DEALING WITH PROBLEM DEBTS

Transcription

1 Dealing with Problem Debts Page DEALING WITH PROBLEM DEBTS Introduction 1. The management of a banking corporation shall establish procedures for dealing with problem debts, as regards both the administrative and the accounting aspects, as specified in this Regulation. Definitions 2. Indebtedness - As specified in Regulation no. 313 Restrictions on the indebtedness of a borrower and a group of borrowers, excluding investments in shares and excluding guarantees given by the borrowers to a third party to ensure the credit received by the third party from the banking corporation; Interest - Bad Debt - Doubtful Debt - Interest, linkage differences (including foreign-currency linkage differences), and exchange-rate differences on foreign-currency denominated balances; A doubtful debt regarding which, after all the possibilities of collection have been exhausted, the banking corporation concludes that there is no longer any chance that it will be collected and that it should be written-off from the banking corporation s books. A debt or part of a debt regarding which, after the debtor s economic position - including the nature of his assets and his repayment ability - has been assessed, and after the collateral in the possession of the banking corporation has been evaluated, the banking corporation s management determined that there is no longer any reasonable chance of collection and that it should be recorded as an expense in the banking corporation s books; Debt-restructuring - An arrangement whereby a banking corporation - whether for economic or legal reasons related to a borrower s financial position

2 Dealing with Problem Debts Page Debt-restructuring with waiver of income - - grants a borrower, either by agreement or law, special terms which would not otherwise be granted, and whose object is to enable the customer to repay the debt under the new terms, with the exception of an arrangement whereby the terms of the debt are altered primarily to reflect changes in market credit terms; Debt-restructuring in which the effective rate of income embedded in the expected flow of receipts under the arrangement is less than the effective rate of income under the original agreement with the customer, including debt-restructuring in which a banking corporation grants the borrower credit under a different linkage scheme than the one in the original agreement: (a) Under special terms which would not otherwise be granted to customers with identical risk features. (b) Under regular terms which would otherwise be granted to customers with identical risk features, if under the existing linkage scheme, according to the original agreement, the customer was obliged to pay a higher interest rate than the normal rate charged by the banking corporation at the time of the restructuring. For this purpose, changes of basic credit characteristics, such as fixed rate credit given as variable rate credit or credit under overdraft account terms given as term credit, will be regarded as a change of the linkage scheme. Special terms - For restructuring a problem debt, these may include: (a) Reducing interest rates; (b) Postponing repayment of principal or interest; (c) Reducing the linkage rate on principal or interest; (d) Forgoing principal or interest accrued in accordance with the terms of the debt;

3 Dealing with Problem Debts Page (e) Any other change in the terms of a problem debt granting special terms to a debtor, on account of the state of his business; Debt in arrears - The full amount of a debt if part of it has not been repaid within 90 days of its due date, with the exception of a debt which is temporarily in arrears. For this purpose, a debt in a checking account in excess of the authorized credit lines will be regarded as being in arrears if not repaid within 90 days, or if that account is not credited with sums sufficient to cover the debt under the credit lines within the period determined by the banking corporation. When a debt in a checking account is considered as being in arrears and it is possible to identify the specific debt which created the arrears, such debt will also be defined as a debt in arrears. When it is not possible to identify the debt that caused the arrears, all of the customer s indebtedness will be defined as a debt in arrears. Despite the foregoing, other debt of the customer (excluding the debt in a checking account) will not be considered as debt in arrears if: (a) It is possible to specifically identify repayments of the debt; or (b) It is not possible to identify such payments, but after the checking account was charged with the payment, the balance in the account was lower than the balance before the payment was made. Debt in temporary arrears - A debt in arrears, which the banking corporation s management regards as temporary and which does not indicate expected credit losses; Debt not accruing income - A debt, the interest on which is not credited to the profit and loss statement, a debt that was restructured and the indebtedness balance (including the accrued interest)

4 Dealing with Problem Debts Page prior to the new arrangement exceeds the expected receipts according to the arrangement, a debt in arrears, or any other debt the accrued interest on which is not regarded as likely to be collected even though the debt itself has not been defined as doubtful; Indebtedness under special supervision - including: (a) Indebtedness over which the banking corporation s management sees fit to increase control and supervision although it does not expect credit losses on it. This need may arise from considerations associated with sectoral or regional developments or with specific considerations connected with the debtor s financial soundness, the extent and quality of information available to the banking corporation regarding the debtor and his business activity, the state of the collateral, arrears in repaying debts, the debtor s connections with other entities regarded as problematic, etc.; 2. Part of a borrower s indebtedness another part of which has been defined as a problem debt under a different classification; Problem debt - Other debt A debt under special supervision, a debt in temporary arrears, a debt which has been restructured or is a debt regarding which restructuring has been approved but not yet executed, a debt not accruing income, or a debt which has been determined to be doubtful in full or in part; A debt that is not a problem debt.

