Circular 5/2015 of the Bank of Spain on the Accounting Specifics of SAREB

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Circular 5/2015, of September 30, of the Bank of Spain, developing the accounting specifics of the Asset Management Company of Assets from the Banking Restructuring, S.A. (BOE of October 2)

On December 27, 2013, the General Courts approved Law 26/2013 on savings banks and banking foundations, which incorporated a modification of the accounting regime to be applied by the Asset Management Company of Assets from the Banking Restructuring, S.A. (hereinafter, Sareb). Through a transitional provision introducing paragraph 10 of the seventh additional provision of Law 9/2012, of November 14, on the restructuring and resolution of credit entities, a series of accounting specifics to be applied by Sareb were established, and it was foreseen that this company was not subject to the obligation to report in the notes as provided in Article 537 of Royal Legislative Decree 1/2010, of July 2, approving the consolidated text of the Capital Companies Law.

The accounting specifics were detailed as follows:

a) The initial accounting recording of the assets transferred to Sareb will be made in accordance with what is provided in the eighth additional provision of the law, taking into account their transfer value.

b) To determine the updated values of the assets, the Bank of Spain will develop the criteria supporting the methodology that Sareb must use to estimate the value of the assets, which will be consistent with that used for determining the transfer prices to Sareb. Subsequent valuations must be calculated considering Sareb's specifics, taking into account the evolution of market prices and in accordance with the time horizons provided in the business plan.

c) The value adjustments that result as necessary due to the application of the preceding letter b) will be calculated by asset units. To this effect, each category of assets individually described in Article 48.1 of Royal Decree 1559/2012 will be considered an asset unit.

d) The income generated as a consequence of the orderly management and liquidation process of all assets transferred will be understood as obtained from the company's ordinary activity and, as such, will be recorded in the income statement of the entity, forming part of its "Net amount of turnover".

Additionally, an authorization was included for the Bank of Spain to develop the aforementioned specifics through a circular, and in particular the criteria for Sareb to develop the methodology referred to in the preceding letter b).

The circular presented responds to the cited authorization and its reason for being lies in the need to ensure coherence between the accounting specifics and the general objectives of Sareb as an asset management company.

Regarding the first of the accounting specifics, the circular has taken into account, as a starting point, the fact that the assets were acquired by Sareb as a whole and for a single price, and that, in accordance with the preceding letter a), they were not accounted for at the fair value of each one, but at their transfer value, which was estimated as a percentage of the value of the asset in the books of the transferring entities, without considering any coverages that might have been established at that time. Therefore, in the initial accounting recognition of each of the assets acquired by Sareb, there could be differences compared to their fair value on the same date, even if there were none for the set of all of them. This fact would mean that, with respect to their fair value, in the initial accounting recording made by Sareb, some assets would be undervalued by the same amount by which others would be overvalued.

Regarding the transfer prices mentioned in letter b), Articles 13 to 15 of Royal Decree 1559/2012, of November 15, establishing the legal regime of asset management companies, have been taken as reference, which regulated the way to determine the transfer value of the assets to Sareb. These criteria have been adapted to reflect the evolution of market prices and the time horizons of Sareb's business plan.

As a consequence of the first of the accounting specifics, the one included in letter c) arises: the subsequent valuation of the assets through a system of "asset units", despite not being fungible elements. This specificity poses a singular accounting system, which allows the offsetting of losses with gains of assets within the same "asset unit".

The aforementioned criteria have been specified in the concept of mortgage value, defined in Order ECO/805/2003, of March 27, on valuation standards for real estate and certain rights for certain financial purposes. As an exception, the circular allows the use of statistical sampling procedures or automatic valuation mechanisms for certain finished housing, including annexes, and commercial premises, always carried out by appraisal societies. In any case, in order for Sareb to improve the estimated valuation of the assets in accordance with the aforementioned criteria, the value may deviate up to 15% according to its own professional judgment, and more than 15% if this could be evidenced by recent market transactions. Finally, Sareb may use its best estimate when valuing assets that are not subject to statistical procedures or automatic valuation mechanisms, provided they do not exceed the threshold of one million euros.

