The question concerns the identification of forbearance measures, namely the ‘Arrangement to Pay’ and the ‘Promise to Pay’. With this question I want to propose that an Arrangement to Pay will not be classified as forbearance. I would like to know whether you agree on my conclusion. Forbearance (EBA definition) Debts with forbearance measures are contracts / the terms (1) of which the debtor is considered unable to comply with (2) due to its financial difficulties so that the institution decides (3) either to modify the terms and conditions of the contract to enable the debtor to service the debt or to refinance, totally or partially, the contract. When determining whether a measure constitutes as forbearance the following aspects should be taken into account: A. Is the counterparty in financial difficulties? B. Is there a modification of the terms and conditions of the contract? C. Is the modification a concession? D. Is the classification of forbearance aligned with the objectives of the regulator?
Implementation of forbearance within a large Dutch bank. Promise to Pay and Arrangement to Pay For the purpose of the classification of forbearance, I consider the Promise to Pay to be a special case of the Arrangement to Pay. The sole difference is that with a Promise to Pay all payments are done at the same time, while in an Arrangement to Pay the payments can be at multiple times. For the remainder of this memo I will therefore only refer to the Arrangement to Pay. Three possible cases can be distinguished with respect to Arrangement to Pay: 1) An Arrangement to Pay for a counterparty in financial difficulties to ensure the counterparty will not become 90 days past due (90DPD). 2) An Arrangement to Pay for a counterparty in financial difficulties which postpones payments to after the 90DPD. 3) An Arrangement to Pay for a counterparty already 90DPD. An Arrangement to Pay in the situation the counterparty is not in financial difficulties will never be considered to be a forbearance measure. Especially measure 2 and 3 have raised discussions on the classification of forbearance. Analysis A. Is the counterparty in financial difficulties? In all cases the counterparty is in financial difficulties. B. Is there a modification of the terms and conditions of the contract? An Arrangement to Pay is not technically a modification of the terms and conditions of the contract, as these remain intact. However, ESMA states “lack of action by the lender towards the borrower (e.g. lack of enforcement of covenants in the contract) can be considered a form of forbearance”. A strict interpretation might allow one to conclude that an Arrangement to Pay can still constitute forbearance. However, an Arrangement to Pay cannot be considered a “lack of action by the lender”. Therefore, it does not meet the criteria given by EBA and ESMA for a modification. C. Is the modification a concession? In principle, a postponement of payments can be considered a concession even if the total amount of payments is not altered. However, in all cases the objective of an Arrangement to Pay should be to ensure the counterparty pays as much as possible given its repayment capacity. The objective of the measure is therefore not to provide additional leeway to the counterparty. Assuming the objective is indeed to maximize the counterparties’ debt servicing capacity, then the measure should not be considered a concession. Usually banks have a maximum period for a counterparty before it is moved to recovery. This provides a natural cap on the length of the period for the Arrangement to Pay. Only in the case that de bank applies the measure in such a way that it is not aimed at maximizing the counterparties’ debt servicing capacity, the measure might be considered as a concession. To remove any uncertainty about this measure, such a measure should not be referred to as Arrangement to Pay. D. Is the classification of forbearance aligned with the objectives of the regulator? EBA states: · it has concerns relating “… to uncertainty surrounding the extent of the use of forbearance, potentially aiming at, or in practice leading to, delaying loss recognition and masking asset quality deterioration”; and · that it aims to “assess the extent of forbearance transactions and their effects on asset quality and loss recognition.” Whenever a counterparty has any arrears a bank needs to take measures with the counterparty to ensure it pays its obligations. At the very least a bank will make an Arrangement to Pay with the counterparty to pay its obligations as soon as realistically possible. When classifying every Arrangement to Pay to a counterparty with any arrears more than 30DPD as forbearance, this would imply that effectively every contract with 30DPD would constitute forbearance. I do not believe this is in line with the objective of the EBA to improve on transparency on, and reduce uncertainty about, the asset quality. In particular, when the Arrangement to Pay postpones payments to after the 90DPD or is applied to a counterparty already 90DPD, it will be recognised as defaulted and impaired. There is no delay in loss recognition nor does it mask asset quality deterioration. Conclusion The Arrangement to Pay does not meet all the mentioned criteria to constitute forbearance, irrespective of the current number of days past due of the counterparty. It is assumed that an Arrangement to Pay is always applied in such a way that it maximised the counterparties debt servicing capacity. A agreement with a counterparty which does not meet this assumption should not be identified as an Arrangement to Pay, but be classified as another type of measure to reduce uncertainty. http://www.eba.europa.eu/documents/10180/449824/EBA-ITS-2013-03+Final+dr...  