5 Dealing with Problem Debts Page Classification of problem debts 3. At least every quarter the banking corporation shall examine the indebtedness of customers and classify them as problem debts and other debts. The problem debts shall be classified in the following categories: (a) Debts determined as doubtful in their entirety; (b) Debts determined as partially doubtful - (c) (d) (e) (f) (1) When the part of the debt which was not provided for is classified as a debt not accruing income; (2) When the banking corporation credits interest in the profit and loss statement to that part of the debt which was not provided for; Debts not accruing income; Debts being restructured: (1) Debts restructured with waiver of income; (2) Debts restructured that year, without waiver of income; (3) Debts regarding which restructuring has been approved but not yet executed; Debts in temporary arrears; Debts under special supervision. Determination of procedures 4. The management of a banking corporation shall determine, subject to the approval of the board of directors, detailed procedures for dealing with problem debts in each of the categories listed in section 3 above, while setting the minimum amounts for debts requiring action in the various groups. These procedures shall define for each stage of the action, the authority of each echelon within the banking corporation. Procedures shall be defined at a minimum for the following subjects: (a) The format of current reports to the banking corporation management in order to enable early detection of developments or events which might affect the condition and classification of a customer s indebtedness. Procedures shall also be prepared for ensuring the quality of the reporting and monitoring of debts defined as problematic; (b) A format for classifying the kinds of debt, as specified in section 3 above, in such a way that it will be possible to identify in the banking corporation s books the population of indebtedness in each group according to relevant cross-sections

6 Dealing with Problem Debts Page (c) (customers, type of credit, etc.); Guidelines regarding the business management of problem debts and procedures for collecting debts from the day they were identified as problematic; (d) Guidelines for applying the rules for accounting recording and financial reporting as required by the regulations contained in this circular; (e) Procedures for further treatment of problem debts, dealing inter alia with the following (f) topics: (1) Waiver of interest; (2) Forgiveness of debts (principal); (3) Restructuring a debt; Procedures for determining provision for doubtful debts or for decisions to write-off bad debts, including a procedure for identifying the events that led to the change in a debt s classification; (g) Procedures for determining full documentation of the decisions and reasons regarding those loans from the time they are identified as problematic. Current reporting to management 5. Reports shall be submitted to the management regarding the development of problem debts as defined in section 4(a) above, at least quarterly, and shall include at least the following details: (a) Development of the balance of problem debts during the past quarter, and information concerning the classification of the various components of the debt; (b) Management s decisions regarding a change in the classification of problem debts and the considerations that led to this change in view of the information contained in the customer s file; (c) Information about problem debts that have been identified as such during the past quarter and the steps taken in dealing with them (business decisions regarding the future management of the indebtedness, classification in the banking corporation s books, etc.); (d) Arrangements reached with customers regarding problem debts, while noting specifically the implications of these arrangements on the profit and loss statement in the current and subsequent periods;

7 Dealing with Problem Debts Page (e) Steps taken to improve the chances of collection or to ensure maximal collection of (f) problem debts; Balances of the provision for doubtful debts and the provision for interest on them and movements in them. THE ACCOUNTING RECORDING Timing of provision 6. (a) When the management of a banking corporation has determined that a debt is doubtful, but no later than the end of that month (henceforth, the date for defining the debt as doubtful) provision for doubtful debts shall be recorded; (b) At least every quarter, the management of a banking corporation shall examine the extent of the provision for doubtful debts and determine which debts shall be writtenoff. Amount of provision 7. (a) The amount of the doubtful debt shall include the interest accrued on the debt up to the time it is defined as doubtful, subject to the provisions in section 8 below; (b) If the doubtful debt was denominated in foreign currency, the amount of provision charged to the profit and loss statement shall be determined in accordance with the exchange rate at the beginning of the quarter in which the debt was defined as doubtful, or at the time the credit was extended to the customer, whichever is later. Interest on doubtful debt 8. As long as a banking corporation has not waived the receipt of interest on a debt defined as doubtful, the corporation shall continue to charge the interest against the debtor account, at the rate set in agreement with the customer. This interest shall not be credited to income in the profit and loss statement, but shall be credited to the provision for interest on doubtful debts account, starting from the beginning of the quarter in which the debt was defined as doubtful. If the banking corporation has defined part of the debt as doubtful, the interest shall be credited solely on that portion of the debt as a credit to the provision for interest on doubtful debts". The provision for doubtful debt accounts and the interest on them shall be

