EBA/GL/2019/01 Section 3: “The scope of the exercise of identifying items associated with particularly high risk that are not already covered by Article 128(2) of Regulation (EU) No 575/2013 should cover all exposure classes, with a particular emphasis on the exposure classes referred to in points (g - Corporates), (p - Equity) and (q – Other items) of Article 112 of Regulation (EU) No 575/2013.”

The selected transactions are currently assigned by the bank to the exposure class “exposures to corporates” in accordance with Article 112 CRR.

EBA/GL/2019/01 Section 4: “Institutions should consider as items associated with particularly high risk, from among those referred to in paragraph 3, at a minimum, those exposures that exhibit levels and ranges of risk drivers that are not common to other obligors or transactions of the same exposure class.”

The transaction represents a portfolio-based funding to an SPV originating itself reverse mortgage loans:

- The main purpose of the underlying transactions is to indirectly participate in the house price appreciation by granting reverse mortgage loans to home owners. The repayment of the loans (incl. all interest and fees charged) is fully due at maturity. In addition, the bank’s borrower follows the strategy aiming to expand the reverse mortgage portfolio and subsequently to sell it to an investor.

- The borrower SPV’s Balance Sheet and P&L structure completely differs from that of a plain vanilla corporate customer (i.e. interest income arising from loan origination instead of sales generated from production/provision of goods/services).

- In contrast to plain vanilla corporate risk where the creditworthiness of a single customer (production/provision of goods and services) determines the risk profile of the transaction, this type of transaction (loan-on-loan/lender financing) exhibits aggregated risks arising from multiple sources where risk measurement is only performed on portfolio-level.

- The borrower entity is deemed by the bank as an unregulated financial sector entity in accordance with Article 394(2) CRR.

EBA/GL/2019/01 Section 5: “For the purposes of paragraph 4, institutions should consider, at a minimum, all of the following exposures as exhibiting levels and ranges of risk drivers that are not common to other obligors or transactions of the same exposure class:

EBA/GL/2019/01 Section 5a: any financing of speculative investments in both financial and non-financial assets other than immovable property, in which the obligor has the intention to resell the assets for profit”

The borrower originates home equity mortgage loans representing financial assets, where its margins highly depend on the development of Canadian and US housing prices. In addition, it aims to sell the portfolio in order to be able to honour its contractual obligation towards the bank.

EBA/GL/2019/01 Section 5a i:” there is a particularly high risk of loss in cases of the default of the obligor, in particular in the case of insufficient market liquidity or high price volatility for the financed object that has not yet been sufficiently mitigated by contractual arrangements, including irrevocable pre-sale contracts”

- The business model underlying the transaction assumes that the home owners having taken out the reverse mortgage loans have no sufficient income to repay the loans at maturity, but have then to sell the property (or to refinance the loan). The repayment of the loans (incl. all interest and fees charged) is fully due at maturity.

- The bank’s interest charged on the borrower is fixed but the return of the underlying assets (interest payable by the ultimate customer on the reverse mortgage loan to the bank’s borrower) is depending on the evolution of the housing market (minimum 3.5% and maximum 8% interest rate). The house appreciation test will be done at the end of the loan term with a final valuation arranged by the bank’s borrower. The final value will be compared to the value at origination to calculate the appreciation which is the basis for the interest payable. If the borrower sells the property for a higher amount than the final valuation, then the higher sale price is taken into account. The overall business case of the borrower is therefore based on a continuing appreciation of home prices in the relevant markets.

- The repayment of the bank’s (bullet) loan at maturity highly depends on a potential sale of the underlying portfolio of reverse mortgages. This portfolio sale however hinges on a positive development of the related real estate markets since the portfolio return is closely linked to home price increases (see interest rate calculation as outlined above). The planned sale of the portfolio could also fail due to unfavourable pricing, not reaching the minimum issuance volume or lack of interest of capital markets in exotic products.

EBA/GL/2019/01 5a ii: “there are insufficient other incomes and assets of the obligor available for mitigating the loss risk for the financing institution, in particular in cases where the loss risk is high in relation to the financial resources of the obligor”

- Guarantee from the sponsor: the sponsor exhibits positive equity but is continuously generating a net loss (on consolidated level).

- Limited enforcement options if customers are deemed vulnerable (2/3rds of applicants are 60+)

- Weak covenant structure providing the bank with little room to preventively set risk mitigating actions

The bank’s position:

The structure of the selected transaction provides significant credit enhancements versus a scenario with direct exposure to the underlying pool of loans.

The bank’s argumentation is primarily backed by the following terms and conditions as contractually agreed:

- the bank’s facility level advance rate (i.e. the maximum loan amount in relation to the full loan amount originated by the bank’s borrower) amounts to 100%, but the originator’s LTV is capped with 50%. Therefore, the bank expects only minimal losses in the event of default of the borrower.

- portfolio eligibility requirement in terms of minimum creditworthiness of the ultimate underlying borrower (measured by means of a generally accepted US scoring method).