ESMA/2012/853: Treatment of Forbearance Practices in IFRS Financial Statements of Financial Institutions  EBA/ITS/2013/03: EBA FINAL draft Implementing Technical Standards On Supervisory reporting on forbearance and non-performing exposures under article 99(4) of Regulation (EU) No 575/2013
It is asked whether different possible cases of Arrangement to Pay should (or not) be classified into the forbearance category:
We understand that Arrangements to Pay are agreements by which a bank agrees to a postponement of payments due a date after the normal due date of the contract. The modalities of this postponement seek to maximize the ability of the counterparty to service its debt. Following the Arrangement, if the counterparty is allowed to repay the amounts due in one payment only, the Arrangement is called a Promise to Pay. Contracts under Arrangements to Pay may be classified as defaulted or impaired.
For the purpose of Template F 19.00 Paragraph 163 of the EBA Final draft ITS on Supervisory reporting on forbearance and non-performing exposures under article 99(4) of Regulation (EU) No. 575/2013 (CRR) defines forbearance measures as "concessions towards a debtor facing or about to face financial difficulties in meeting its financial commitments".
According to , paragraph 164 (a) "a concession refers to...a modification of the previous terms and conditions of a contract the debtor is considered unable to comply with due to its financial difficulties ("troubled debt") to allow for sufficient debt service ability, that would not have been granted had the debtor not been in financial difficulties". In order for a concession to be identified, the modification of the previous terms and conditions of a contract shall be linked to the financial difficulties of the debtor, and it has for purpose to enable sufficient debt service ability.
Paragraph 165 then provides examples of what a concession includes. These examples are however non-exhaustive. In general, the classification as forborne should consider the substance of the agreement rather than the "formal" modification of the terms and conditions (i.e. an agreement by a lender to extend the payment date of a contract beyond the originally contractually agreed due date is a modification, even if the contract is not formally modified).
On the basis of paragraphs 163 and 164, two conditions shall be satisfied in order for an exposure to be classified as forborne: 1) the financial difficulties of the debtor and 2) a modification of the previous terms and conditions of a contract due to the debtor's situation.
In addition, paragraph 172 specifies four situations that have to be treated as forbearance measures as, in these situations, the two above conditions are considered met:
(a) a modified contract was classified as non-performing or would in the absence of modification be classified as non-performing;
(b) the modification made to a contract involves a total or partial cancellation by write-offs of the debt;
(c) the institution approves the use of embedded forbearance clauses for a debtor who is under non-performing status or who would be considered as non-performing without the use of these clauses;
(d) simultaneously with or close in time to the concession of additional debt by the institution, the debtor made payments of principal or interest on another contract with the institution that was non-performing or would in the absence of refinancing be classified as non-performing.
Based on the examples provided by the submitter, our understanding is that Arrangements to Pay or Promises to Pay are extended to borrowers in state of financial difficulties and allow them to postpone the contractually-agreed date of their payments due to a later date in order to maximise their ability to service their debt. We understand that Arrangements or Promises to Pay are an arrear management tools and are extended to borrowers that are in financial difficulties. The two conditions (financial difficulties and concessions) identified in paragraphs 163 and 164 are therefore satisfied and Arrangements to Pay and Promises to Pay qualify forbearance measures.
Especially, in the three cases on which guidance is asked:
The classification as forborne exposure is unrelated to the classification of this exposure as defaulted, impaired, or non-performing: exposures with forbearance measures can be performing forborne or non-performing forborne, according to the conditions detailed in paragraphs 157, 164 and 172.
The present Q&A on Supervisory reporting is provisional. It will be reviewed after the respective Implementing Regulation is in force and published in the Official Journal, which may differ from the text of the relevant draft ITS to which it relates