Consequently, in exercise of the powers granted, the Board of Governors of the Bank of Spain, upon proposal of the Executive Commission and in agreement with the Council of State, has approved this circular, which contains the following rules:

First Rule.

Object and scope of application.

This circular constitutes the development of the authorization granted to the Bank of Spain in paragraph 10 of the seventh additional provision of Law 9/2012, of November 14, on the restructuring and resolution of credit entities. In accordance with the indicated provision, the Asset Management Company of Assets from the Banking Restructuring, S.A. (hereinafter, Sareb), must comply with the general obligations of formulating annual accounts in the terms provided in Royal Legislative Decree 1/2010, of July 2, approving the consolidated text of the Capital Companies Law, except as provided in Article 537, with the necessary specifics - provided for in Law 9/2012 - to ensure the coherence of the accounting principles applicable to it with the mandate and general objectives of the company established by the legislation applicable to it.

In everything not specifically regulated in this circular, which develops the accounting specifics provided for in Law 9/2012, the General Accounting Plan approved by Royal Decree 1514/2007, of November 16, and its development provisions will apply.

Second Rule.

Asset units.

1. For the purposes of this circular, each of the five categories described in paragraph 1 of Article 48 of Royal Decree 1559/2012, of November 15, establishing the legal regime of asset management companies, will be considered an "asset unit".

2. Assets adjudicated or received in payment of debts will remain in the "asset unit" in which the financial assets from which they originated were initially registered - that is, on the date of transfer -.

Third Rule.

Value adjustments for impairment of assets after initial recognition.

1. At the end of each fiscal year, or whenever the entity must provide public information about its financial situation referring to another date, Sareb will evaluate the need to make value adjustments for impairment of each of the "asset units". To this end, it must analyze, with the best available information, whether the book value of the "asset unit" (including, if applicable, the accrual of interest for financial assets representing debt and deducting previously recognized accumulated impairment) is higher than the estimated value of the "asset unit" as a whole, in accordance with the methodology developed by Sareb according to the criteria established in the fourth rule of this circular. The accumulated impairment will be reflected in the balance sheet associated with each "asset unit" as a whole. Sareb will recognize the impairment, net of its tax effect, charged to an account under the heading "Adjustments for change in value" of equity. The debit balance of this account will be charged to the income statement when the result of the year is positive, for the entire amount. For these purposes, the profit before taxes of Sareb will be considered, without considering the eventual accrual of remuneration of subordinated financing. [1]

2. The impairment of each "asset unit" may be reversed when it is evidenced that the value of the assets of the "asset unit" has been recovered, in accordance with the methodology developed by Sareb, with the limit of the value that the "asset unit" would have if no impairment had been recorded. Such reversal will be made by first reducing the balance of the account under the heading "Adjustments for change in value" of equity. Once the balance of this account is zero, it will be credited, if applicable, to the income statement for the amount of the pending reversal to be recognized. [1]

3. In each "asset unit", the amount of losses on impaired assets may be offset with gains on non-impaired assets included in the same "asset unit", estimated in accordance with the criteria of the fourth rule of this circular.

4. Regardless of the legal form used, the value at which real estate assets adjudicated or received in payment of debts must be recognized is the book value of the financial assets applied on the date of adjudication or receipt of the assets.

Procedural, registry, and liquidated taxes expenses may be added to the initial value, provided that this does not exceed the estimated value in accordance with what is provided in paragraph 4 of the fourth rule.

5. The stay of an asset in its corresponding "asset unit" will be subject to compliance with the requirements contained in letter a) of paragraph 1 of Article 36 of the Commercial Code and, therefore, to the existence of sufficient objective elements confirming the probability that the recovery of the value of the registered asset is not remote.

6. The derecognition of assets from the balance sheet will be made at their book value, without considering the value adjustments for impairment estimated by "asset units" as a consequence of the application of what is provided in the fourth rule.

[1]

Paragraphs 1 and 2 drafted according to Circular 2/2017, of July 28, single rule.

Fourth Rule.

Relevant criteria for the development of the valuation methodology by Sareb.

