Circular Letter No. CC/2024/00000049

Circular Letter No. CC/2024/00000049
Subject: Supervisory expectations on prudential coverage of non-performing exposures by less significant credit institutions

1. Article 47-C of Regulation (EU) No 575/2013 (CRR) establishes the mandatory prudential treatment, under Pillar 1, of non-performing exposures (NPEs) originated on or after April 26, 2019, requiring the deduction from Common Equity Tier 1 capital of NPEs that are not sufficiently covered by impairments or other adjustments.

2. For NPEs originated before April 26, 2019, prudential legislation does not define minimum coverages, leaving it to competent authorities to exercise their supervisory powers within the framework of the Supervisory Review and Evaluation Process (SREP).

3. In 2018, the European Central Bank (ECB) published supervisory expectations in this regard, applicable to significant credit institutions.

4. Regarding less significant credit institutions in Portugal, the Banco de Portugal considers that, in addition to what is defined in the "EBA Guidelines on non-performing and restructured exposures (EBA/GL/2018/06)", additional actions are necessary to promote a regular and prudent increase in NPE coverages, and consequently a reduction in the prudential exposure of institutions to these assets.

5. In this context, this Circular Letter discloses the Banco de Portugal's expectations regarding prudential coverage for NPEs originated before April 26, 2019, applicable to less significant credit institutions.

6. This Circular Letter takes into account the ECB's expectations on this matter, having been adjusted to consider criteria of proportionality and simplification for adoption by less significant credit institutions.

Supervisory Expectations of the Banco de Portugal

7. Less significant credit institutions in Portugal must consider minimum prudential coverage percentages for NPEs originated before April 26, 2019.

8. The definition of NPE, for the purposes of this Circular Letter, corresponds to that set out in Article 47-A of the CRR, and the prudential coverage expectations must respect the provisions of Article 47-C of the CRR, specifically the definitions of the various types of secured exposures and the calculation of the amount of insufficient coverage for NPEs.

1 Consider for this purpose the set of ECB expectations for prudential coverage of exposures originated before April 26, 2019, which were classified as non-performing after April 1, 2018 ("Addendum to the ECB Guidelines on NPL", originally published in March 2018) and before April 1, 2018 (published on July 11, 2018), as per the ECB Communication on supervisory expectations regarding the coverage of non-performing positions. 2 See Circular Letter No. CC/2019/00000061

Mod. 40000375/T – 01/14

9. Institutions must ensure minimum prudential coverages, giving priority to the accounting recognition of impairments, up to the maximum possible amount under International Financial Reporting Standard 9 (IFRS 9). In situations where the applicable accounting recognition does not reach the minimum prudential coverages, institutions must make deductions from Common Equity Tier 1 capital.

10. For NPEs originated before April 26, 2019, and classified as NPEs by December 31, 2024, the minimum levels of prudential coverage are 100% for the following cases:
    a) Unsecured exposures with more than 3 years of age since classification as NPE; b) Secured exposures with real estate collateral with more than 9 years of age since classification as NPE; and c) Secured exposures with other credit protection or subject to public guarantee with more than 7 years of age since classification as NPE.

11. Without prejudice to the above, institutions may consider a transition period of 3 years for the full application of the expectations in the previous point, ensuring progressive coverage in accordance with the percentages indicated in the Annex Table to this Circular Letter.

12. For NPE exposures originated before April 26, 2019, classified as NPEs by December 31, 2024, but which have not yet reached the ages indicated in points a) to c) of point 10, institutions must effect a progressive increase in coverages until they reach the level defined in point 10, in accordance with the percentages indicated in the Annex Table to this Circular Letter.

13. For NPEs originated before April 26, 2019, and classified as NPEs from January 1, 2025, institutions must follow the minimum coverages required under Article 47-C of the CRR.

14. The calculation of the minimum prudential coverage amount must be determined individually for each exposure, separating the secured part from the unsecured part, in accordance with paragraph 1 of Article 47-C of the CRR.

15. Any shortfalls relative to the minimum prudential coverage amount must be determined at the level of each exposure; compensation of coverage deficits with excess coverages between exposures or between entities within the group must not be performed.

16. For NPEs originated before April 26, 2019, that have been restructured with an increase in exposure – as provided for in the second paragraph of Article 469-A of the CRR – and that fall within the minimum coverages provided for in Article 47-C of the CRR, institutions must maintain the existing prudential coverages for these exposures, which were established under this Circular Letter. In such situations, institutions must continue to apply the minimum prudential coverages considering the initial origination date, so as to avoid a reduction in the coverage of these exposures.

17. Compliance with these expectations will be considered by the Banco de Portugal in the SREP process of less significant institutions, from the reference date of December 31, 2025, inclusive. If impairments and voluntary deductions from Common Equity Tier 1 capital do not adequately cover the associated credit risk, the Banco de Portugal will assess the need to adopt specific supervisory measures, namely, the determination of additional capital requirements or deductions to capital.

3 Under Article 3 of the CRR, which establishes that institutions may hold capital and its respective components beyond what is required by the said regulation, and may apply stricter measures than those required by it.

Mod. 40000375/T – 01/14

18. The prudential coverage expectations present in this Circular Letter may be adjusted following guidelines that may be established by the European Central Bank in the context of the Single Supervisory Mechanism for less significant credit institutions.

19. This Circular Letter enters into force on the day following its publication.

Annex to Circular Letter No. CC/2024/00000049
Table - Gradual application of supervisory expectations regarding minimum coverage of NPEs originated before April 26, 2019, and classified as NPEs by December 31, 2024: