05 October 2011

FRC: ASB welcomes the publication of FSA Guidance Paper 'Forbearance and Impairment Provisions - Mortgages'

This review is primarily aimed at residential mortgage lenders or mortgage administrators. This review should be considered by the management responsible for any aspect of forbearance activities, credit-risk reporting, finance, audit and the compliance functions of firms.

Since, under the International Financial Reporting Standards (IFRS) financial reporting framework, quantitative data provided in annual reports about a firm’s exposure to risk (including credit risk) should be based on information provided internally to a firm’s key management personnel, it is also relevant to financial reporting disclosure, and to external auditors of firms who are active in providing forbearance facilities for customers.

This prudential review looked at forbearance practices in firms which impact on the loss risks and loss-risk recognition of first charge residential mortgages. It followed earlier work considering the conduct implications of arrears-handling standards in mortgage firms. In particular, this review considers mortgage book impairment across firms’ mortgage-servicing operations, rather than being specific to specialist debt management following the crystallisation of mortgage arrears.

The main aims of the review were:

• to understand the extent and variation of forbearance practices in firms and to identify good (and poor) practice;
• to assess whether there is clear and transparent reporting of forbearance, impairmentand loss risks of a portfolio; and
• to understand whether lenders have sustainable business models where loss risks are fully recognised and embedded within the loss models of the firm, including impairment provisions; and, whether the executives of the business are aware of these loss risks.

This review is focused on the prudential risk responsibilities of firms, and so on practices that impact on the loss risks of accounts (forbearance provided to support financial stress), the effective management of these risks and the mechanisms for their recognition and reporting. FSA is supportive of forbearance facilities that benefit both lenders (firms) and customers. FSA recognises that the provision of support and forbearance has, generally, been good for consumers and can enable customers in temporary financial difficulties to stay in their property. This review is very much aligned with the provision of forbearance and support which takes into consideration the individual circumstances of customers undergoing financial stress. FSA believes forbearance based on sound conduct principles provides for sound prudential management.

However, FSA observed and is concerned that where support or forbearance is provided without careful consideration of the customer’s individual circumstances it can place them in an even worse position. In some cases this can lead to the mortgage moving permanently onto non-sustainable terms. Clearly, this outcome is neither in the interest of the customer or the firm. From a prudential perspective, these kinds of accounts have a higher long-term loss risk which should be accounted for within reporting by firms.

The guidance provided in this document covers the following:

• the provision of forbearance support for customers undergoing financial stress;
• the recognition of impairment within the book through management committees and board reporting; and
• the disclosure of impairment and its recognition through loss provisions in external reporting.

Press release

© FRC