1. Sareb will develop the methodology to estimate value adjustments for impairment according to the criteria established in this circular.

2. The valuation methodology must be approved and periodically reviewed by its board of directors, and will be consistent with the criteria approved in Chapter III of Royal Decree 1559/2012, of November 15, establishing the legal regime of asset management companies, to fix its transfer value, in order to ensure its coherence with the evolution of market prices at the time of estimation and with the time horizons provided in Sareb's business plan.

3. The details of the methodology, as well as its changes, must be sufficiently documented.

4. Real estate assets.

a) The methodology developed by Sareb to estimate the value of real estate assets will take into consideration the following criteria:

i. It will consider the specific characteristics that a duly informed buyer would use to decide on its acquisition, such as its geographical location, the availability of infrastructure, its legal situation, the conditions for its sale or exploitation, the supply and demand of similar assets, its most likely use, as well as aspects related to urban planning, demographic evolution, and supply prices. For the purpose of taking into account the legal situation of the asset and urban planning considerations, Sareb must use, in the valuation of land, the urban levels defined in Article 4 of Order ECO/805/2003, of March 27, on valuation standards for real estate and certain rights for certain financial purposes.

ii. It will consider the ability of the asset to generate cash flows according to the most likely use that Sareb intends and that is financially sustainable according to its business plan. The most likely use will be estimated according to the legal situation and market conditions of the asset, without necessarily having to coincide with its urban classification at the time of valuation. The estimation of the value of a real estate asset will be considered financially sustainable when it is capable of generating cash flows that produce a return adequate to the investment made by Sareb.

iii. In the real estate investments maintained by Sareb under a regime of obtaining income, the value will be estimated from the discounting of future cash flows, considering the occupancy level corresponding to the date of estimation, the probability of future occupancy of the property, and current market rents.

b) Unless otherwise provided in the following letter d), the methodology that Sareb must develop for real estate assets will estimate the value of the assets from their mortgage value, in accordance with the criteria provided for the purpose indicated in letter a) of Article 2 of Order ECO/805/2003, of March 27, with the adjustments necessary to reflect the evolution of market prices and the time horizons of the business plan. Any valuation that results in 15% above the mortgage value or the value obtained through statistical sampling procedures or automatic valuation models, in accordance with what is provided in the following letter d), must be evidenced by more than one market transaction on similar assets.

c) The mortgage value will be calculated individually, according to valuation reports (full appraisals) by independent experts with demonstrable experience in the area and in the type of assets. At least every three years, the review of the mortgage value and the change of independent expert are mandatory, and a valuation with greater frequency is necessary when market circumstances evidence a possible impairment not reflected in the valuation. Except for the first review and valuation of the transferred asset portfolio (hereinafter, first valuation), the valuation of the assets will be carried out by appraisal societies registered in the Official Register of Appraisal Societies of the Bank of Spain, in accordance with the criteria provided in Order ECO/805/2003, of March 27, on valuation standards for real estate and certain rights for certain financial purposes. In the valuation of land, exclusively the dynamic residual method established in Article 36 of the aforementioned order will be used.

d) In the calculation of the value of finished housing and annexes to them, such as garages or storage rooms, Sareb may opt to carry out full individual appraisals, statistical sampling procedures, or use automatic valuation models. Statistical sampling procedures or automatic valuation models may also be used to determine the value of commercial premises, but exclusively for those located in towns where there is a representative market of comparable real estate, in the sense that operators willing to negotiate a purchase or rental can be found, practically at any time. Furthermore, they must take into consideration that the surface area of the real estate whose observed market prices are used in the valuation are similar to the premises being valued, and the distribution of the surface area of the real estate (facade/depth ratio) must be taken into account. When the valuation is estimated through statistical sampling procedures or automatic valuation models, it will be carried out annually, although it will not be mandatory to change the independent expert every three years.

However, if the requirements provided below for the use of automatic valuation models or statistical sampling procedures are not met, full individual appraisals will be carried out.

