures from a bank, the exposures are directly booked at the purchase price (NBV). Nevertheless, in our opinion, the data on GBV provided by the seller can be used to show the difference between GBV and NBV, which performs the same economic role as a specific credit risk adjustment. Namely, the amount IC = 1-NBV/GBV provides a measure of “Implicit Coverage” (“IC”) for each exposure, and can be compared to the 20% threshold to see whether a risk weight of 100% (instead of 150%) applies. To the best of our knowledge, however, the use of the “IC” measure is not explicitly foreseen by any provision in the CRR.
Rationale for the question is that the purchaser of an NPL portfolio is subject to CRR and computes the capital requirement against credit risk under the Standardised Approach (based on Articles 127 and 178 of the CRR). The purchased NPLs are booked at the purchase price (net book value, “NBV”), which is significantly below the loans’ gross value (“GBV”).
The AMC, even booking at NBV the defaulted exposures, has the GBV data on its records.
According to Article 111(1) of Regulation (EU) No 575/2013 (CRR), under the standardised approach (SA) the exposure value (EV) of a loan shall be its accounting value remaining after specific credit risk adjustments, additional value adjustments in accordance with Articles 34 and 110 and other own funds reductions related to the asset item have been applied.
The reference to the accounting value is in line with Article 24(1) CRR, which clarifies that “the valuation of assets and off-balance sheet items shall be effected in accordance with the applicable accounting framework”, as defined in Article 4(1)(77) CRR. In this sense, the CRR provisions do not prescribe what should be recorded in the balance sheet, but they rather take what is recorded on the balance sheet of an institution in accordance with applicable accounting rules as a starting point for prudential purposes.
Article 4(1)(95) CRR defines “credit risk adjustment” as the amount of specific and general loan loss provision for credit risks that has been recognised in the financial statements of the institution in accordance with the applicable accounting framework.
Additionally, for the purposes of the exposure value referred to in Article 111 CRR, Article 1(1) of Regulation (EU) No 183/2014
(RTS on the specification of the calculation of specific and general credit risk adjustments) specifies that the amounts required to be included in the calculation of general and specific credit risk adjustments by an institution shall be equal to all amounts by which an institution’s Common Equity Tier 1 capital has been reduced in order to reflect losses exclusively related to credit risk according to the applicable accounting framework and recognised as such in the profit or loss account, irrespective of whether they result from impairments, value adjustments or provisions for off-balance sheet items.
As a consequence, unless amounts satisfy the above conditions and are calculated in accordance with the provisions specified in Regulation (EU) No 183/2014, they cannot be considered credit risk adjustments for the purposes of Article 111 CRR and Article 127 CRR.