Calendar provisioning: discussion points on management of non-performing exposures given the impact of the Covid-19 pandemic
Table of Contents: 1. Introduction; 2. The regulatory framework; 3. The regulation of calendar provisioning; 4. The impact of the Covid-19 pandemic; 5. The potential effects of calendar provisioning on the management of NPEs.
This contribution analyses the main aspects of the rules on calendar provisioning and the intended effects of the system on management of positions classified as non-performing – including given the impact of the Covid-19 pandemic.
Calendar provisioning refers to a set of European source rules introduced with the aim of improving the quality of banks’ assets, reducing non-performing exposures in a sustainable way, through a gradual and prudential provisioning plan.
- The regulatory framework
The current rules governing the minimum coverage of non-performing exposures were introduced with the “Guidelines on non-performing loans” of the European Central Bank (ECB) of March 2017 , supplemented in March 2018 by the “Addendum to NPL Guidelines” (the Addendum)  which for the first time has issued a series of guidelines (the so-called supervisory expectations), operational from 1 April 2018, concerning the prudential coverage of exposures classified as non-performing exposures (NPE).
In its press release of 11 July 2018, the ECB  set out the supervisory expectations for provisioning outstanding amounts of non-performing loans (NPLs), which it is anticipated will become significant within the framework of the dialogue between the supervising and supervised entities through the sending of SREP letters to the individual banks, which therefore will have the possibility of justifying the legitimacy of certain deviations – and avoid imposition by the ECB of a second pillar supervisory measure.
Regulation (EU) 2019/630 of the European Parliament and of the Council (Regulation 2019/630)  was published on 17 April 2019 and partially amended by Regulation (EU) 2013/575 of the European Parliament and of the Council (“CRR”)  laying down prudential requirements for credit institutions and investment companies, introducing new rules on minimum coverage for NPEs, which provide for a system of deduction from the bank’s Tier 1 common equity (CET1) insofar as certain minimum coverage levels provided for in the new legislation have not been reached. This regulatory framework, included in Pillar One, provides no room for flexibility and applies only to NPEs generated by loans disbursed from 26 April 2019.
With a view to harmonising the system of rules laid down in the Addendum with those established in Regulation 2019/630 , in August 2019 the ECB again issued a “Notice on Supervisory Expectations for NPE Coverage” , clarifying aspects of the EBA’s guidance on NPEs, providing more detail on the ECB’s supervisory expectations for provisioning the solidity of NPEs, and illustrating the interaction between the ECB’s expectations for NPE coverage under Pillar II and Pillar I prudential rules.
In accordance with the ECB’s statement of 20 March 2020 , Regulation (EU) 2020/873 of the European Parliament and of the Council (Regulation 2020/873) was published on 24 June 2020 , which in the scope of a series of measures to amend the CRR to address the emergency caused by the spread of Covid-19, amended Regulation 2019/630, specifying the role of public guarantees within the Pillar 1 framework (on this point see below).
- The regulation of calendar provisioning
In light of the above, the scope of application of calendar provisioning may be tripartite depending on the characteristics of the NPEs . In particular, if the NPEs in portfolio have reached the non-performing stage:
(i) from 1 April 2018 onwards and with a date of origination on or after 26 April 2019, the minimum level of coverage will be governed by Regulation 2019/630 (Pillar 1 Perimeter);
(ii) from 1 April 2018 onwards and with a date of origination before 26 April 2019, the minimum level of coverage will be governed by the Addendum (Pillar 2 Addendum);
(iii) prior to 1 April 2018, the minimum level of coverage will be managed in the context of the annual SREP letter sent by the ECB to the individual banks (Pillar 2 Stock Perimeter).
With regard to the Pillar 1 Perimeter, European legislation has introduced regulatory requirements which are binding on all banks from the entry into force of Regulation 2019/630 (i.e. 26 April 2019). According to the principle of the prudential backstop, each bank is required to comply with a minimum level of coverage, the so-called minimum loss coverage  (MLC), in order to cover future losses arising from NPEs. The MLCs planned for NPEs vary according to the period when they were non-performing (the so-called vintage), the presence or absence of guarantees (so-called secured or unsecured receivables) and the type of guarantees backing the credit.
