Banco Sabadell
Investor Relations
Spanish banks
An9Spotter’s Guide to provisioning on loans and real estate
This document has been prepared by:
Investor Relations at Banco Sabadell - [email protected]
Disclaimer: This document is based on a new regulation which could be subject to interpretations
Banco Sabadell - Investor Relations
An updated spotter’s guide to provisioning on loans and real estate
October 2010
Different types of loan risk*
Loans are classified according to their likelihood of default within 5 risk
categories. Based on this risk, a provision (specific or generic) is created
Loan risk type
Type of provision created
Normal
Generic
Substandard
Specific
Doubtful for other reason
than NPL
Specific
Non-performing
Specific
Write-off
Written-off
In this note we refer
to these three risks
as “non-normal”
* This note focuses on loan risk and therefore excludes country risk
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An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Generic provision for ‘normal risk’ loans
The generic provision will depend on the type of risk for each ‘normal risk’ loan;
there are six possible categories:
Risk
α
High
2.5%
β
Includes (mainly)
1.64% Credit cards and overdrafts
Mid-high 2.0%
1.10% Loans for durable goods and to 'high risk' countries
residents
Mid
1.8%
0.65% Rest of loans to EU and 'low risk countries' residents
Mid-low 1.5%
0.44% Other backed secured lending; Other backed or non
secured leasing
Low
0.6%
0.11% Mortgage secured finished property loans and real estate
leasing with LTV<80%; 'A' or higher rated companies
No risk
0.0%
0.0% EU governments, public debt guaranteed loans
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An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Building up the generic provision fund ...
How is the generic provisions fund constituted?
Generic provision = α * growth in loans + β * stock in loans – specific provision
The provisioning is therefore influenced by the credit cycle:
Good cycle
Turning cycle
Strong volume growth
Low NPLs
Softer volume growth
Rising NPLs
Very low volume growth
High NPLs
Alphas and betas
calculation is high
Specific provision low
Alphas and betas
calculation is low
Specific provision rising
Alphas and betas
calculation negligible
Specific provision high
Bad cycle
Banco Sabadell - Investor Relations
An updated spotter’s guide to provisioning on loans and real estate
October 2010
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… with upper and lower limits
In good credit cycles the fund reaches the upper limit and only what is necessary to
stay at 125% is provisioned
125% of average alphas x stock
UPPER LIMIT
10% of average alphas x stock
LOWER LIMIT
In bad credit cycles the fund could reach the bottom limit and only what is
necessary to stay at 10% is provisioned
Banco Sabadell - Investor Relations
An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Non ‘normal risk’ loans create specific provisions
How are specific provisions created?
If a loan classified as ‘normal’ risk becomes one of the following three ‘non-normal’
risks, it will (1) cancel its generic provision and (2) generate an always higher
specific provision
1
2
Substandard risk
Loans where payments are up to date but show weaknesses related to its
economic sector, geographical area or similar for which it is reasonable to expect
potential losses (i.e. real estate)
Doubtful loan for other reason than non-performing
If there is reasonable doubt about the future payments, driven by a deterioration of
the client’s financials, payment delays, low cash-flow or others
3
Non-performing loan
When one of the instalments is overdue >90 days. If the loan affected represents
over 25% of the client outstanding debt, then all the client’s loans are also
added to NPL
Each of these categories generate a different amount of specific provision
Banco Sabadell - Investor Relations
An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Different types of risks require different specific provisions
Each risk type generates a different amount of specific provision:
Substandard risk
1
The specific provision will be usually at least 10-15% of the exposure or a higher
percentage of the expected amount not to be recovered
Doubtful loan for other reason than non-performing
2
The specific provision will be the expected amount not to be recovered and at least
25% of the total doubtful loan; this can be 10% when related to weak financials
Non-performing loan
3
Upon classification as NPL, the loan enters a provisioning calendar (see next page).
