2. Design

No: 41033343

Date(g): 6/1/2020 | Date(h): 11/5/1441

Status: In-Force

Effective from Jul 01 2020 - Jun 30 2020
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The design phase should identify options to be used to resolve NPLs, establish specific targets for NPL reduction, together with performance indicators detailing how the NPL reduction strategy will be implemented over short, medium and long term periods. Following are key components of the design phase:

i. Strategy implementation options

Banks should review the range of NPL strategy implementation options available and their respective financial impact. Examples of implementation options, not being mutually exclusive, are:
•	Hold/restructuring strategy: A hold strategy (A hold strategy is not to terminate the relationship with the troubled borrower) option is strongly linked to the operating model, restructuring and borrower assessment expertise, operational NPL management capabilities, outsourcing of servicing and write-off policies.
•	Active portfolio reductions: These can be achieved through either sales and/or writing off provisioned NPL loans that are deemed unrecoverable. This option is to be linked to provision adequacy, collateral valuations, quality loan data, and NPL investor demand.
•	Change of loan type: This includes foreclosure, loan to equity swapping, loan to asset swapping, or collateral substitution.
•	Legal options: This includes insolvency proceedings and foreclosure proceedings
•	Out-of-court solutions: Out-of-court debt restructuring involves changing the composition and/or structure of assets and liabilities of borrowers in financial difficulty, without resorting to a full judicial intervention, and with the objective of promoting efficiency, restoring growth, and minimizing the costs associated with the borrower’s financial difficulties (for details on out of court solutions please refer to section 6.2.2.)
	Banks should ensure that their NPL strategy includes not just a single strategic option but rather combinations of strategies/options to best achieve their objectives over the short, medium and long term and explore which options are advantageous for different portfolios or segments and under different conditions.
	Banks should also identify medium and long-term strategic options for NPL reductions which might not be achievable immediately, e.g. a lack of immediate NPL investor demand might change in the medium to long term. Operational plans might need to foresee such changes, e.g. the need for enhancing the quality of NPL loan data in order to be ready for future investor transactions.
	Where banks assess that the above-listed implementation options do not provide an efficient NPL reduction in the medium to long-term horizon for certain portfolios, segments or individual loans, this should be clearly reflected in an appropriate and timely provisioning approach. The bank should write off loans that are deemed to be uncollectable in a timely manner.

ii. Targets

Before commencing the short to medium-term target-setting process, banks should establish a clear view of what reasonable long-term NPL levels are, both on an overall basis but also on a portfolio-level basis. In spite of uncertainty around the time frame required to achieve these long-term goals, however, they are an important input to setting adequate short and medium-term targets.
Banks should include, at a minimum, clearly defined quantitative targets in their NPL strategy (where relevant including foreclosed assets), which should be approved by the senior management committee. The combination of these targets should lead to a concrete reduction, gross and net (of provisions), of NPLs, at least in the medium term. While expectations about changes in macroeconomic conditions can play a role in determining target levels (if based on solid external forecasts), they should not be the sole driver for the established NPL reduction targets.
In determining, the targets banks should establish at least the following dimensions:
•	by time horizons, i.e. short-term (indicative 1 year), medium-term (indicative 3 years) and possibly long-term;
•	by main portfolios (e.g. retail mortgage, retail consumer, retail small businesses and professionals, MSME corporate, large corporate, commercial real estate);
•	by implementation option chosen to drive the projected reduction, e.g. cash recoveries from hold strategy, collateral repossessions, recoveries from legal proceedings, revenues from the sale of NPLs or write-offs.
The NPL targets should at least include a projected absolute or percentage NPL reduction, both gross and net of provisions, not only on an overall basis but also for the main NPL portfolios.
Where foreclosed assets are material, a dedicated foreclosed assets strategy should be defined or, at least, foreclosed assets reduction targets should be included in the NPL strategy. It is acknowledged that a reduction in NPLs might involve an increase in foreclosed assets for the short term, pending the sale of these assets. However, this timeframe should be clearly limited as the aim of foreclosures is a timely sale of the assets concerned.
Targets shall be initially defined for all main portfolios on a quarterly basis for the first year. Each of these high-level targets is to be accompanied by a standard set of more granular monitoring items, e.g. non-performing loan ratio and coverage ratio, etc.

Below shows high-level quantitative targets as per better international practices.

Sustainable solutions-oriented operational target:
•	Loans with long term modifications / NPL plus performing forborne loans with Long term Modifications.
Action-oriented operational targets:
•	Active NPL MSMEs for which a viability analysis has been conducted in the last 12 months / Active NPL MSMEs.
•	MSME and Corporate NPL common borrowers for which a common restructuring solution has been implemented.
•	Corporate NPLs for which the bank(s) have engaged a specialist for the implementation of a company restructuring plan.
Banks running the NPL strategy process for the first time should not solely focus on the short-term horizon. The aim here is to address the deficiencies identified during the self-assessment process and thus establish an effective and timely NPL management framework, which allows the successful implementation of the quantitative NPL targets approved for the medium to long-term horizon.
Note 1:
As an illustration. Banks which have internally calibrated (through the cycle) TTC PD’s against a validated rating system, should not aim to foreclose accounts, against which a viable restructuring could lead to an ECL output which is less than the internal (if the same has been internally computed) or regulatory loss given default, if legal proceeding were to be initiated against the borrower.
Hence, for instance, by forgiving 20% of the outstanding amount would lead to a risk classification into a grade, which has 16% PD, (ignoring the 12 month period, for which the restructured loan would be classified as NPL. provided performance is satisfactory) and assuming that the internally computed LGD is 36%, the ECL % expected to arise from such a transaction would be around 24.6%, (20 % concession and ((100% -20 % concession) .16 PD 36% LGD) = 4.6%))) vs an expected LGD for foreclosure of say 43%.
The above is a simplified illustration, SAMA is cognizant that:
•	Obligors granted a material concession in course of foreclosures are classified as NPL for provisioning purposes for at least a year, which should be taken into account whilst computing the cost of foreclosure to the bank and;
•	Expert Level Judgement or rating system override with respect to grade classification may be warranted whilst making the above assessment
However, the purpose of outlining the above is to endorse a long term vision in terms of making a balanced decision with respect to restructuring a distressed borrower ( i.e. determining the viability of a borrower) rather than seeking outright enforcement proceeding.