5.4.1 Monitoring Arrangements for Restructured Loans

No: 41033343

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

Status: In-Force

Restructured borrowers should be subject to intensive monitoring to ensure their continued ability to meet their obligations, The specialized team should use the bank’s EWS system to alert business segments of any potential problems. All borrowers should be subject to periodic review, the timing of which and depth of analysis required should be proportional to the size of the loan together with the level of risk inherent in the credit. Those loans which are material in nature and pose the greatest risk to the bank should be reviewed monthly on an abbreviated basis focused on recent developments. More in-depth reviews would be done on a quarterly and annual basis in conjunction with receipt of interim and annual financial statements. Smaller loans might be monitored semi-annually for the first year with annual reviews thereafter. Finally, the smallest loans could be subject to an annual review of their financial statements.

Senior management should also be monitoring closely the key performance indicators (KPIs) of specific portfolio segments to ensure that the goals embedded in the strategic plan are on track. Deviations from the plan should be identified and appropriate time-bound, corrective action plans put in place and monitored.

A. Changing the risk rating of the loan

All banks should have clear written policies and procedures in place which outline the specific criteria together with required cure periods which must be satisfied to upgrade (or downgrade) the risk rating on a loan. While the goal of the restructuring is to improve the loan's risk rating, the borrower must demonstrate its ability to meet the terms of the restructuring as well as show an improvement in its risk profile for a specified period of time before an upgrade is appropriate. It requires a one year waiting period after restructuring before a loan becomes eligible for consideration of an upgrade.
It is important to realize that upgrade is not automatic after the one year period, but rather should be based on the borrower's current and expected future performance. The borrowers should demonstrate that financial difficulties no longer exist. The following criteria should be met in order to dispel concerns regarding financial difficulties:
i.	the borrower has made all required payments in a timely manner for at least one year;
ii.	the loan is not considered as impaired or defaulted;
iii.	there is no past-due amount on the loan;
iv.	the borrower has demonstrated its ability to comply with all other post restructuring conditions contained in the master restructuring agreement; and
v.	the borrower does not have any other loans with amounts more than 90 dpd or 180 dpd (as the case may be) at the date when the loan is reclassified.
Particular attention should be paid to bullet and balloon loans (with reduced front payments). Even after one year of flawless performance, the repayment in full of a balloon loan that relies on a large payment at the end of repayment period can be questionable.

B. Transferring the borrower back to the originating unit

The following criteria should be applied when transferring a borrower back to the business unit:
i.	The borrower regularly meets all its obligations from the restructuring agreement;
ii.	At least one year has passed from the beginning of validity of the restructuring and
iii.	The borrower has repaid at least 10 percent of the restructured principal in that period;
iv.	The borrower's indebtedness, measured with the net financial liabilities/EBITDA indicator, etc.;
v.	The transfer had been approved on the basis of the analysis of the borrower's financial position by the competent committee of the bank.
Once a borrower has demonstrated its ability to meet the all the terms of its restructured obligations for a period of at least one year, repaid at least 10 percent of its restructured loan, and no longer displays any of the signals which would cause automatic transfer to the specialized team, the loan should be transferred back to the originating unit for servicing and follow up. Borrowers need to be seen to be viable by their customers and suppliers. A bank's willingness to work with a company to resolve its problems together with the resumption of a normalized banking relationship provides the public with a level of comfort that allows them to do business with the company.

C. Monitoring of workout activities

Banks should establish a robust set of metrics to measure progress in the implementation of their work out strategy for all the accounts.
The monitoring systems should be based on targets approved in the risk strategy and related operational plans which are subsequently cascaded down to the operational targets of the business and specialized teams. A related framework of key performance indicators (KPIs) should be developed to allow the senior management committee and other relevant managers to measure progress.
Clear processes should be established to ensure that the outcomes of the monitoring of restructured indicators have an adequate and timely link to related business activities such as pricing of credit risk and provisioning.
Restructuring related KPIs can be grouped into several high-level categories, including but not necessarily limited to:
i.	Bad/ stressed loan KPI's;
ii.	Borrower engagement and cash collection;
iii.	Restructuring activities;
iv.	Liquidation activities;
v.	Other (e.g. NPL-related profit and loss (P&L) items, foreclosed assets, early warning signals, outsourcing activities).

D. Bad/ stressed loan KPI’s:

Banks should define adequate indicators comparable with the portfolio should be monitored on a periodic basis.

Banks should closely monitor the relative and absolute levels of stressed loans and early arrears in their books at a sufficient level of portfolio granularity. Absolute and relative levels of foreclosed assets (or other assets stemming from workout activities), as well as the levels of performing forborne loans, should also be monitored.

Another key monitoring element is the level of impairment/provisions and collateral/ guarantees overall and for different NPL cohorts. These cohorts should be defined using criteria which are relevant for the coverage levels in order to provide the senior management and other relevant managers with meaningful information (e.g. by number of years since NPL classification, type of product/loan including secured/unsecured, type of collateral and guarantees, country and region of loan, time to recovery and the use of the going and gone concern approach).

