Circular Letter No. CC/2024/00000050: Supervisory Expectations on Prudential Coverage for Real Estate Acquired via Loan Repayment

Circular Letter No. CC/2024/00000050 Sent to: Credit Institutions. Mod. 40000375/T – 01/14 Subject: Supervisory expectations on prudential coverage for exposures to real estate acquired via loan repayment

1. Under Articles 112 and 114 of the General Regime for Credit Institutions and Financial Companies (RGICSF), credit institutions may not, as a rule, acquire real estate that is not indispensable to their installation and operation or to the pursuit of their corporate object, except for those resulting from acquisitions via loan repayment, and situations arising therefrom must be regularized within a period of two years.

2. Circular Letter No. CC/2023/00000021, of June 2023, consolidates and updates the expectations of the Bank of Portugal regarding the management of real estate acquired via loan repayment, with a view to minimizing the time of their holding in the balance sheet or ensuring the prudential coverage of exposures to these assets.

3. This Circular Letter complements the provisions in paragraphs 9 to 13 of Circular Letter No. CC/2023/00000021. In particular, for real estate acquired via loan repayment that, under Article 114 of the RGICSF, remains in the balance sheets of credit institutions after the period referred to in number 1 and without prejudice to the reduction plan for these exposures defined by the institutions, this Circular Letter sets out the supervisory expectations of the Bank of Portugal regarding minimum prudential coverage levels based on the time of holding these real estate assets in the balance sheet.

Supervisory Expectations of the Bank of Portugal

4. Credit institutions must consider minimum percentages of prudential coverage of the book value of real estate acquired via loan repayment.

5. Institutions must fill potential gaps in minimum prudential coverage by prioritizing the accounting recognition of impairments and value adjustments, to the maximum extent possible under applicable accounting standards. In situations where applicable accounting recognition does not achieve minimum prudential coverage levels, institutions must make deductions from their Common Equity Tier 1 (“CET1”) own funds on their own initiative1.

6. Applying International Financial Reporting Standard 5 (“IFRS 5”), it results that the acquisition value of the real estate acquired via loan repayment (i.e., book value) must be the minimum between the net book value of the credit and the fair value of that real estate at the time of loan repayment.

7. Thus, credit institutions must ensure a progressive minimum prudential coverage of the book value of real estate acquired via loan repayment, at least at a minimum rate of 1/6 per year on the acquisition value, starting from the beginning of the 4th year following the respective acquisition, according to the formula in paragraph 8 and the following table:

Number of years in balance sheet	<4 years	≥ 4 and <5 years	≥ 5 and <6 years	≥ 6 and <7 years	≥ 7 and <8 years	≥ 8 and <9 years	≥ 9 years
Minimum reduction rate (accumulated)	0%	16.7%	33%	50%	67%	83.3%	100%

8. Additionally, and to the extent that real estate acquired via loan repayment is related to non-performing credit exposures for which CET1 deductions have been previously made in addition to the formation of accounting impairments2, institutions must not reverse these deductions with the acquisition of these real estate assets via loan repayment. When this results in a positive effect on own funds, the CET1 reduction must be maintained in full or partially, becoming associated with the acquired real estate.

9. The calculation of the minimum accumulated coverage, each year, for each of the real estate assets acquired via loan repayment, must be carried out as follows: (i) If acquisition value of the real estate > (Net book value of original credit - previous deductions): Minimum coverage amount = (Original acquisition value - previous deductions + value adjustments recognized in profit or loss at the time of acquisition) * reduction rate + previous deductions - value adjustments recognized in profit or loss at the time of acquisition (ii) If acquisition value of the real estate ≤ (Net book value of original credit - previous deductions): Minimum coverage amount = Original acquisition value * reduction rate where, in both sub-paragraphs (i) and (ii) above:

• Minimum coverage amount: minimum accumulated amount of impairments and/or CET1 deduction.
• Original acquisition value: initial value recorded at the moment the real estate is recognized in the balance sheet, determined in accordance with applicable accounting standards.
• Reduction rate: percentage from the table in point 7, applicable depending on the number of years each real estate asset has been recorded in the balance sheet.
• Previous deductions: when applicable, the value of any prudential CET1 deductions associated with the credit secured by the real estate, determined prior to its acquisition.
• Value adjustments recognized in profit or loss at the time of acquisition: when applicable, the value recorded in the profit or loss of the period at the time of acquisition for the difference between the fair value of the real estate and the net book value of the credit secured by the real estate.

10. For less significant credit institutions, the assessment of compliance with these expectations will be considered by the Bank of Portugal in the supervisory review and evaluation process (SREP) from the reference date of December 31, 2025, inclusive. If impairments and CET1 deductions do not adequately cover the risk of these exposures, the Bank of Portugal will assess the need to adopt specific supervisory measures, including, among others, the determination of additional own funds requirements or deductions to own funds.

11. This Circular Letter takes effect the day following its publication, and credit institutions must consider the expectations indicated from the reference date of December 31, 2024, inclusive.

1 Under Article 3 of the CRR, which establishes that institutions may maintain own funds and their components beyond what is required by the said regulation, and may apply more stringent measures than those required by it.

2 Under Article 47-C of Regulation (EU) No 575/2013 (CRR), which establishes mandatory prudential treatment within the Pillar 1 framework applicable to non-performing exposures (NPE) resulting from loans originated from April 26, 2019 (reported in line 0513 of map C.01 and map C.35 of COREP), or other deductions under Article 3 for other non-performing exposures (reported in line 0524 of map C01 of COREP).