CALCULATION for QIS 3. TENTATIVE EXPLANATORY NOTE FOR : * Guarantee Societies * Banks using guarantees as a Capital alleviation

Transcription

1 AECM Association Européenne du Cautionnement Mutuel Associacão Europeia de Caucionamento Mútuo Europese Vereniging voor Onderlinge Borgstelling Associazione Europea di Garanzia mutua Europaischer Verband der Bürgschaftsbanken Kölczönös Garanciabistositók Európai Egvesülete Asociación Europea de Caución Mutua European Association of Mutual Guarantee Societies CALCULATION for QIS 3 TENTATIVE EXPLANATORY NOTE FOR : * Guarantee Societies * Banks using guarantees as a Capital alleviation I. CASE STUDY : THE GUARANTEE SOCIETY. Two main considerations : Guarantee Societies should focus on two questions : are they subject to the Basel Accord (yes, if they are banks)? what is their own capital requirement? And thus, what Approach ought be choosen? 1. Guarantee Societies without banking status (Italian Confidi, Belgian SCM, Bürges Förderung, Finnvera...) No specific requirement on behalf of the Basel Cimmittee. 2. Guarantee Banks declaring for the Standardised approach for their own Capital Requirement calculation 2.1. (case : SIAGI, CMZRB, BüBA, SPGM, SZRB, HITELGARANCIA...) -Their guarantee commitments in off balance sheet is the accurate amount equivalent to the current guarantees provided to banks, including commitments taken and communicated to the bank but not yet set in force. -The first step is to separate own commitments from those counter-guaranteed by a stronger guarantor (State, Region, EIF). Let's consider the "public counter-guaranteed"section : the mitigation provided by this public guarantor is taken into account if this guarantor can be qualified as direct, irrevocable, unconditionnal, explicit... His weight is substituded in the weight of the "final borrower" (the SME) for the covered part of the portfolio, including defaulted exposures. Imagine that the

2 Guaranteeing Public Authority has a rating AAA, this section of the portfolio is weighted at 0% ( = a) -Remaining commitments are to be analysed. They form a Retail portfolio if (see full definition in the note) roughly if they refer to entreprises with a turnover < 50 Mio and individual guarantee of < 1Mio. If not, then the commitments are "corporate". Thus, this divides again the portfolio into two sections. -The "retail" second section, without counter-guarantee and not past due, receive a weighting of 75% on the total amount. ( = b1) -The "corporate" portfolio (without public guarantee and not defaulted) comes then into account with the question : are those borrowers externally rated? Supposing that the underlying entreprises are unrated, a weighting of 100% is applied. ( = b2). -Default commitments (see definition in the note) are weighted at 150% for their non-guaranteed portion. Specific Provisions are withdrawn from their total amount (= c) -For the other assets in the balance sheet (property, equipment, other assets), they weight at 100% ( = d) -Totalling (a1), (b1), (b2), (c), (d), the bank calculates 8% of the weighted total amount. -The result gives the minimum capital requirement of the guarantee bank. - Subsidiary question : is the capital structure such that Tier 2 < Tier 1? Tier 2 exceeding Tier 1 could be rejected as not qualified equity means. - The European directive about great risks ( 10% of the equity on a single counterparty and 25% of the equity on a single counterparty) has to be applied (case Spanish SGR) The situation is more complex because SGR have to mitigate their portfolio with the collaterals received from their "borrowers". The only collaterals that could be considered are financial ones. Mortgages could not be considered except if they apply to residential propoerties (please check with Bank of Spain) The same calculation as here above is then made. 2. Guarantee Schemes with a bank Status declaring for the IRB approach for their own Capital Requirement calculation -Their rating system has to be approved by the supervisor qualify the bank for the IRB approach. - Their capital requirement is based on the risk components of the portfolio an their associated risk weights.. -First of all the counter-guaranteed portion of the portfolio under state protection receives the weighting of this guarantor. (the EIF counter-guarantee should probably provide a AAA rating )

3 -In the remaining portfolio, the "retail" sub-portfolio is set aside ( Entreprises with Turnover < 50 Mio and exposure < 1 Mio on each bank). -In the retail portfolio (section "other retail"), homogeneous pools are created, based on three characteristics ; the borrower, the operation, the capacity to repay the credit (ex. start ups - short terms, or existing companies-long term... or whatever according to the experience of the Guarantee Scheme). -For each cell of these pools, provided that the number of deals allows statistical treatment, PD, LGD, EAD, M are calculated. The parameters are first calculated (mathematical model or whatever, but giving accurate results) on annual basis. Then, their value is estimated as weighted averages of a number of years ( minimum of 2 years in 2006, 3 years in 2007 and 5 years as by 2009 and later on) * PD : Defaults of each year / outstanding of that year * EAD is calculated considering past due interests. * LGD is an estimate of the losses after recoveries, considering the effect of existing collaterals which increase recoveries after default, and the cost of default management and court procedures * M is estimated 2,5 years for the foundation IRB and are calculated in the advanced IRB. -Defaulted deals are set in a special section. They are weighted with a PD of 100, except the proportion benefiting from a state counter-guarantee. The latter still receives the risk weighting of the counter-guarantor.. - Specific provisions and partial write offs are deducted (123,5 x Provisions) from the Expected Losses (EL = 12,5 x PD x LGD) associated to the weighted assets of each asset class. - Each new entries in the portfolio (new guarantees issued from the moment that the system is built) are classified into the pools, with an estimate of their PD... - The amount belonging to each individual cell, according to the model in use, are transformed into assets weightings with the supervisor's curves (See Impact Study, Technical guidance, p 139) Examples, with a maturity of 2,5 years, PD = 0,50 % PD = 1% PD = 2% PD = 3% PD = 4% PD = 5% LGD = 45% 36,86 52,90 69,20 77,67 83,50 88,56 LGD = 85% 69,63 99,93 130,71 146,71 157,72 167,29 Example : a pool of 1000 with an associated PD of 2% and a LGD of 45% gets a risk weighting of (1000 x 69,20) and requires a capital of ( 1000 X 69,20% x 8%) = 55,36. The weight is applied to the exposure amount. -The corporate portfolio is considered in the same way : * For each pool, a PD function is calculated. * LGD is fixed at 75% for unsecured and 45% for exposures with collaterals A distinction is made between small corporates ( Turnover < 5 mio) and larger corporates. The same calculation is made.

4 3. CALCULATION IN IMPACT STUDY 3 QIS3 allows participants to provide their own data to their national supervisor on an Exell Sheet. In this case, formulas are used for the IRB approach. (see I Capital requirements calculation : Definition of symbols EXP = e exponent (calculated in the spread sheet) ^ : exponent (calculated in the spread sheet) R = Correlation coefficient b = Maturity adjustment N = parameters of the normal curve (calculated in the spread sheet) G = inverse of the normal curve ( calculated in the spread sheet) K = capital requirement with PD, LGD, EAD expressed as whole numbers rather than decimals. I1 Capital requirements for corporate, sovereign and bank exposures (235) R = 0,12 x (1 -EXP ( -50 x PD)) / (1-EXP(-50)) + 0,24 x {1- (1 - EXP(-50 x PD)) / (1 - EXP(-50)) } b = (0, ,05898 x log (PD)) ^2 K = LGD x N { (1-R) ^-0,5 x G (PD) + (R / (1- R)) ^0,5 x G (0,999) } x (1-1.5 x b (PD)) ^-1 x ( 1 + (M - 2,5) x b (PD)) I1I Capital requirements for retail exposures Three separate risk functions for retail-mortgage / retail-revolving and oither retail a) Residential mortgages (288) R = 0,15 K = LGD x N { (1-R) ^-0,5 x G (PD) + ( R / (1-R)) ^0.5 x G (0,999) } b) Revolving exposures : SME exposures in overdrafts, current accounts (289) R = 0,02 x (1 - EXP( -50 x PD)) / (1 - EXP (-50)) + 0,15 x { 1 - (1 - EXP ( -50 x PD)) / ( 1 - EXP ( -50)) } K = LGD x N { (1- R) ^-0,5 x G(PD) + (R / (1 - R))^0,5 x G(0,999) } -0,90 PD x LGD (-0,90 PD x LGD allows 90% of the expected losses to be covered by future margin income) c) Other retail exposures : SME exposures in investment credits (291) R = 0,02 x (1 - EXP( -35 x PD)) / (1 - EXP (-35)) + 0,17 x { 1 - (1 - EXP ( -35 x PD)) / ( 1 - EXP ( -35)) } K = LGD x N { (1- R) ^-0,5 x G(PD) + (R / (1 - R))^0,5 x G(0,999) }