With specific reference to forborne exposures, Article 47-quater of Regulation 2019/630 provides that these may only be used for determining the MLC of the suspension for one year – only if the first measure is granted . This means that, as a result of the suspension, the percentage cover valid at that time will be applicable for a further year, after which, if the exposure is still non-performing, the applicable write-down percentage must be determined as if no measure had been granted, taking into account the date on which the exposure was originally classified as non-performing .
Although these rules are already in force, the levels of deduction deriving from the introduction of the NPL prudential backstop will be indicated by the banks in the context of Corep reports from the reference date of 30 June 2021.
With reference to the Perimeter of the Pillar 2 Addendum, the same minimum coverage levels are provided for under Pillar 1, except for forborne exposures under Article 47-quater, paragraph 6, of Regulation 2019/630, for which no specific treatment is provided.
Since the vintage period commences on 1 April 2018 and the first MLC (35% for unsecured exposures) is triggered after two years, the minimum coverage levels started as early as from 1 April 2020.
In accordance with the instructions for compiling the Short Term Exercise (STE) published by the ECB in December 2019 , the supervised entities may request an exemption from the application of the coverage percentages provided for in the Pillar 2 Addendum only in the hypothesis: (i) of regular payments leading to full repayment; (ii) of a combination of second pillar expectations with first pillar capital requirements generating a request for coverage in excess of 100% of the exposure. In any case, positions that are more than thirty days overdue or for which no contractual payment has been made in the last twelve months cannot be exempted.
With reference to the Pillar 2 Stock Perimeter, a minimum coverage level is required from the end of 2020 on vintage exposures equal to or greater than 7 or 2 years after classification as NPE, depending on whether they are secured or unsecured exposures. Each supervised institute is identified in one of three macro-bands (first band = high; second band = intermediate; third band = low) to which several MLCs were assigned according to the sustainability of NPEs by the same institutes.
Finally, in accordance with the provisions of the Addendum, for the minimum coverage levels of Pillar 2 Addendum and Pillar 2 Stock, from the beginning of 2021 banks will be required, as part of the SREP supervisory dialogue, to notify the ECB of any divergence between the actual practices adopted and supervisory expectations on prudential provisions.
Unlike the Pillar 1 measures, which provide for an automatic deduction from the banks’ own funds in the event that NPEs are not sufficiently covered by provisions or other adjustments, the Pillar 2 measures (Addendum and Stock) are not binding, since they are supervisory expectations, the actual implementation of which is subject to a provisioning gap, i.e. a deviation between existing value adjustments and those dictated by the new rules, and thus the establishment of a supervisory dialogue based on the comply or explain principle.
It should also be borne in mind that the Addendum and the ECB’s Reporting Instructions for coverage of non-performing exposures template of November 2019 identified, first, a series of specific circumstances that banks can rely on to justify the deviation from supervisory expectations (the so-called explain case study) and, therefore, to avoid such deviations being counted in the provisioning gap and, secondly, situations that do not provide for the possibility of exemption.
- The impact of the Covid-19 pandemic
It is reasonable to assume that the economic crisis triggered by the Covid-19 pandemic will have a significantly negative impact both on the number of non-performing exposures (including in the light of the new definition of default in effect from 1 January 2021 ) and on credit recovery time-scales; it suffices to consider the effect of certain (albeit temporary) measures adopted by the emergency legislator, such as the suspension and deferral of enforcement proceedings involving the debtor’s main residence and/or the automatic staying and/or deferral of trial deadlines.
As is well known, in order to cope with the liquidity crisis affecting households and businesses, individual Member States have taken action by preparing a series of public measures aimed at supporting and relaunching the economy.
In this context, the ECB  made provision for a specific exemption from supervisory expectations for MLCs on NPEs, accompanied by public guarantees as part of efforts to contend with the Covid-19 emergency situation, establishing that in such cases there will be no minimum coverage requirements for the first seven years from classification to credit default .
