Regulation (NAP) - Asset Classification and Provisions

Banco Central of São Tomé and Príncipe PROponent(S): P.S.B.S. NAP – PERMANENT APPLICATION REGULATION ENTRY INTO FORCE: 06/08/2007 | ISSUE DATE: 06/08/2007 DOC NO.: 07/2007 | P. 1/7

Subject: ASSET CLASSIFICATION AND PROVISIONS

The Central Bank of São Tomé and Príncipe, by virtue of the powers assigned under point 2.d of Article 8° and f of Article 38° of its Organic Law, Considering the combined provisions of Articles 27°, 30° and 40° of the Financial Institutions Act, has decided that:

Article 1° Asset Classification Policy

1. The Board of Directors of banks authorized to operate in the Country, including "offshore" banks licensed under Decree-Law 62/95, shall adopt a policy on the classification of their assets and the creation of provisions for probable losses in their credit portfolio, and ensure its implementation, which shall be in compliance with the provisions of this NAP.
2. The Executive Management and the Risk Management Committee shall establish procedures to ensure compliance with the asset classification policy approved by the Board of Directors and ensure the implementation of the policy and its respective procedures and routines.
3. The asset classification procedure shall include the following elements: (a) a written analytical model approved for evaluating the quality of credits and other assets, to be applied consistently; (b) estimates shall be based on reasonable and verifiable assumptions; and (c) considerations regarding the impact on debtors of changes in economic activity in general shall be realistic and conservative.
4. The asset classification policy shall be reviewed at least on an annual basis by the Risk Management Committee, Executive Management, and Board of Directors.

Article 2° Classification of Credits

1. Banks must analyze all their credits, and all relevant available information, with the objective of classifying them at least by the end of each quarter.
2. The classification shall be carried out systematically and in accordance with the policy and procedures established by the bank.
3. The classification shall be carried out in at least the following categories: a) Normal — An asset is considered "normal" if (a) it is current; (b) the debtor is fulfilling, and is expected to continue to fulfill, all contractual terms; (c) there is no reason to consider that the bank is or will be subject to a risk of loss. b) Under Supervision — An asset shall be classified "under supervision" if there is a potential weakness in the financial position of the debtor or in the offered guarantees, and it will require greater attention from bank management to avoid credit deterioration. Credits overdue by 30 to 89 days in the payment of principal or interest must necessarily be classified in this category. c) Below Normal — An asset is classified as "below normal" if the asset has one or more deficiencies that make the complete collection of interest and principal questionable, since (a) the debtor's financial conditions (including equity or credit repayment capacity) are not favorable and are deteriorating; (b) the offered guarantees, if any, are insufficient or are deteriorating; (c) there are other elements that raise concerns regarding the debtor's repayment capacity according to agreed terms; (d) interest or principal payments are overdue by 90 days or more; and/or (e) a violation of contractual terms has already occurred. d) Doubtful Credit — An asset shall be classified as "Doubtful" when events occur that make the total collection or repayment of the credit highly questionable or unlikely based on current circumstances or conditions and the expected recovery value from guarantees, if any. The possibility of loss is very high; however, due to pending circumstances that could lead to an improvement in asset quality, its classification as a loss is deferred to a later moment. Assets that are overdue on interest or principal payments by 180 days or more shall be classified as doubtful. e) Loss — An asset shall be classified as "Loss" if, at the time of classification, it is considered unrecoverable and of insignificant value that should not be included in the bank's equity accounts and financial statements. The classification as loss does not mean that the asset has no recoverable value, but rather that the bank should not defer writing off the asset given its insignificance. This classification does not cancel the debtor's obligation to repay the bank for due interest and principal, nor does it mean that the bank will no longer exercise its legal rights to demand repayment of the obligation. Rights that are overdue by 360 days, whether in interest or principal payments, shall be classified as loss.
4. After the classification of credits according to the bank's policy, each one shall be included in one of the above categories.
5. Whenever a customer is classified into different categories than those referred to in point 3 above, the bank must apply the inclusion by assigning the most rigorous classification.
6. Any credit that presents an impairment loss, i.e., its book value exceeds its recoverable value through sale or liquidation, shall be adversely classified among the last categories.
7. If during the quarter the bank becomes aware of a significant deterioration in the quality of a credit, the bank shall immediately assign a new classification to the asset to reflect the new situation.
8. The minimum timeframes for classifying credits in the categories mentioned in Article 3 shall be, temporarily and for a period of six years, considered doubled, for credits with real guarantees, and tripled, for mortgage credits intended to finance the borrower's housing.

