Since Hoist Finance is a regulated financial institution, the changes to the regulatory landscape for banks do not only increase the size of our potential market, but also have a direct impact on our own business model.
We benefit from our banking platform, enjoying access to a unique source of funding from our deposit customers in Sweden and Germany. We are also in a strong position to understand the banks and financial institutions that we make business with, since we face many of the same challenges as they do.
Through tackling some of the recent regulatory challenges (as described below), we believe that we will make our business stronger and more resilient to future market developments, supporting us in our strategic goal to develop a leading position in our key markets.
In December 2018, Hoist Finance was required by the Swedish Financial Supervisory Authority (SFSA) to adjust risk weights for the unsecured NPLs on our balance sheet from 100 per cent to 150 per cent. This had an impact both on our purchasing capacity in 2019 and our level of competitiveness in the unsecured NPL portfolio market.
Article 127 of the EU’s Capital Requirement Regulation (CRR) stipulates a risk weight of 100 per cent for non-performing exposures where so called “credit risk adjustments” of more than 20 per cent have been made, and a risk weight of 150 per cent in other cases. Hoist Finance had historically interpreted the regulations to mean that, if an acquired asset’s purchase price reflects a write-down of more than 20 per cent, a 100 per cent risk weight is to be applied. This had also been the general interpretation of the financial industry as a whole and had been accepted by the SFSA.
On 21 September 2018, the European Banking Authority (EBA) published its final response concerning consideration of “specific credit adjustments” for non-performing loans from a capital perspective, referencing Article 127 of the regulation. The EBA’s response indicated an alternative strict prescriptive interpretation of “credit risk adjustments” which only takes into account write-downs of the institution itself that have impacted equity, i.e. not historic write-downs undertaken by previous creditors (i.e. the selling banks). Since write-downs for most non-performing loans have impacted the seller’s, not the purchaser’s, balance sheet, the EBA’s new interpretation requires Hoist Finance to apply a risk weight of 150 per cent for unsecured NPLs.
On 18 December 2018, the SFSA announced its endorsement of the EBA’s response, thereby modifying its previous interpretation. As a result, Hoist Finance adjusted the necessary risk weights as of this date, and continues to operate with these revised risk weights.
We did not and continue not to agree with the EBA’s interpretation, which fails to take into account the fact that the acquired loans are purchased at fair value and therefore inherently demonstrate a substantial reduction in risk which should in turn be reflected by lower risk weights, a key principle of Article 127 of CRR. According to EBA’s interpretation, a NPL portfolio which is written down by more than 20% by the originating banks and subsequently acquired by us at an even lower purchase price would have a risk weight of 100 per cent for the originating bank and 150 per cent for us. This is in our view contradictory and inconsistent with the fundamental principle that an exposure risk weight should depend only on its risk and not its owner.
Our hope is of course that this inconsistency will be remedied in future, however Hoist Finance is in any case taking proactive actions to mitigate the impacts of the change to our risk weights.
In April 2019 the European Council adopted a new framework (Regulation (EU) 2019/630, which amends the Capital Requirements Regulation), known as the NPL Prudential Backstop, to deal with build-up of banks’ non-performing loans. This new framework establishes common minimum loss coverage levels for all banks (including Hoist Finance), ensuring that they set aside enough money to cover future losses from non-performing exposures. The framework sets out a phased approach to deductions to own funds for non-performing exposures, with the profile of this phasing being dependent upon whether NPLs are secured or unsecured, and whether any collateral is movable or immovable. The different profiles are shown in the table above.
This new framework came into effect on 25th April 2019 and applies only to exposures that were originated after this date, in order to facilitate a smoother transition for banks. For Hoist Finance, the transition period is effectively longer since we are an acquirer, as opposed to an originator, of loans, meaning that we will not be impacted by these provisions until we have acquired a portfolio which contains loans that were originated, and have become non-performing, since 25th April 2019. During 2019, we have not acquired any portfolios which include a meaningful volume of such loans. Nevertheless, this will have a longer-term impact upon us and therefore we have already adapted our business model and processes in light of this new framework.
Monitoring tools have been established in order to evaluate our levels of backstop-impacted assets, and pricing models have been updated to ensure that these assets are valued in a manner which appropriately reflects the updated loss coverage requirements. During 2019, we have worked on a number of mitigating actions which are intended to reduce the impact of the Prudential Backstop requirements.