The ECB has made it clear that NPE stock pre-dating the outbreak of the pandemic will not benefit from ad hoc measures; however, given that the expected market conditions are unlikely to allow banks to meet the agreed targets for reducing these stocks, the ECB has stated that flexibility margins will be assessed on a case by case basis within the supervisory dialogue.
Regulation (EU) 2020/873 of the European Parliament and of the Council of 24 June 2020  setting forth anti-pandemic measures, introduced a series of amendments to Regulation 2013/575 (the Quick fix) . In particular, Article 47-quater, in addition to the provisions already made by the ECB, treated the guarantees and counter-guarantees granted by national governments or other public entities, which were assigned a weighting of 0% in accordance with the provisions of the CRR  (the so-called standardised method), as guarantees provided by export credit agencies, thereby equating state guarantees and guarantees of export credit agencies due to their asserted substantive similarity in terms of the ability to mitigate risk.
Finally, to complete the overview, reference may be made to some measures that may have an indirect impact on calendar provisioning.
At European level, the flexibility aspects introduced by the ECB in the classification of loans as unlikely-to-pay if the loan is backed by public guarantees established as part of interventions related to the Covid-19 emergency merit a reference; these are the subject of public or private moratoria granted due to the crisis caused by the pandemic . In this regard, the EBA recently clarified that the suspension of the write-down of loans subject to a public moratorium will take effect until 21 March 2021 . The interpretation was necessary because initially the EBA, in providing for the exemption from the reclassification to non-performing of loans subject to a moratorium until 21 March 2021, had at the same time adopted a mechanism whereby the exemption itself could not go beyond nine months. In the case of moratoria guaranteed by the Italian state, however, the nine months ended up expiring – at least for the first moratoria – as early as the first week of February. The last interpretation adopted by the EBA therefore allows the reclassification of loans subject to a public moratorium to be postponed until 31 March 2021.
With reference to the actions of the Italian legislator, consider Article 55 of Decree-Law of 17 May 2020 (the “Cura Italia” Decree), No. 18, as converted into law, which provided, inter alia, for the possibility of converting into tax credits some deferred tax assets (Deferred Tax Assets – DTAs) deriving from tax losses and ACE surpluses following the transfer of non-performing loans, with effect from the date of their transfer. Such loans may be offset without limits on amount and time if the non-performing loans were transferred by 31 December 2020, or repayment may be requested. As a result of the transfer the DTAs converted into credits will be re-classified for supervisory purposes as DTAs that do not depend on future profitability .
- The potential effects of calendar provisioning on the management of NPEs
The new regime, imposing higher capital and/or income statement charges on banks, will lead them to revise their strategies and methods for managing non-performing loans, moving from a wait and see model to a proactive and all-pervasive approach.
In this context, with a view to reducing the level of provisions, it will become fundamental for banks to analyse the existing NPE portfolio, identifying potential impacts according to, inter alia, (i) whether the exposure is secured or unsecured, (ii) the geographical location of the debtor (to which the time-frame for the recovery of the credit is closely related), (iii) the type of debtor, (iv) the time elapsed since the classification as in default, (v) the level of provisions already made and (vi) the stage at which the possible credit recovery process takes place.
For each cluster, it will then be necessary to identify the optimal strategy in order to minimise the economic and financial impacts arising from calendar provisioning, for example, by deciding whether to accelerate the credit recovery activity or transfer the credit. In the first case, it is essential that debt recovery processes facilitate – as far as possible – alignment between the actual time-frame and that provided for by calendar provisioning, including by using the logic of management by objectives and enhanced integration between internal structures, servicers and external legal counsel
The new rules could also affect policies on the granting of new loans, for example, inducing an even greater preference for the financing of sectors with a stable risk profile and/or a positive outlook.
Such considerations will become increasingly urgent given that the current scenario of economic crisis risks expanding the scope of NPEs.
