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General
A very important factor in the credit approval process is the detailed assessment of risk associated with each loan exposure, and the credit rating of the customer in particular. Every lending decision is based on a thorough analysis of the loan exposure, including an evaluation of all relevant factors. Following the initial loan application, the bank’s loan exposures are as a rule reviewed once a year. If the borrower’s creditworthiness deteriorates substantially, shorter review intervals are obligatory.
For internal credit assessment in Austria and by BA-CA’s banking subsidiaries in CEE, Bank Austria Creditanstalt uses various rating and scoring models for the customer/business segments to be assessed, in line with the various asset classes pursuant to Section 22b of the Austrian Banking Act and in Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006 relating to the taking up and pursuit of the business of credit institutions. There are country-specific or region-specific models (e.g. for corporate customers) and global models (e.g. for banks). The assessment of a loan exposure is based on data from the respective company’s financial statements and on qualitative factors.
The various rating and scoring models provide the basis for efficient risk management of the BA-CA Group and are embedded in all decision-making processes relating to risk management. They are also a key factor for capital required to be held against risk assets. Great attention is given to consistency in the presentation for supervisory purposes and the requirements of internal control.
Our master scale includes three rating classes for doubtful and non-performing loans. As part of the rating process, each borrower is assigned a probability of default. With the master scale our internal ratings can be compared with the market and with the major international rating agencies (Standard & Poor’s, Moody’s, Fitch) while also enhancing comparability of the various partial portfolios.
All internal rating and scoring systems are further developed on an ongoing basis and are subject to regular validation on an annual basis, including a review to verify if the rating/scoring system provides a correct representation of the risks to be measured. All model assumptions are based on multi-year statistical averages for historical defaults and losses.
With risk-adjusted pricing and a stronger focus on risk management, we aim to improve the diversification and the risk/earnings ratio of the portfolio. For real estate customers, the customer-related rating is complemented by a transaction rating.
Bank Austria Creditanstalt uses a scoring system for retail customers. The automated rating tool is used for assessing, monitoring and managing the large number of loan exposures to private customers, small businesses, independent professionals and non-profit organisations. Retail scoring comprises an application scoring procedure based on effective and recognised mathematical and statistical methods, and a behaviour scoring procedure taking into account such factors as amounts received in the account and customers’ payment practices. The scoring system for retail customers provides information that is updated on a monthly basis. This gives the bank an accurate tool for lending decisions and early recognition of risk. Automated data processing helps Bank Austria Creditanstalt to reduce costs required for credit control while accelerating lending decisions. Lending guidelines used jointly with the sales units reflect the bank’s risk appetite while meeting the specific requirements in retail banking in connection with the new divisional structure (differentiated pricing and product policies, customer segment-specific sales channels).
Detailed results
Net writedowns of loans and provisions for guarantees and commitments for 2006, adjusted for all one-off effects, were about € 401 m, slightly lower than the figure of € 421 m, also adjusted for one-off effects, for 2005. This means that the net charge as a percentage of total loans outstanding was reduced from 0.26 % to 0.23 %. Particularly strong contributions to this favourable development came from the Corporates Division and from the CEE Division, while the risk situation in the Retail Division remained strained.
When analysing the net writedowns of loans in 2006, two one-off effects should be noted:
The one-off addition of € 79 m to loan loss provisions in the Retail Division in the third quarter of 2006 did not represent a current provisioning charge but a one-off effect which will relieve the future burden of current provisioning. This measure reflects a basic change in the provisioning practice for retail lending business. With the introduction of quantitative methods ahead of Basel II, which has already reached an advanced stage in the Corporates Division, the bank can calculate expected risk in retail customer business with increasing accuracy; problem loans can be identified at an earlier stage, requiring impairment losses to be recognised.
The earlier identification of problem loans is based on more refined retail scoring procedures. In addition, default criteria and the transfer to Special Accounts Management are defined in stricter terms. Most of the € 79 m additionally allocated to loan loss provisions in the third quarter of 2006 related to the increase in flat-rate specific provisions made for loan restructuring and write-offs of low-volume loans to retail customers including small businesses; a smaller amount was accounted for by higher provisioning rates for doubtful loans exceeding € 50,000 against which specific provisions have been made, and losses caused by fraud in transactions for which sales partners acted as intermediaries.