5 II CASE STUDY OF BENEFICIARY BANKS HAVING RECOURSE ON GUARANTEES Two main considerations : Can the guarantee society be qualified as a "Guarantor" in the Basle definition? The bank should recognise it as a counterpart. If yes, what capital alleviation can it provide? It depends on the approach choosen by the bank. 1. The Qualification as guarantor? A "Guarantee scheme" can be a qualified guarantor with a status of : a Corporate (Confidi), a Public Sector Entiry (Finnvera) a bank (SPGM), a Sovereign ( Belgian State, Flemish Region, VWF) But some operational conditions must be encountered. - Direct guarantee : thus, indirect protection is not eligible : ex. The risk weighting of the German State counter-guaranteeing the German Bürgschaftsbank will be taken into account for the CAD of the Bürgschaftsbanken (direct), but not for the protection of the beneficiary bank (indirect). (We will try to improve this rule) - Explicit protection : no guarantee should cover a portfolio of various faint deals, but it should rather refer to single deals, clearly defined and incontrovertible. If the borrower benefits from various credits in the bank, those benefiting from the Guarantee Society protection can be individualized in the bank book. (this is not a problem for any Guarantee Society member of AECM) -Unconditional protection : no contractual clause may allow the guarantor to pay out in a timely manner in case of default and that the guarantee convention should never be provided, subject to conditions (Yes, if the self financing of the entreprises is at least Yes, if the bank takes a mortgage on this asset... - Yes, if the credit is well used for the take over of a barber's shop, round the Basel street...). But the credit application and file should be clear enough to give a just "yes" answer. However, in the IRB approach, conditional guarantees are accepted! (this could require that some usual practices are reconsidered among some of our members) -Irrevocable protection : no specific clause my allow the guarantor to cancel unilaterally the credit cover. This could be conflicting with daily practices of members, which reserve to themselves the full right to withdraw if the bank has issued the credit for other purposes or with other conditions than indicated in the decision file. We want to discuss the point further on with the Basel Committee.

6 - Payment at first call : the lender may pursue the guarantor instead of prosecuting the main obligor. + The guarantee must be enforceable in all relevant juridictions. This refers to a situation of default (399, 400) What is the definition?: The bank considers the borrower as unlikely to pay its credit obligations in full, without recourse to actions such as realisation of securities. As a consequence, the banks puts the credit obligation on non-accrued status, or makes charges-off, provisions, or consents a restructuring of the credit obligation with disminished financial obligations, or files for the obligor's bankruptcy, or the obligor files for bankruptcy or similar protection Obligor is past due more than 90 days (supervisor may substitute figures up to 180 days for persons or local public authorities) This rule does not fit with our management principles, because our guarantee is a suppletive obligo, compelling the bank to prosecute the borrower first before calling the guarantor's payment. The opinions of various people participating in Basel works are very careful! Nevertheless, we can read interesting comments in the web site of "Banque de France", question 15 put by the French Public Guarantee Society "Sofaris" ( : "The guarantee of Sofaris can still be considered provided that -the bank keeps Sofaris posted about its recovery procedures -the bank is not allowed to consents any reduction of financial obligations of the final borrower or any restructuration of the credit without the agreement of Sofaris -the payment of the final los will occur after agreement of all parties that all has been done to recover on the main obligor. The recovery policy remains under the control of the guarantor and only an active and serious policy will justify the payment of the covered amount" In our opinion, it is wise to provision that "in case of default, after court process, the Guarantee Society is entitled to be substituted in the rights of the bank". - The extend of the guarantee : the guarantor covers all the payments that the main obligor is expected to make in the loan contract. This is a real problem for many Guarantee Societies which offer their coverarge for unpaid capital only, or for unpaid capital and a limited amount of unpaid interest. We keep on discussing about this. In our opinion, if the contract Bank-Guarantee Society is clearly and explicitely documented, it will provide a recognised coverage to the contractual extend. If the Guarantee Society is a "guarantor", then Viewpoint of the Beneficiary banks declaring for Standardised Approach, for their SME guaranteed portfolio -The bank focuses on the guaranteed part of is loan portfolio, whatever Retail or Corporate. -If the risk weighting of the guarantor is lower than that of the main obligor, the latter is taken into account instead of the former. -If the the secured and unsecured portions are of equal seniority, the protected portion is assigned (in due proportion) the risk weight of the protection provider (principle of substitution). How?