Coverage movements should also be monitored and reductions clearly explained in the monitoring reports. Where possible, indicators related to the NPL ratio/level and coverage should also be appropriately benchmarked against peers in order to provide the senior management with a clear picture on competitive positioning and potential high-level shortcomings.

Finally, banks should monitor their loss budget and its comparison with actual. This should be sufficiently granular for the senior management and other relevant managers to understand the drivers of significant deviations from the plan.

Key figures on NPL inflows and outflows should be contained in periodic reporting to the senior management, including moves from/to NPLs, NPLs in cure period, performing, performing forborne and early arrears. Inflows from a performing status to a non-performing status appear gradually (e.g. from 0 dpd to 30dpd. 30dpd to 60dpd. 60dpd to 90dpd, or 180 days as the case may be etc.) but can also appear suddenly (e.g. event-driven). A useful monitoring tool for this area is the establishment of migration matrices, which will track the flow of loans into and out of non-performing classification.

Banks should estimate the migration rates and the quality of the performing book month by month so that actions can be taken promptly (i.e. prioritize the actions) to inhibit the deterioration of portfolio quality. Migration matrices can be further elaborated by loan type (housing, consumer, real estate), by business unit or by other relevant portfolio segment to identify whether the driver of the flows is attributed to a specific loan segment.

E. Borrower’s engagement and cash collection

Key operational performance metrics should be implemented to assess the specialized unit or employees' (if adequate) efficiency relative to the average performance and/or standard benchmark indicators (if they exist). These key operational measures should include both activity-type measures and efficiency type measures. The list below is indicative of the type of measures, without being exhaustive:
i.	Scheduled vs. actual borrower engagements;
ii.	Percentage of engagements converted to a payment or promise to pay;
iii.	Cash collected in absolute terms and cash collected vs. contractual cash obligation split by:
	-	Cash collected from borrower payments;
	-	cash collected from other sources (e.g. collateral sale, salary garnishments, bankruptcy proceedings);
iv.	promises to pay secured and promises to pay kept vs. promises to pay due;
v.	total and long-term restructuring solutions agreed with the borrower (count and volume).

F. Workout activities

One key tool available to banks to resolve or limit the impact of NPLs is restructuring if properly managed. Banks should monitor workout activity in two ways: efficiency and effectiveness. Efficiency relates mainly to the volume of credit facilities offered restructuring and the time needed to negotiate with the borrower while effectiveness relates to the degree of success of the restructuring option (i.e. whether the revised/modified contractual obligations of the borrower are met).

In addition, proper monitoring of the quality of the restructuring is needed to ensure that the ultimate outcome of the restructuring measures is the repayment of the amount due and not a delaying of the assessment that the loan is uncollectable.

In this regard, the type of solutions agreed should be monitored and long-term (sustainable structural) solutions should be separated from short-term (temporary) solutions.

It is noted that modification in the terms and conditions of a loan or refinancing could take place in all phases of the credit life cycle; therefore, banks should ensure that they monitor the restructuring activity of both performing and non-performing loans.

G. Efficiency of workout activity

Depending on the potential targets set by the bank and the portfolio segmentation, key metrics to measure their efficiency could be:
	a)	the volume of concluded evaluations (both in number and value) submitted to the authorized approval body for a defined time period;
	b)	the volume of agreed modified solutions (both in number and value) reached with the borrower for a defined time period;
	c)	the value and number of positions resolved over a defined time period (in absolute values and as a percentage of the initial stock).
It might also be useful to monitor the efficiency of other individual steps within the workout process, e.g. length of decision-taking/approval procedure.