In the past year the bank also made adjustments resulting from improvements in systems and data histories. On the basis of data, now available for the first time, for customers with payments past due more than 90 days or other defaults, which in themselves did not lead to a specific provision being made, group-specific provisions were made pursuant to IAS 39. Moreover, the methodologies used for calculating “incurred but not reported losses” were restructured in line with analyses of data collected for the planned use of the advanced internal ratings-based approach. “Incurred but not reported losses” are now calculated for the “loss detection period” estimated by experts for specific customer groups, i.e. the period between the objective occurrence of the loss event and the time when it is detected. While provisions for “incurred but not reported losses” were previously calculated only in the retail segment, system improvements now make it possible, as part of the introduction of the new computation logic for this type of provisions, to extend the application of this method to include all business segments.
Apart from the adjustment of provisions in accordance with IFRSs, net writedowns of loans in the fourth quarter in both Austria and CEE returned to the levels recorded in the first two quarters. Therefore, as mentioned above, the overall figure for net writedowns of loans in 2006 was slightly lower than the figure for the previous year, equally adjusted for one-off effects. Particularly gratifying was the fact that especially in Bank Austria Creditanstalt AG, non-performing loans (NPLs) were reduced by 13 % in 2006; as a result, the coverage ratio – i.e. the extent to which unsecured NPLs are covered by provisions – in the Group as a whole improved to 81 %.
An analysis by segment shows that net writedowns of loans in the Retail Division reflected a further increase in insolvencies of private individuals, while business insolvencies continued to occur mainly in the sector of small businesses, which are now included in the Retail Division following the changes in segmentation effected in the third quarter of 2006. Strategic projects launched by the bank in this area include various measures aimed at improving the risk/earnings position in the short to medium term.
Although 2006 also saw business insolvencies involving larger amounts, the Corporates Division continues to benefit from favourable economic trends and from the prudent risk policy. In the past year, the Special Accounts Management department successfully completed various restructurings in the sub-segments Corporates & Public Sector, International Trade Finance & Financial Institutions and International Customers. As the related provisions were released, net writedowns of loans in this segment were significantly lower than the already excellent result in 2005.
As in previous years, net writedowns of loans in large-volume real estate business developed favourably. After a steady reduction from € 46 m in 2001, net writedowns of loans were € 14.3 m, only slightly above the previous year’s level. An equally satisfactory risk trend was seen in the Private Banking & Asset Management Division and in transactions of the CEE Division which are recorded in BA-CA AG. The trend in net writedowns of loans at the Austrian subsidiaries allocated to the various business divisions also met expectations.
The banking subsidiaries in Central and Eastern Europe also continued to benefit from favourable risk trends, with net writedowns of loans even remaining below the ambitious expectations. Improvements in risk control instruments over the past few years made a substantial contribution to this development. However, a comparison of the figures for net writedowns of loans in 2006 and 2005 is not meaningful as HVB Splitska banka d.d. and Bank BPH S.A. were sold and deconsolidated in the course of 2006, and therefore net writedowns of loans at these banks are only included on a pro-rata basis in overall results. Another factor to be taken into account in any comparison is the inclusion, planned for 2007, of subsidiaries of Bayerische Hypo- und Vereinsbank AG and of UniCredit S.p.A. in Central and Eastern Europe.
Active Credit Portfolio Management
Since the implementation of active credit portfolio management (ACPM) for defined customers of the Corporates segment – and in addition to the unchanged credit risk process – the bank has actively managed the related segment of its credit portfolio via the capital market. Credit risk associated with customer business has been attributed to ACPM by means of reference rates derived from market prices at matching maturities. Bank Austria Creditanstalt thereby ensures risk-adjusted pricing and quick manageability of this portfolio segment via the capital market. ACPM aggregates the risk position and optimises the bank’s risk provisioning. The purpose of ACPM is to help improve the risk/earnings ratio by more widely diversifying the portfolio through active hedging and reinvestment.
The ACPM Committee, like the Market Risk Committee (MACO), meets regularly to discuss short-term business management issues relating to the risk/earnings position of ACPM as well as limit adjustments and positioning decisions.
In December 2006, BA-CA and HVB jointly securitised credit risk associated with loans to medium-sized companies via KfW’s PROMISE platform. Referred to as PROMISE-XXS 2006-1 GmbH, the transaction had a total volume of € 4.5 bn, of which about € 550 m was placed in capital markets in the form of ABS notes; the first-loss tranche was sold to external investors. This securitisation is the largest transaction within KfW’s entire PROMISE programme to date. Use of the KfW programme enables Bank Austria Creditanstalt to grant new loans to Austrian medium-sized companies and small businesses; the related credit risk can then be securitised via future ABS transactions. As at 31 December 2006, the reduction of risk-weighted assets at BA-CA amounted to € 951 m.