Moreover, the effect of the rules on calendar provisioning risks being further magnified by interaction with other regulations that directly and/or indirectly affect non-performing loans or the variables that result in their emergence, first and foremost the new definition of default introduced by the European legislator. Considering that the new definition of default will contribute to the increase of NPEs and, consequently, the banks will face higher minimum levels of coverage, this could make it more convenient, from a management perspective and making use of the options provided for in IFRS 9, to transfer their bad loans to third parties.
In addition, the combination of rules on the default classification of exposures and those on calendar provisioning could also have an impact on debt restructuring processes.
In concluding restructuring agreements, even where they involve loan write-offs, banks must, in fact, take due account of the prospects for credit recovery provided for in the plans underlying the agreements themselves, so that they are consistent with the MLC imposed for that specific credit category by calendar provisioning.
Finally, the situation in which the debt restructuring involves various creditor banks could also present some problems: in fact, any application not identical to calendar provisioning by all the banks involved – especially with reference to the Pillar 2 rules, which, as mentioned above, do not provide for binding rules but rather supervisory expectations based on the principle of comply or explain – could lead to the most disadvantaged creditors not to accede to the agreement .
This article is for information purposes only and is not, and cannot be intended as, a professional opinion on the topics dealt with. For further information please contact Stefano Padovani and Anna Guadagnin.
 The method of calculation, reporting and interaction with the supervisory entity has been defined in a number of subsequent initiatives, among which the following merit a mention: (i) the publication of the first proposal for COREP tables to report the deductions made to CET1 in application of Regulation 2019/630, with effect from 30 June 2021, which was followed by (ii) the publication of the Final Report “Draft Implementing Technical Standards on supervisory requirements for institutions under Regulation (EU) No 575/2013”, currently under examination by the European Commission, and (iii) the sending in December 2019 by the ECB to institutions subject to supervision of the reporting schemes (the so-called templates) and technical compilation notes for NPE clusters subject to the SREP process (“Instructions for Short Term Exercise”, or for brevity, “STE”).https://www.bankingsupervision.europa.eu/press/letterstobanks/shared/pdf/2019/ssm.supervisory_coverage_expectations_for_NPEs_201908.it.pdf.
 See AIFIRM, Position Paper No. 23 “Implement Calendar Provisioning: rules and impacts”, in www.aifirm.it.
 See the Compromise text of the European Council of 14 March 2019 approving the introduction of minimum loss coverage.
 Article 47-ter of Regulation 2019/630 defines concession measures (so-called forbearance) as follows “A forbearance measure is a concession by an institution towards an obligor that is experiencing or is likely to experience difficulties in meeting its financial commitments. A concession may entail a loss for the lender and shall refer to either of the following actions: (a) a modification of the terms and conditions of a debt obligation, where such modification would not have been granted had the obligor not experienced difficulties in meeting its financial commitments; and (b) a total or partial refinancing of a debt obligation, where such refinancing would not have been granted had the obligor not experienced difficulties in meeting its financial commitments”. The rule goes on to list situations that are considered concession measures.
AIFIRM, Position Paper n. 23 “Implementing Calendar Provisioning: rules and impacts”, op.cit.
 See footnote 18.
 See the note published by the Bank of Italy on 15 October 2020 (https://www.bancaditalia.it/compiti/vigilanza/normativa/archivio-norme/circolari/c285/risposte_domande_applicativi/Nota-di-chiarimenti-2020.10.15.pdf?pk_campaign=EmailAlertBdi & pk_kwd=it.).
 ECB press release of 20 March 2020, followed by a “question and answer” document.
 This derogation applies to both first and second pillar measures.
It should be noted that the Bank of Italy published its Communication of 23 December 2020 implementing the Guidelines of the European Banking Authority on reporting obligations relating to the provisions contained in Regulation 873/2020 for financial intermediaries.
 Part 3, Title II, Chapter 2 of the CRR.
 ECB press release of 20 March 2020, followed by a “question and answer” document.
 AIFIRM, Position Paper n. 23 “Implement Calendar Provisioning: rules and impacts”, op.cit.
 AIFIRM, Position Paper n. 23 “Implement Calendar Provisioning: rules and impacts”, op.cit.