| 2.2.1 | In general, a corporate exposure is defined as a debt obligation of a corporation, partnership, or proprietorship. Banks are permitted to distinguish separately exposures to small- and medium-sized entities (“SMEs”).
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| | SME exposures
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| 2.2.2 | SME is defined as a corporate where the reported sales1 for the consolidated group of which the firm is a part are less than SR. 15 MM and the max claims on the counterparty are at SR. 10 MM. To ensure that the information used is timely and accurate, banks should obtain the consolidated sales figure from the latest available audited financial statements2 and have it updated at least annually. The basis of consolidation for the borrowing group should follow that used by Banks for their risk management purposes.
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| 2.2.2.1 | Banks should manage SME on a pooled basis in their internal risk management systems in the same manner as other retail exposures. This could be as part of a portfolio segment or pool of exposures with similar risk characteristics for risk assessment and quantification.
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| 2.2.2.2 | VIP and High Net Worth Private Accounts
These are defined to be exposure to VIP accounts and high net worth individuals that do not meet the criteria for retail exposures under Para 2.5.
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| | Specialized lending (“SL”) exposures
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| 2.2.3 | Except otherwise specified, a corporate exposure should be classified as SL if it possesses all of the following characteristics, either in legal form or economic substance:
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| | • | the exposure is to an entity (often a special purpose entity (“SPE”)) which was created specifically to finance and/or operate physical assets;
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| | • | the borrowing entity has little or no other material assets or activities, and therefore little or no independent capacity to repay the obligation, apart from the income that it receives from the asset(s) being financed;
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| | • | the terms of the obligation gives the lender a substantial degree of control over the asset(s) and the income that it generates; and
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| | • | as a result of the preceding factors, the primary source of repayment of the obligation is the income generated by the asset(s), rather than the independent capacity of a broader commercial enterprise.
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| 2.2.4 | The five sub-classes of specialized lending are project finance, object finance, commodities finance, income-producing real estate, and high-volatility commercial real estate. Each of these sub-classes is defined below.
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| | (Refer para 220, International Convergence of Capital Measurement and Capital Standards – June 2006)
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| | Project finance
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| 2.2.5 | Project finance (“PF”) is a method of funding in which the lender looks primarily to the revenues generated by a single project, both as the source of repayment and as security for the exposure. This type of financing is usually for large, complex and expensive installations that might include, for example, power plants, chemical processing plants, mines, transportation infrastructure, and telecommunications infrastructure. PF may take the form of financing of the construction of a new capital installation, or refinancing of an existing installation, with or without improvements.
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| 2.2.6 | In such transactions, the lender is usually paid solely or almost exclusively out of the money generated by the contracts for the facility’s output, such as the electricity sold by a power plant. The borrower is usually an SPE that is not permitted to perform any function other than developing, owning, and operating the installation. The consequence is that repayment depends primarily on the project’s cash flow and on the collateral value of the project’s assets. In contrast, if repayment of the exposure depends primarily on a well-established, diversified, credit-worthy, contractually obligated end user for repayment, it is considered a secured exposure to that end user.
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| | Object finance
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| 2.2.7 | Object finance (“OF”) refers to a method of funding the acquisition of physical assets (e.g. ships, aircraft, etc.) where the repayment of the exposure is dependent on the cash flows generated by the specific assets that have been financed and pledged or assigned to the lender. A primary source of these cash flows might be rental or lease contracts with one or several third parties. In contrast, if the exposure is to a borrower whose financial condition and debt-servicing capacity enables it to repay the debt without undue reliance on the specifically pledged assets, the exposure should be treated as a collateralized corporate exposure.
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| | Commodities finance
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| 2.2.8 | Commodities finance (“CF”) refers to structured short-term lending to finance inventories, or receivables of exchange-traded commodities (e.g. crude oil, metals, or crops), where the exposure will be repaid from the proceeds of the sale of the commodity, and the borrower has no independent capacity to repay the exposure. This is the case when the borrower has no other activities and no other material assets on its balance sheet. The structured nature of the financing is designed to compensate for the weak credit quality of the borrower. The exposure’s rating reflects its self-liquidating nature and the lender’s skill in structuring the transaction rather than the credit quality of the borrower.
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| 2.2.9 | Such lending can be distinguished from exposures financing the inventories, or receivables of other more diversified corporate borrowers. Banks are able to rate the credit quality of the latter type of borrowers based on their broader ongoing operations. In such cases, the value of the commodity serves as a risk mitigant rather than as the primary source of repayment.
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| 2.2.10 | Income-producing real estate (“IPRE”) refers to a method of providing funding to real estate (such as, office buildings, retail shops, residential buildings, industrial or warehouse premises, and hotels) where the prospects for repayment and recovery on the exposure depend primarily on the cash flows generated by the asset. The primary source of these cash flows would generally be lease or rental payments or the sale of the asset. The distinguishing characteristic of IPRE versus other corporate exposures that are collateralized by real estate is the strong positive correlation between the prospects for repayment of the exposure and the prospects for recovery in the event of default, with both depending primarily on the cash flows generated by a property.
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| 2.2.11 | High Volatility Commercial Real Estate
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High-volatility commercial real estate (HVCRE) lending is the financing of commercial real estate that exhibits higher loss rate volatility (i.e. higher asset correlation) compared to other types of SL. HVCRE includes:
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| | • | Commercial real estate exposures secured by properties of types that are categorized by the national supervisor as sharing higher volatilities in portfolio default rates;
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| | • | Loans financing any of the land acquisition, development and construction (ADC) phases for properties of those types in such jurisdictions; and
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| | • | Loans financing ADC of any other properties where the source of repayment at origination of the exposure is either the future uncertain sale of the property or cash flows whose source of repayment is substantially uncertain (e.g. the property has not yet been leased to the occupancy rate prevailing in that geographic market for that type of commercial real estate), unless the borrower has substantial equity at risk. Commercial ADC loans exempted from treatment as HVCRE loans on the basis of certainty of repayment of borrower equity are, however, ineligible for the additional reductions for SL exposures described in paragraph 277, International Convergence of Capital Measurement and Capital Standards – June 2006
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| | | (Refer para 227, International Convergence of Capital Measurement and Capital Standards – June 2006)
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| | | Where SAMA would categorize certain types of commercial real estate exposures as HVCRE in their jurisdictions, it would make public such determinations. SAMA would then ensure that such treatment is then applied equally to banks under their supervision when making such HVCRE loans in that jurisdiction.
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| | | (Refer para 228, International Convergence of Capital Measurement and Capital Standards – June 2006)
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1 This term is used interchangeably with “turnover” or “revenue”.
2 This does not apply to those customers that are not subject to statutory audit (such as a sole proprietor). In such cases, banks should obtain their latest available management accounts