Bank Austria Creditanstalt uses securitisation as an instrument for managing its loan portfolio and capital resources. The most recent securitisation transaction – which followed Success-2005, PROMISE Austria-2002, Mozart Funding, Amadeus Funding No 1 – has strengthened BA-CA’s pioneering role in the Austrian banking market with regard to such products. Further transactions are planned for 2007.
Implementation of BASEL II within the BA-CA Group
In spring 2003, Bank Austria Creditanstalt set up a group-wide project to create the conditions enabling the bank to meet the new rules, effective from 2007, for holding adequate capital against risk assets. Project groups set up in previous years in the area of credit risk management worked on refining credit risk parameters. Their work was the basis for the project that is now under way. The Basel II project was set up as a group-wide programme comprising BA-CA AG and all Austrian and foreign subsidiaries, all risk categories (credit risk, operational risk and market risk) and all three pillars of Basel II.
From the different approaches that may be chosen under Basel II, the BA-CA Group has opted for the advanced internal ratings-based (AIRB) approach. The switch to the advanced approach in the Group will take place in stages. Initially the focus is on BA-CA AG, which will introduce the AIRB approach for the major part of its portfolio on 1 January 2008. Like the parameter estimates themselves, the resulting new requirements in terms of internal and external reporting are an integral part of the programme.
The Group has also chosen the most advanced approach (AMA) in respect of operational risk. In coordination with UniCredit, the AMA will be used in BA-CA AG and in selected subsidiaries starting from 1 January 2008, with the roll-out in the other major subsidiaries following step by step.
2007 will see the final phase of the Basel II project in BA-CA AG. Work in this year will focus on the supervisory review, scheduled for the period from April to June, and on cooperation with the supervisory authority during that period. During this on-site assessment, BA-CA will demonstrate that it meets all regulatory requirements for adoption of the AIRB approach. The supervisory authority will issue a permit for use of the AIRB approach if BA-CA can prove that the input parameters for the calculation of capital resources using conclusive Basel II-compliant methods are determined by way of strictly observed processes. The review will focus on how the risk parameters (probability of default, loss given default, etc.) are reflected in the rating system and on whether a sufficient history of data is available. Bank Austria Creditanstalt has already invested a significant amount of work in refining the rating systems, data quality and data history, and of course in the IT systems required for this purpose.
An important aspect of the supervisory review will be the assessment of rating models and the actual integration of rating procedures and rating results in bank-internal control. Bank Austria Creditanstalt will ensure that the rating results are used not only for supervisory purposes (calculation of risk assets) but are also taken into account in the lending decision, in risk-adjusted pricing, etc. Evidence of this must be provided as part of the fulfilment of use-test requirements for all internal rating procedures applied, both locally and for the Group as a whole.
In the second quarter of 2007, the supervisory authority will also review the qualitative and quantitative implementation of operational risk management and its integration in bank-internal control.
As mentioned above, Basel II implementation has been established as a group-wide programme overseen by UniCredit with regard to group-wide topics and decisions. For example, with a focus on unlocking synergies, portfolios have been defined for which uniform group-wide rating models are to be used. The computation core will be used as a Group solution for the calculation of risk assets.
Close cooperation ensures group-wide consistency in the implementation of Basel II. Group standards prepared by the UniCredit holding company in cooperation with the major legal entities are used as an instrument for group-wide implementation with a view to meeting the legal requirements and ensuring group-wide control. Integrating the Group standards in the processes and organisational set-up of all business divisions within a short time makes substantial demands on all those involved, all the more so as specific local features and legal requirements have to be taken into account.
Austrian subsidiaries
All Austrian subsidiaries in the new Group structure will use the standardised approach.
CEE subsidiaries
The CEE subsidiaries will use the Basel II standardised approach from the beginning of 2008. Efforts will of course be made to switch to the advanced IRB approach at most of the subsidiaries in order to realise the expected cost savings on the cost of capital. A high-level roll-out plan for the gradual switch to the IRB approaches at the subsidiaries has been set up and will be refined on an ongoing basis. Cooperation with the new subsidiaries transferred to BA-CA has already started to ensure that all measures required for compliance are taken step by step.