In the case of use of statistical sampling procedures, Sareb must commission the valuation to appraisal societies registered in the Official Register of Appraisal Societies of the Bank of Spain. To this end, the sample will contain a sufficiently representative number of the typology and geographical scope in which the real estate to be valued are located, to ensure that the extrapolation has a sufficient level of reliability.

In the event of using automatic valuation models, Sareb must commission the valuation to appraisal societies registered in the Official Register of Appraisal Societies of the Bank of Spain. To this end, Sareb will have a procedure, approved by its governing body, that collects the circumstances in which automatic valuation models may be used, the minimum quality requirements required of the models, and the controls established to ensure compliance with these requirements.

In any case, Sareb must have in its databases all the relevant information, with accredited reliability, of the real estate to be valued. Likewise, it must ensure that the appraisal society carrying out the valuation has methodologically solid models and has a database of real estate with sufficient quality and depth for the application of said models.

The information that Sareb provides to the appraisal societies must be previously reviewed by the internal audit department or function, in order to verify the integrity of the databases, examining sufficient samples of these for this purpose. The department carrying out the internal audit functions must issue a report stating the work carried out and its conclusions on the quality of the data provided to the appraisal societies.

When market conditions or other circumstances indicate that asset prices may be experiencing significant decreases, the margin of error must be reduced, to increase the reliability of the estimates.

When statistical sampling procedures or automatic valuation models are used, Sareb will take into consideration the statistics of the National Statistics Institute on the evolution of the price of new and used or second-hand housing.

As an exception to what is provided in the preceding paragraphs, for real estate assets of a nature different from those described in the first paragraph of letter d) and with an aggregated book value per lot less than one million euros, Sareb may use its best estimate to determine their updated value, at least annually. In any case, the indicated estimate must respect what is provided in paragraphs 1 to 3 above. For the purpose of applying this dispensation, Sareb will aggregate the value of the assets that are to be sold as a lot to determine if the reference threshold is exceeded, regardless of whether they have individualized registry identification. In this sense, land belonging to the same unit of action or urban development will be valued as a lot.

5. Financial assets representing debt, including those issued by bank asset funds.

a) The value of the financial assets representing debt acquired by Sareb will be estimated individually according to the repayment capacity of the main debtors obliged to pay, considering, if applicable, the possible existence of guarantors or sureties with demonstrated repayment capacity. Notwithstanding the above, in the event of several financial assets representing debt against the same holder, Sareb may carry out a joint analysis to the extent that they have real guarantees. In the event of not having real guarantees, Sareb must proceed in accordance with what is provided in the following letter b).

When it is estimated that the recovery of the amounts due will be carried out through the execution of the guarantees, and these represent a first-rank real right on real estate assets, or of lower rank if the requirements of the following letter b) are met, the financial asset will be valued taking into consideration the value of the guarantees, following the criteria established in paragraph 4 of this rule for real estate assets. For the purpose of estimating the recoverable amount, Sareb will deduct from the value of the guarantee, estimated with the criteria of this circular, the necessary expenses to execute the guarantee, maintenance expenses, and marketing costs until the subsequent sale of the real estate asset. Sareb may adjust the estimates on execution, maintenance, and marketing costs with the most up-to-date information available.

Regarding the application of the criteria provided in paragraph 4 of this rule to estimate the value of the guarantee, in those cases where a full individual appraisal is carried out and it is not possible to visit the interior of the property, compliance with the remaining requirements required by Order ECO/805/2003 will suffice, although a condition highlighting such circumstance will be added to the corresponding report.

b) The value of the financial assets representing debt that do not have first-rank real guarantees on real estate assets will be estimated individually according to the repayment capacity of the main debtor, documentarily verifiable and evidenced on the compliance with contractual obligations without significant delays or delays in payments, or collectively whenever this way adequately reflects the expected loss of this portfolio. Financial assets without real guarantee on real estate assets that present delays in the debtor's contractual obligations - and, if applicable, that of the guarantors - exceeding 18 months from the date of transmission of the assets to Sareb, or from the date of the first default if it is later than this date, will be considered, unless evidence to the contrary, with zero value. The same criterion will be applied to the residual value of the assets with real guarantee other