This calendar represents a minimum, but higher provisions can be set if deemed
necessary by the bank
Banco Sabadell - Investor Relations
An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Specific provisions for non-perfoming risks
With the new regulation, the previous two calendars (long and short) are reduced
to one single calendar, which implies that the loan must be fully provided for
within 12 months, as follows:
up to 6 months
6 to 9 months
9 to 12 months
>12 months
25%
50%
75%
100%
• Non-mortgage secured and unsecured loans: The above percentages will apply
if the asset is classified as non-performing
• Mortgage secured: The above percentages only apply to the outstanding amount
over and above the mortgage recognized guarantee1, with a minimum
coverage equivalent to the generic provision
1
See definition on the next page
Banco Sabadell - Investor Relations
An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Specific provisions for non-perfoming risks
Mortgage recognised guarantee: Is the result of applying a percentage to the
lowest of:
(1) the registered cost of the property
(2) the appraisal value
The percentages depend on the type of guarantee as per the following table:
1
80% for finished residential property, if usual residence
2
70% for rural building under development, and all-purpose finished
offices, premises and plants and rural land
3
60% for finished property (rest)
4
50% for land plots, land and other real estate assets
This deduction will only be allowed for the first loan guaranteed by these
mortgages
Banco Sabadell - Investor Relations
An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Specific provisions for non-perfoming risks
For the loan transactions that are considered as “doubtful and non-performing
loans”, the maximum seniority for the appraisal value will be 3 years, unless
significant falls in the market prices require a more recent appraisal in order to
better reflect these situation
In some cases, it will be possible to use appraisal values achieved through
statistic methods. For transactions or swapped assets below € 500,000 related
to the first loan with a finished residential property guarantee, the entity could
apply an estimation of the current value, being the lowest of:
(1) 80% of the last available appraisal
(2) Results obtained through statistic methods (carried out less than 1 year ago)
Appraisals will be carried out by independent appraisal companies. This
company must be approved by Bank of Spain. The list of approved appraisal
companies is available at the following link:
http://www.atasa.com/index.php?es,asociados,codigo
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An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Provisions for real estate assets
Some minimum provisions are required for repossessed or swapped real estate
assets, according to the asset seniority in the balance sheet:
From acquisition and until 12 months
Over 12 months
Over 24 months
10%*
20%
30%**
* The value at which they have to be recognized will be the lower of:
a. The book value of the asset (swapped loan), with a minimum provision
of 10%
b. Current appraisal value of the asset minus the estimated costs of sale,
with a minimum provision of 10% of the current appraisal value
** but could be below 30% if an appraisal proves the value has not dropped to this
level, always with a minimum provision of 20%
For each appraisal of the same repossessed or swapped real estate asset, the
appraisal company must be switched
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An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Example 1. LTV < recognized guarantee
Finished residential property, being the usual residence of the borrower.
Recognized guarantee: 80%
Old regulation
Cost of
acquisition = 120
New regulation
In this case, slow calendar is applied
Recognized guarantee: 70%
(13 July 2009 regulation letter)
Appraisal
value = 100
Recognized
guarantee = 80%
To be provisioned:
Loan = 75
To be provisioned
Loan value – recognized guarantee
= 75 – 70 = 5
Loan value – recognized guarantee
= 75 – 80 = –5
5 * 2% = 0.1
The 1st year, 0.1 will have to be
provisioned (the rest between the
4th and 6th year)
No provisions will be needed.
