MIPRU 4.2F 1Exposures and risk weights

1This section applies to a firm carrying on any home financing connected to regulated mortgage contracts or home financing and home financing administration connected to regulated mortgage contracts (see MIPRU 4.2.23 R).

MIPRU 4.2F sets out the risk weights that a firm should apply to exposures in the form of loans secured on real estate property, other loans, exposures in the form of funds, and past due items, when calculating risk weighted exposure amounts for calculating the credit risk capital requirement under MIPRU 4.2.23 R.

Without prejudice to MIPRU 4.2F.36 R, an exposure or any part of an exposure must be assigned a risk weight of 35% where:

1. (1)

   the exposure is fully and completely secured, to the satisfaction of the firm, by mortgages on residential property; and

2. (2)

   the residential property is, or will be, occupied or let by the owner or the beneficial owner in the case of personal investment companies.

Without prejudice to MIPRU 4.2F.36 R, an exposure, or any part of an exposure, must be assigned a risk weight of 75% where:

1. (1)

   the exposure arises from a mortgage on residential property up to a limit of 100% of the value of the property which is not fully and completely secured, to the satisfaction of the firm, by that mortgage; and

2. (2)

   the residential property is, or will be, occupied or let by the owner or the beneficial owner in the case of personal investment companies.

An exposure or any part of an exposure must be assigned a risk weight of 100% where the exposure arises from a mortgage on residential property that exceeds the value of the available collateral, as assessed in accordance with MIPRU 4.2F.29 R.

1. (1)

   A firm must not treat a lifetime mortgage as an exposure fully and completely secured on residential property for the purposes of MIPRU 4.2F.4 R unless the amount of the exposure is calculated according to the following formula:

   

   where:

   1. (a)

      P is the current outstanding balance on the lifetime mortgage;

   2. (b)

      i is the interest rate charged on the lifetime mortgage, which for the purposes of this calculation must not be lower than the discount rate referred to in (c);

   3. (c)

      d is the discount rate which is the risk-free rate as represented by the yield on 10-year UK government bonds; and

   4. (d)

      T is the projected number of years to maturity of the exposure.

2. (2)

   Notwithstanding MIPRU 4.2F.7R (1)(c), a firm may calculate an annual average discount rate, provided there is no obvious bias in its calculation and it is consistent in its approach.

Without prejudice to MIPRU 4.2F.36 R, an exposure, or any part of an exposure, to a tenant under a property leasing transaction must be assigned a risk weight of 35% where:

1. (1)

   the transaction concerns residential property;

2. (2)

   under the transaction, the firm is the lessor and the tenant has an option to purchase; and

3. (3)

   the firm is satisfied that the exposure is fully and completely secured by its ownership of the property.

1. (1)

   In exercising its judgment under MIPRU 4.2F.4 R to MIPRU 4.2F.9 R, a firm may be satisfied only if the conditions in (2) to (6) are met.

2. (2)
   1. (a)

      The value of the property does not materially depend upon the credit quality of the borrower.

   2. (b)

      The condition in (a) does not preclude situations where purely macroeconomic factors affect both the value of the property and the performance of the borrower.

3. (3)

   The minimum requirements about:

   1. (a)

      legal certainty in MIPRU 4.2F.12 R;

   2. (b)

      monitoring of property values in MIPRU 4.2F.14 R;

   3. (c)

      documentation in MIPRU 4.2F.20 R; and

   4. (d)

      insurance in MIPRU 4.2F.21 R;

   are met.

4. (4)

   The valuation provisions in MIPRU 4.2F.26 G to MIPRU 4.2F.29 R are met.

5. (5)

   The value of the property exceeds the exposures by a substantial margin, as set out in MIPRU 4.2F.29 R.

The requirements about legal certainty referred to in MIPRU 4.2F.11R (3)(a) are as follows:

1. (1)

   the mortgage or charge must be enforceable in all relevant jurisdictions which are relevant at the time of conclusion of the credit agreement, and the mortgage or charge must have been properly filed on a timely basis;

2. (2)

   the arrangements must reflect a perfected lien (i.e. all legal requirements for establishing the pledge must have been fulfilled); and

3. (3)

   the protection agreement and the legal process underpinning it must enable the firm to realise the value of the protection within a reasonable timeframe.