8 Dealing with Problem Debts Page managed in such a way that it will be possible at any time to attribute the provisions to the specific debts. Debts denominated in foreign currency 9. If a debt denominated in foreign currency has been defined as doubtful, and as long as the terms of the debt (in arrangement with the customer) according to which it is denominated in foreign currency have not been changed, the accounts regarding the provision for the doubtful debt and for the provision for interest on it shall be administered in the same foreign currency. Debts not accruing income 10. (a) Interest accrued on debts that do not accrue income shall be recorded as income to the profit and loss statement only when actually collected. Until collection, the customer s account shall be charged as a credit to provision for interest on debts not accruing income account, starting from the beginning of the quarter in which the debt was defined as not accruing income; (b) The account for provision for interest on debts not accruing income shall be administered separately and in a way that enables its components to be attributed at any time to specific debts classified to that group of debts; The provision for interest account, for debts in foreign currency classified as debts not accruing income, shall be administered in foreign currency; (c) Interest on arrears in the payments of borrowers who are mortgagors shall be credited to income only upon collection. Attributing provisions on indebtedness with several components 11. (a) When indebtedness is comprised of different kinds of indebtedness, with different interest, linkage, or currency terms, and is defined as partially doubtful debt, the banking corporation shall determine the way the provision is attributed to the components of the indebtedness considering the specific collateral or other special circumstances. In the absence of special circumstances, the provision shall be attributed to the components of the indebtedness in accordance with business considerations in the nature of the relationship between the banking corporation and the customer. This

9 Dealing with Problem Debts Page determination may also be based on the relative shares of the components of the indebtedness. (b) The attribution method shall be determined at the same time with the determination of the provision for doubtful debt, and shall be documented together with the reasons for it. Once the attribution of provisions has been made on a given basis, the banking corporation is not entitled to change it for provisions made in the past for that indebtedness. The attribution of additional provisions made in the future shall be determined according to the business considerations prevailing at the time the additional provision is made. (c) If at a date later than that at which provision for a doubtful debt was made an arrangement is reached with the customer regarding the repayment of the debt, the banking corporation shall examine whether the conditions of the arrangement require a different attribution of the provision to that determined at the time it was made. A change in the attribution method, if required, shall be documented in the customer s file and shall be binding on the banking corporation in the future. Reduction of provision for doubtful debts 12. If the management of a banking corporation has determined that there were special conditions which justify the reduction of the provision for a doubtful debt, and in the absence of circumstances requiring a given attribution of the reduction to principal or interest (e.g., a legal agreement or regulation), the provision for interest on the debt shall be reduced first. The reduction shall be credited to the other financing income section in the notes to the profit and loss statement. Collection of problem debts 13. (a) General As a rule, amounts collected against a problem debt shall first of all be regarded as having been received against that part of the indebtedness that was not defined as a doubtful debt or that was not classified as a debt not accruing income. (b) Collection of a doubtful debt Collection against a debt for which full provision as a doubtful debt was made shall be dealt with first as collection of interest, in the absence of circumstances dictating any

10 Dealing with Problem Debts Page other approach (e.g., an agreement or legal regulation). This interest shall be credited to the other financing income section in the notes to the profit and loss statement. (c) Collection on account of debts not accruing income If a portion of a debt that has been defined in the past as a debt not accruing income is collected, and in the absence of circumstances that require other treatment, the amounts collected shall first of all be considered as being received against interest. This interest shall be credited to the other financing income section in the notes to the profit and loss statement. (d) Collection of debts previously written-off If debts that were previously written-off are collected, the amounts collected shall be credited to the provision for doubtful debt account in the profit and loss statement. (e) Non-cash collection If a banking corporation acquires ownership of an asset (including other rights to an asset, excluding mortgage rights) in full or partial payment of a problem debt, the collection shall be recorded at market value (less taxes and direct indebtedness that apply to the sale of the asset) of the asset at the time it was transferred to the ownership of the banking corporation. If the banking corporation sells the asset at a time close to the transfer of its ownership to the banking corporation, the aforesaid market value shall be replaced by the amount received for the sale of the asset, and the recordings shall be adjusted accordingly. If, however, the actual ownership of the asset is transferred only at the time the transfer is recorded in the land deeds, or other legal document, the value shall be calculated in accordance with the date the agreement regarding the transfer was made. Waiver of interest 14. (a) If a banking corporation waves the receipt of interest accrued to a customer s account, after the date at which his debt has been determined as doubtful or as a debt not accruing income, the interest on the customer s account shall be cancelled out against the provision for interest on doubtful debts or against the provision for interest on debts not accruing income.