Established provisions by the old
regulation could be released
(exc. minimum generic provision)
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An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Example 2. LTV > recognized guarantee
Land plots, land and other real estate assets. Recognized guarantee: 50%
Old regulation
Cost of
acquisition = 120
New regulation
In this case, fast calendar is applied
Appraisal
value = 100
Loan = 75
To be provisioned:
Recognized
guarantee = 50%
To be provisioned:
Loan value * 27.8%
= 75 * 27.8% = 20.85
Loan value – recognized guarantee
= 75 – 50 = 25
The 1st year, 20.85 will have to be
provisioned (the rest during the
2nd year)
For this type of assets, 25 will have
to be provisioned (the whole
amount the 1st year)
Banco Sabadell - Investor Relations
An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Example 3. Unsecured loan
Non-mortgage secured and unsecured loans
Old regulation
New regulation
In this case, fast calendar is applied
Loan = 75
To be provisioned:
To be provisioned:
Loan value * 27.8% =
75 * 27.8% = 20.85
Loan value = 75
The 1st year, 20.85 will have to be
provisioned (the rest during the 2nd
year)
For this type of loan, the whole
amount will have to be provisioned
the 1st year
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An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Example 4. Non Performing Loans (1)
The impact of the new regulation on the provisioning of loans will depend on:
(1) The portfolio breakdown
(2) Assumptions
(1) The portfolio breakdown
Nonmortgage
secured
and
unsecured
loans 4,000
1
2
2,100
1,200
Mortgage
secured
6,000
4
900
1,800
3
1
Finished residential property, if usual residence: 80%
2
Rural building under development, and all-purpose
finished offices, premises and plants and rural land: 70%
3
Finished property (rest): 60%
4
Land plots, land and other real estate assets: 50%
Banco Sabadell - Investor Relations
An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Example 4. Non Performing Loans (2)
(2) Assumptions
9 Loan portfolio: 10,000 million
9 NPLs are distributed proportionally to the weight of each type of loan
9 For simplicity, we compare the average value of the loans in the portfolio with the average
LTV for each category. In fact, this transaction would be carried out individually for every loan
9 In these cases, the NPL entries represent more than the 25% of each loan. Therefore the
whole loan amount that defaults is considered NPL
9 NPL entries are distributed following these calendars:
New regulation:
Up to 6 months
6 to 9 months
9 to 12 months
> 12 months
Coverage
25%
50%
75%
100%
Weight of the
portfolio
10%
15%
30%
45%
Up to 6 months
6 to12 months
12 to 18 months
18 to 24 months
> 24 months
Coverage
5,3%
27,8%
65,1%
95,8%
100,0%
Weight of the
portfolio
10%
45%
15%
10%
20%
year one
year two
year three
3 to 4 years
4 to 5 years
5 to 6 years
over 6 years
Coverage
2%
0%
0%
25%
50%
75%
100%
Weight of the
portfolio
55%
20%
5%
5%
5%
5%
5%
Old regulation:
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An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Example 4. Non Performing Loans (3)
B
Recognized
guarantees
Mortgage secured
C
Total
loans
from
NPLs
D
Portfolio
weight
(in %)
600
60%
E=
(C/G)
Average
portfolio
LTV
F
G
Cost of
the Appraisal
value
finished
property
H = Min
(F, G)
I = (H*B)
Minimum
(cost,
valuation)
Recognized
guarantee
(amount)
J
Fund
needed
(new)
K
L = K-J
Surplus
Constituted
(Deficit) due
fund
to the new
(old rules)
rules
22
206
184
Finished residential
property
80%
210
35%
75%
270
280
270
216
0
2
2
Rural building under
development/finished
offices, premises…
70%
120
20%
55%
200
220
200
140
0
63
63
Finished property (rest)
60%
180
30%
62%
450
290
290
174
5
94
90
Plots, land and other
real estate assets
50%
90
15%
67%
250
135
135
68
17
47
30
400
40%
310
210
-100
332
416
84
33%
42%
Non mortgage
secured and
unsecured loans
Total
1,000
Specific coverage
In this example, the application of the new rules, would allow 84 million of release in
credit provisions and specific coverage would drop
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An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Example 5. Real estate portfolio
The impact of the new regulation on the provisioning of real estate assets
will depend on:
(1) The date of acquisition
(2) Appraisal values after the second year
Real Estate Portfolio:1,000 million.
Breakdown by acquisition period
1H08
10%
1H10
10%
2H08
20%
2H09
30%
1H09
30%
1H08
2H08
1H09
2H09
1H10
Calculation
base
% of the
portfolio
Provisions
needed
100
200
300
300
100
25% *
20%
20%
10%
10%
25
40
60
30
10
1,000
17%
165
Under this example, the application of the new rules would imply a minimum
coverage ratio of the real estate portfolio of 17%
* The updated appraisal value allows a coverage under 30%
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An updated spotter’s guide to provisioning on loans and real estate
October 2010
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Investor Relations
BancoSabadell Sant Cugat Building
Polígon Can Sant Joan
Sena, 12
08174 Sant Cugat del Vallès
Tel. (+34) 93 728 12 00
[email protected]
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An updated spotter’s guide to provisioning on loans and real estate
October 2010
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