RPT-Fitch: EBA Problem Loan Definition Is Important Component of AQR

Tue May 13, 2014 4:04am EDT

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May 13 (Reuters) - (The following statement was released by the rating agency)

The ECB's asset quality review (AQR) will improve the comparability of asset quality measures across eurozone banks by applying a simplified version of the European Banking Authority's definition of non-performing loans, Fitch Ratings says. We believe it is a sensible compromise to achieve reasonably harmonised metrics within the time constraint. But full implementation of the EBA's guidelines by end-2014 across the EU will make asset quality reporting, and stress tests and analysis based on this data, even more robust.

Clearer and more comparable disclosure of asset quality numbers is important for bank analysis. Problem loans have a direct and material effect on a bank's results, regulatory capital reporting and market valuation. A lack of universality has hampered understanding of European banks' asset quality, but the EU is making positive strides this year. The EBA's comprehensive definition of problem loans will go some way to achieving harmonisation, although implementation is not required until end-2014 reporting and is awaiting endorsement by the European Commission. Analysts are likely to ask for harmonised asset quality disclosure ahead of this.

We believe the ECB's AQR based on end-2013 balance sheets will go part of the way to addressing the issue. Even with a simplified problem loan definition, the AQR will strengthen the consistency of input data and results. We understand that the definition has more relaxed contagion rules for the retail segment, so that not every loan product for a customer has to be classified as impaired just because one loan falls into the definition. Forbearance is not explicitly included but the ECB expects that the IFRS definition will mean most banks include it. Loans with identified objective evidence of impairment but no impairment loss due to strong collateral have to be classified as impaired.

Many banks reviewed their portfolios last year, applying more conservative classifications of impaired loans than in the past and boosting provisions. This practice was often prompted by national regulators. Our analysis of 108 banks with relevant public data from the sample of 124 EU banks participating in the EBA's stress test shows that reported impaired loans increased by 8.1% in 2013.

There was a reduction or no increase in impaired loans at 38% of the banks in our analysis, mainly because of progress with portfolio deleveraging and restructuring. But 30 banks saw impaired loans rise by more than 20%.

We believe a full transition to the EBA's harmonized definitions will increase problem loans at all EU banks, except the most conservative ones. This is likely to lead to a fall in reserve coverage ratios, particularly for retail portfolios where a stricter customer view will be applied instead of a product view.

For a detailed analysis of asset quality measurement in EU banks, including the EBA's harmonised definitions and data for banks included in the EU-wide stress test, see "Weaknesses in Problem Loan Reporting in EU Banks," published today at www.fitchratings.com

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