11 Dealing with Problem Debts Page (b) Waiver of interest against another problem debt that has been debited to a customer s account by the beginning of the quarter in which it was waived, shall be recorded as a debt write-off and not as a reduction in interest income. (c) Waiver of interest that has been debited to a customer s account for a debt not classified as a problem debt and which was incurred in the regular course of business as a result of negotiations not connected with the debtor s business situation, may be presented as a reduction in interest income. (d) For this purpose, interest waiver is only in coordination with the customer, and must be documented. Debt write-off 15. (a) If the management of a banking corporation has determined that a debt defined in the past as doubtful should be written-off, the balance of the debt and its components shall be written-off against the appropriate provisions (i.e., provision for doubtful debts and provision for interest on doubtful debts). (b) If it has been determined that a debt not yet classified as doubtful should be written-off, the banking corporation must create provision against the debt, and the balance in the account of the debtor shall be written-off against it. (c) When the banking corporation reaches an arrangement with the customer whose debt has been written-off, the receipts shall be recorded only on the basis of actual collection. Financial reporting 16. See the Regulations on Reporting to the Public - section 660.

12 Dealing with Problem Debts Page APPENDIX: PROBLEM DEBTS IN HOUSING LOANS OF Introduction 1. Despite the aforesaid in the body of the Regulation, a banking corporation shall calculate the specific provision for doubtful debts against housing loans in accordance with the extent of arrears as specified in this appendix. The provision in accordance with the extent of arrears, derived from that method of calculation, is a minimum provision. If, however, as a result of information that the banking corporation has regarding developments or events connected with the credit portfolio, it becomes apparent that the provision in accordance with the uniform method is not sufficient, the management of the banking corporation must create additional provision, as is required by the information in its possession. Definitions 2. Housing loan - In accordance with its meaning in section 231 definition of "residential mortgage loans" in Directive no. 204 (Measurement and Capital Adequacy IRB approaches to credit risk), and including a loan for the purchase of a right to an apartment in return for key money. Calculation of provision 3. The balance of the minimum specific provision in accordance with the extent of the arrears against a housing loan shall be calculated for each loan separately in accordance with the following formula: BX% C A Extent of arrears (in months) balance of arrears (including related payments and interest in arrears), divided by the amount of the last payment whose maturity has come due in accordance with the amortization table (including related payments); B Overall balance of debt (including balance in arrears, allied payments, and interest in arrears debited to the customer s account) C Balance of provision for interest in arrears X% Percentage determined, in accordance with extent of arrears, on the basis of the table below:

13 Dealing with Problem Debts Page Extent of arrears, A X% 6 < A 9 8% 9 < A 12 16% 12 < A 15 24% 15 < A 18 32% 18 < A 21 40% 21 < A 24 48% 24 < A 27 56% 27 < A 30 64% 30 < A 33 72% 33 < A 80% 3a. The content of the above notwithstanding, the specific loan-loss provision for a loan which is not repaid in periodic payments of principal and/or interest (monthly or quarterly), shall be calculated in accordance with the relevant rules for that loan, and not by the "extent of arrears" method. 4. Repealed. Determination of reporting procedures 5. The procedures of the management of a banking corporation for dealing with problem debts in the area of housing loans shall contain, in addition to the aforesaid in the body of the Regulation, procedures for a format of the current reports to the management, in order to enable early detection of developments or events that might affect the credit risk of groups of mortgagors according to cross-sections determined by the management. These cross-sections may be based on geographic considerations, quality of collateral, use of loan funds (purchase of apartment, renovations, etc.) as well as other socio-economic criteria of borrowers (age, salary, etc.). The report shall also include an analysis of the balance of arrears in accordance with the extent of the arrears and the cross-sections determined by the management. * * *