7 * If the guarantor is a Sovereign (ex. The Flemish Guarantee Fund, in Belgium it is a Department of the Region, without specific juridic status), the portfolio receives the Sovereign's risk weight (0% in this Belgian case because the Flemish Region is rated AA) * If the guarantor is a Public Sector Entity ( ex. Bürges), it is treated as a bank. * If the guarantor is a bank (ex. SIAGI), and if the national supervisor chooses for option 1, the guarantor has a risk weight of (his national State + 1) (ex. Siagi : 20% because the French State is rated AAA / Various Candidate Countries are rated A-) *If the guarantor is a bank but the national supervisor has opted for option 2, than the guarantor has to be rated (ex. Rated BBB, it would provide a weight of 50% on the portfolio with a maturity of > 12 months and a a weight of 20% for the portfolio > 12 months) * If the guarantor is a corporate (ex. Confidi), then it has to be externally rated ( weighting 100% as soon as it is BBB+ or less). 3. Viewpoint of the Beneficiary banks declaring for IRB Approach, for the alleviation of their credit risk by guarantees -The bank focuses on the guaranteed part of is loan portfolio, whatever Retail or Corporate. -A risk weighting of the garantor lower than that of the main obligor it is not taken into account. -If the the secured and unsecured portions are of equal seniority, the protected portion receives (in due proportion) the risk weight of the borrower, without taking into account the double default of the main obligor and the garantor. How? It is based on the Internal rating that the beneficiary Bank is giving to the Guarantor. In the Foundation Approach, the PD of the guarantor takes the place of the borrower's PD. In the Advanced approach, the bank can either play on LGD (its recoveries after the guarantor's intervention in the loss), or choose the Foundation Approach (and thus substitution the PD of the protection provider to the PD of the borrower). -The rating of the garantor depends on its own risk parameters (the PD of its own portfolio, its P&L, the quality of its portfolio monitoring), and solvency (its provisions vs risks, its capitalisation... ) The question of disclosures of the Guarantor concerning its financial situation becomes of crucial importance. The AECM working group should discuss this point. Interesting to note the Moody's and S&P standards MOODY's STANDARD AND POORS Rating P.D. 1 year Rating P.D. 1 year Aaa 0,00% AAA 0,00 % Aa1 0,00 AA+ 0,00 Aa2 0,00 AA 0,00 Aa3 0,00 AA- 0,03 A1 0,00 A+ 0,06 A2 0,00 A 0,04 A3 0,00 A- 0,05 Baa1 0,07 BBB+ 0,18 Baa2 0,06 BBB 0,29 Baa3 0,39 BBB- 0,33

8 Ba1 0,64 BB+ 0,48 Ba2 0,54 BB 1,07 Ba3 2,47 BB- 1,76 B1 3,48 B+ 3,24 B2 6,23 B 9,29 B3 11,88 B- 11,89 C 18,85 CCC 24,72 Investment grade 0,05% Investment grade 0,10% Speculative Grade 3,69% Speculative Grade 4,72 %