PART RELATING TO THE PRINCIPAL FINANCIAL STATEMENT LINE ITEMS
4. Loans and receivables
4.1 Loans and advances to banks
Classification
This line item comprises monetary financial assets with banks, whether disbursed directly or purchased from third parties, which carry fixed or determinable payments and are not quoted in an active market (current accounts, guarantee deposits, debt securities, etc.).
This balance also includes amounts due from Central Banks, other than unrestricted deposits which are classified as “cash and cash equivalents”.
Details of the recognition, measurement, derecognition and recording of these loans can be found in the subsequent note 4.2 on “loans and advances to customers”.
4.2 Loans and advances to customers
Classification
Loans and advances to customers include non-structured monetary financial assets with customers, whether disbursed directly or purchased from third parties, which carry fixed or determinable payments and are not quoted in an active market (current accounts, mortgage loans, other kinds of loans, debt securities etc.).
Financial instruments are designated as loans and advances to customers upon initial recognition, or following reclassifications allowed by paragraphs 50 to 54 of IAS 39, as amended by Regulation (EC) 1004/2008 of the European Commission issued on 15 October 2008.
Recognition
The initial recognition of a loan takes place on the grant date or, in the case of debt securities, on the settlement date, with reference to the fair value of the financial instrument, as uplifted by any directly-attributable acquisition costs/revenues. Costs and revenues with the above characteristics are excluded if they are reimbursable by the borrower or represent normal internal administrative costs.
The initial fair value of a financial instrument is usually equal to the amount disbursed or the cost incurred in buying it.
Measurement and recognition of income and expense
Subsequent to initial recognition, loans to customers are measured at amortised cost. This is their initially-recorded value as decreased/increased by repayments of principal, write-downs/write- backs and the amortisation – determined using the effective interest method – of the difference between the amount paid out and that repayable on maturity, which typically represents costs/income directly attributable to the individual loans.
The effective interest rate is the rate that discounts the flow of estimated future payments over the expected duration of the loan so as to obtain exactly the net book value at the time of initial recognition, which includes directly-related transaction costs/revenues and all fees paid or received between the contracting parties. This financial method of accounting distributes the economic effect of costs/income over the expected residual life of each loan.
Estimates of the flows and the contractual duration of the loan take account of all contractual clauses that could influence the amounts and due dates (such as early repayments and the various options that can be exercised), but without considering any expected losses on the loan.
The amortised cost method is not applied to short-term loans, since the discounting effect would be negligible, and these are therefore stated at cost. The same measurement criterion is applied to loans without a fixed repayment date or which are repayable upon demand.
At every reporting date an analysis is performed to identify any problem loans for which there is objective evidence of possible impairment. This category includes loans classified as “non- performing”, “watch list”, “restructured” or “past due”, as defined by the supervisory regulations.
The adjustment to the value of each loan represents the difference between its amortised cost (or cost for short-term and demand loans) at the time of measurement and the discounted value of the related future cash flows, determined using the original effective interest rate.
Key elements in determining the present value of future cash flows comprise the estimated realizable value of loans, also taking account of any available guarantees, the expected timing of recoveries and the forecast loan-recovery costs. Cash flows relating to loans due to be recovered in the short term (12/18 months) are not discounted.
The approach taken for case-by-case determination of the recoverable value of non-performing loans depends on their amount:
up to Euro 25,000: the positions are analyzed case-by-case but are not discounted, since they are frequently not taken to court, but sold after the usual attempts to obtain recovery on an amicable basis; these loans generally remain in this category for not more than 12/18 months, representing the short term;
from Euro 25,000 to Euro 150,000: the positions are analyzed on a case-by-case basis to estimate the amount recoverable, which is discounted over the average recovery period, based on past experience and statistics;
amounts exceeding Euro 150,000 are analyzed on a case-by-case basis to estimate the amount recoverable, which is discounted over the likely recovery period, as determined by the competent corporate functions.
Watch list loans exceeding Euro 150,000 are analyzed on a case-by-case basis to estimate the amount recoverable, which is discounted over the likely average recovery period, based on past experience and statistics. The remaining positions are assessed on a collective basis using Probability of Default (PD) and Loss Given Default (LGD) parameters (which differ according to the amounts concerned), with the related future nominal cash flows discounted over the estimated average recovery period, based on past experience and statistics.
Restructured loans exceeding Euro 150,000 are valued by discounting the “implied” loss arising from the restructuring of the position. The remaining positions are assessed collectively using PD and LGD parameters, calculated on the basis of past experience and statistics that are intended to estimate the latent loss. The related estimated future cash flows are discounted over the estimated average recovery period, as determined with reference to past experience and statistics. If restructured loans that have been analyzed case-by-case are expected to produce an impairment loss, they are immediately classified either in the watch list or as non-performing and valued in accordance with the rules applying to these categories.
Loans past due are written down on a collective basis. This test is performed by grouping loans into categories that reflect a similar degree of credit risk. The related loss percentages are then estimated with reference to past experience and statistics, in order to measure the inherent loss for each category of loan. Estimated future cash flows are determined using PD and LGD parameters by technical form and the resulting flows are discounted on the basis of average recovery times, determined with reference to past experience and statistics.
Loans for which no objective evidence of loss has been individually identified, i.e. performing loans, are tested for impairment on an overall basis. This test is performed by grouping loans into categories that reflect a similar degree of credit risk. The related loss percentages are then estimated with reference to past records, in order to measure the inherent loss for each category of loan. Estimated future cash flows are determined using PD and LGD parameters by technical form and the resulting flows are discounted on the basis of average recovery times, determined with reference to past experience and statistics.
The expected loss (equal to gross value x PD x LGD) is adjusted for the Loss Confirmation Period (LCP), which expresses the average delay between the deterioration of the debtor‟s financial conditions (“incurred loss”) and the actual classification of individual exposures as defaulted, for various categories of homogeneous loans; its purpose is to “adjust” PD, which is typically expressed on an annual time span.
The PD, LGD, LCP parameters, and the average recovery period used to estimate future nominal cash flows are updated once a year when preparing the financial statements for the year.
No write-downs are recorded in relation to loans represented by “repurchase agreements” and “securities lending”, or to loans to non-profit organisations and local and public administrations. Provisions made for an impaired loan are only reversed if the credit quality has improved to the extent that timely recovery of the principal and interest, with respect to the original terms for the loan contract, is reasonably certain, or if the amount actually recovered exceeds the recoverable amount estimated previously. Only for non-performing loans, write-backs also include the positive effect of discounting adjustments made due to the progressive reduction in the estimated time required to recover the related loans.
Adjustments, net of previous provisions and the partial or total recovery of amounts previously written down, are recorded in the “net impairment adjustments on loans and advances” line item of the income statement.
Derecognition
Loans are derecognized as assets when they are deemed to be unrecoverable or are transferred together with substantially all the related risks and benefits.