Article 3° Classification of Other Assets that are not Credits

1. Banks must conduct a review of their other assets at least by the end of each quarter for asset classification purposes and to verify if any of these assets have undergone depreciation or loss of value that should be recognized in accordance with this regulation.
2. The classification shall be carried out systematically and in accordance with the policy and procedures established by the bank.
3. When a bank incorporates a new asset into its balance sheet or reclassifies an asset to a different account, the bank must ensure that the new records and financial statements reflect the quality and conditions of that asset.
4. If during the quarter the bank becomes aware of a significant deterioration in the quality of a credit, the bank shall immediately assign a new classification to the asset to reflect the new situation.

Article 4° Exemption from Classification

1. The obligation to classify assets and establish minimum provisions does not cover rights against the following entities, as well as assets secured by them, or off-balance sheet operations negotiated on their behalf or with their guarantee: a) State of São Tomé and Príncipe; b) Central Bank of São Tomé and Príncipe; c) Central governments and central banks of OECD member countries; d) Multilateral cooperation and development banks.

Article 5° Recognition of Value Losses in Assets

1. An asset shall be considered impaired or suffering a loss of value when it is probable that the bank will not be able to recover all amounts due under the contractual terms of the asset, or when there is no longer reasonable assurance of such recovery.
2. At the time of credit classification, any unrecoverable amount shall be recognized by establishing a specific provision that correspondingly reduces the value of the asset, or by writing off the loss amount, both charged to the bank's income statement account, in the period in which the loss is recognized.
3. The minimum value of provisions for loss in the credit portfolio shall be determined by applying the following percentages to the sum of credits recorded in each category: a) Normal 2% b) Under Supervision 10% c) Below Normal 25% d) Doubtful 50% e) Loss 100%
4. The total value of provisions established for credit risk losses must be sufficient to absorb all estimated losses related to the credit portfolio.
5. In the case of other assets that are not credits, and in situations where losses to their value are considered permanent, the losses shall be recognized as expenses in the periods in which they occur, to adjust the value of the assets.
6. It is admitted that provisions for credits classified as normal and under supervision may be considered as provisions for general credit risks.
7. Provisions for general credit risks shall also be established on acceptances, guarantees, and endorsements provided, weighted in credit equivalents, in accordance with Regulation No. 2/92 of October 27, and instructions of the same date from the Central Bank of São Tomé and Príncipe, at a percentage corresponding to 2% of the calculated value.
8. The provisions referred to in numbers 2 and 3 of this Article shall be established, temporarily, as follows: a) For a period of six years, counted from the publication of this regulation, in full on due installments, and on 30% of future installments; b) For three consecutive years, in full on due installments and on 60% of future installments; and c) In full on the total value of the credit, including due and future installments, from the seventh year onward.

Article 6° Recognition of Income/Profits

1. Banks must suspend the recognition by the accrual principle (periodization) of income from assets that are considered as loss and/or adversely classified, as well as those overdue by 90 days or more.
2. The income referred to in the above point may only be recorded as period income when received in cash.
3. Income already recorded but not yet received, from an asset falling under the situations provided for in point 1 above, shall be immediately reversed.
4. The bank must maintain control of these operations and of the income due to be recorded in off-balance sheet accounts.

Article 7° Return of an Asset to Normal Status

1. An asset that was adversely classified may return to a "normal" classification status only when the contracted income and principal are considered fully recoverable according to contractual terms, and specifically, if: a) The bank has received payment of all due income and principal and expects the repayment of future income and principal as established in the contract; b) The debtor has paid all due principal and income for at least six months, and all contractual payments, including compensation for delays, are considered recoverable in a timely manner; or c) The asset has become more secure or guaranteed and is in the collection process.

Article 8° Receipt of Goods or Values in Payment in Kind (Dação de Pagamento)

1. The receipt of goods or values in payment in kind for a due credit shall be made at the maximum, by the value of the principal of the credit or asset to be received.
2. If the value of the asset received in payment is lower than the principal amount due, the difference shall be recorded as a loss, charged to the specific provision account or income statement account.

Article 9° Prohibitions

1. Banks are prohibited from renegotiating, renewing, or modifying the terms of a credit to avoid an adverse classification.
2. The advance of additional resources to a customer to fulfill a current obligation with the bank is prohibited.

Article 10° Duty to Report/Inform

1. Banks must submit a report regarding the position at the end of each quarter, in the form established by the Central Bank of São Tomé and Príncipe, with the classification of assets as established by this regulation.
2. The report shall be forwarded to the Banking Supervision Directorate by the 20th day of the month following the reference quarter.

Article 11° Revocation Regulation No. 5 of October 27, 1992 is hereby revoked.

Article 12° Effectiveness/Validity This NAP enters into force immediately.