H. Effectiveness of workout activity

The ultimate target of loan modifications is to ensure that the modified contractual obligations of the borrower are met and the solution found is viable. In this respect, the type of agreed solutions per portfolio with similar characteristics should be separated and the success rate of each solution should be monitored over time.
Key metrics to monitor the success rate of each restructuring solution include:
	i.	Cure rate (the rate arrived at by conducting performance analysis of the forborne credit facilities after their designated cure period) and re-default rate (the rate arrived at by performing a performance analysis of the forborne credit facilities after their designated cure period):
		Given the fact that most of the loans will present no evidence of financial difficulties right after the modification; a cure period is needed to determine whether the loan has been effectively cured. The minimum cure period applied to determine cure rates should be minimum for 12 months. Thus, banks should conduct a vintage analysis and monitor the behavior of forborne credit facilities after 12 months from the date of modification to determine the cure rate. This analysis should be conducted per loan segment (borrower with similar characteristics or basis industry segment) and, potentially, the extent of financial difficulties prior to restructuring.
		Cure of arrears on facilities presenting arrears could take place either through restructuring measures of the credit facility (forborne cure) or naturally without modification of the original terms of the credit facility (natural cure). Banks should have a mechanism in place to monitor the rate and the volume of those defaulted credit facilities cured naturally. The re-default rate is another key performance indicator that should be included in internal NPL monitoring reports for the senior management and other relevant managers.
	ii.	Type of workout measure: Banks should clearly define which types of workout measures are defined as short-term versus long-term solutions. Individual characteristics of workout agreements should be flagged and stored in the IT systems and periodic monitoring should provide the senior management and other relevant managers with a clear view on what proportion of restructuring solutions agreed are:
		o	of a short-term versus long term nature; and
		o	have certain characteristics (e.g. payment holidays ≥ 12 months, increase of principal, additional collateral, etc.).
	iii.	Cash collection rate: Another key metric of workout activity is the cash collection from restructured credit facilities. Cash collection could be monitored against the revised contractual cash flows, i.e. the actual to contractual cash flow ratio, and in absolute terms. These two metrics may provide information to the bank for liquidity planning purposes and the relative success of each workout measure.
	iv.	NPL write-off: In certain cases, as part of a workout solution, banks may proceed with a restructuring option that involves NPL write-off, either on a partial or full basis. Any NPL write-off associated with the granting of these types of restructuring should be recorded and monitored against an approved loss budget. In addition, the net present value loss associated with the decision to write off unrecoverable loans should be monitored against the cure rate per loan segment and per restructuring solution offered to help better inform the banks’ restructuring strategy and policies. All NPL write off policies developed by banks are required to follow the rules defined under the circular on “Credit Risk Classification and Provisioning”.
Indicators relating to workout activities should be reported using a meaningful breakdown which could for instance include the type and length of arrears, the kind of loan, the probability of recovery, the size of the loans or the total amount of loans of the same borrower or connected borrowers, or the number of workout solutions applied in the past.

I. Liquidation activities

Provided that no sustainable restructuring solution has been reached, the bank is still expected to resolve the stressed loan. Resolution may involve initiating legal procedures, foreclosing assets, loan to asset/equity swap, and/or disposal of credit facilities.

Consequently, this activity should be monitored by the bank to help inform strategy and policies while also assisting with the allocation of resources.

J. Legal measures and pre-closure

Banks should monitor the volumes and recovery rates of legal and foreclosure cases. This performance should be measured against set targets, in terms of number of months/years and loss to the bank. In monitoring the actual loss rate, banks are expected to build historical time series per loan segment to back up the assumptions used for impairment review purposes and stress test exercises.

For facilities covered with collateral or another type of security, banks should monitor the time period needed to liquidate the collateral, potential forced sale haircuts upon liquidation and developments in certain markets (e.g. property markets) to obtain an outlook regarding the potential recovery rates.

In addition, by monitoring the recovery rates from foreclosure and other legal proceedings, banks will be in a better position to reliably assess whether the decision to foreclose will provide a higher net present value than pursuing a restructuring option. The data regarding the recovery rates from foreclosures should be monitored on an ongoing basis and feed potential amendments to banks' strategies for handling their loan recovery / legal portfolios.

Banks should also monitor the average lengths of legal procedures recently completed and the average recovery amounts (including related recovery costs) from these completed procedures.

K. Loan to asset/equity swap

Banks should carefully monitor cases where the loan is swapped with an asset or equity of the borrower, at least by using the volume indicators by type of assets and ensure compliance with any limits set by the relevant national regulations on holdings. The use of this approach as a restructuring measure should be backed by a proper business plan and limited to assets where the bank has sufficient expertise and the market realistically allows the determined value to be extracted from the asset in a short to medium-term horizon. The bank should also make sure that the valuation of the assets is carried out by qualified and experienced appraisers.

L. Other monitoring items

i. P&L-related items

Banks should also monitor and make transparent to their management bodies the amount of interest accounted for in the P&L stemming from restructured loans. Additionally, a distinction should be made between the interest payments on those restructure actually received and those not actually received. The evolution of loan loss provisions and the respective drivers should also be monitored.

ii. Foreclosed assets
	If foreclosure is a part of banks' strategy, they should also monitor the volume, aging, coverage and flows in their portfolios of foreclosed assets (or other assets stemming from restructured loans). This should include sufficient granularity of material types of assets. Furthermore, the performance of the foreclosed assets with respect to the predefined business plan should be monitored in an appropriate way and reported to the senior management and other relevant managers on an aggregate level.
iii. Miscellaneous
	Other aspects that might be relevant for reporting would include the efficiency and effectiveness of outsourcing/servicing agreements. Indicators used for this are most likely very similar to those applied to monitor the efficiency and effectiveness of internal units, though potentially less granular.
	Generally, where restructuring-related KPIs differ from a regulatory and an accounting or internal reporting viewpoint, these differences should be clearly reported to the senior management and explained.