1. (1)

   The requirements about monitoring of property values referred to in MIPRU 4.2F.11R (3)(b) are as follows:

   1. (a)

      the value of the property must be monitored on a frequent basis and, at a minimum, once every three years;

   2. (b)

      more frequent monitoring must be carried out where the market is subject to significant changes in conditions;

   3. (c)

      statistical methods may be used to monitor the value of the property and to identify property that needs revaluation;

   4. (d)

      the property valuation must be reviewed promptly by an independent valuer when information indicates that the value of the property may have declined materially relative to general market prices; and

   5. (e)

      for loans exceeding the higher of £2.5 million or 5% of the capital resources of the firm, the property valuation must be reviewed by an independent valuer at least every three years.

2. (2)

   In (1), ‘independent valuer’ means a person who possesses the necessary qualifications, ability and experience to execute a valuation and who is independent from the credit decision process.

The requirements in MIPRU 4.2F.11R (3)(c) are that the types of residential real estate accepted by the firm and its lending policies in this regard must be clearly documented.

The requirements about insurance in MIPRU 4.2F.11R (3)(d) are that the firm must have procedures to monitor that the property taken as protection is adequately insured against damage.

The property must be valued by an independent valuer at or less than the market value using reliable standards for the valuation of residential property.

1. (1)

   Market value means the estimated amount for which the property should exchange on the date of valuation between a willing buyer and a willing seller in an arm's length transaction after proper marketing, where the parties had each acted knowledgeably, prudently and without compulsion.

2. (2)

   The market value must be documented in a transparent and clear manner.

1. (1)

   Mortgage lending value means the value of the property as determined by a prudent assessment of the future marketability of the property taking into account long-term sustainable aspects of the property, the normal and local market conditions, and the current use and alternative appropriate uses of the property.

2. (2)

   Speculative elements must not be taken into account in the assessment of the mortgage lending value.

3. (3)

   The mortgage lending value must be documented in a transparent and clear manner.

The value of the collateral must be the market value or mortgage lending value reduced as appropriate to reflect the results of the monitoring required under MIPRU 4.2F.11R (3)(b) and MIPRU 4.2F.14 R and to take account of any prior claims on the property, such as a first-charge mortgage from another lender.

A firm may not treat an exposure as fully and completely secured by residential property located in the United Kingdom for MIPRU 4.2F.4 R (residential mortgages) or MIPRU 4.2F.9 R (property leasing transactions) unless either of the following is 80% or less of the value of the residential property on which it is secured:

1. (1)

   the amount of the exposure;

2. (2)

   the secured part of the exposure in MIPRU 4.2F.4 R or MIPRU 4.2F.9 R.

If a firm has an exposure arising through a second-charge mortgage secured on the same property as a first-charge loan from a different firm, the exposure, taking into account the first-charge mortgage, must be split into the following components and risk weighted as follows, after taking into account the seniority of the first-charge loan:

1. (1)

   the amount of the exposure or any part of the exposure, up to a limit of 80% of the value of the residential property, must be assigned a risk weight of 35% where:

   1. (a)

      the exposure is fully and completely secured, to the satisfaction of the firm, by a mortgage on residential property; and

   2. (b)

      the residential property is, or will be, occupied or let by the owner, or the beneficial owner in the case of personal investment companies; and

2. (2)

   the amount of the same exposure that is unsecured, above 80% of the value of the residential property up to a limit of 100% of the value of the residential property, must be assigned a risk weight of 75%; and

3. (3)

   any remaining part of the exposure, above 100% of the value of the property, must be assigned a risk weight of 100%.

Exposures to residential property situated in an EEA State or a third-country must be assigned a risk weight of 75% up to a limit of 100% of the value of the property.

Exposures, or any part of an exposure, secured by mortgages on offices or other commercial premises must be assigned a risk weight of 100% where the exposure:

1. (1)

   cannot properly be considered to fall within any other standardised credit risk exposure class specified in MIPRU 4.2A.6A R (Exposure classes); or

2. (2)

   does not qualify for a lower risk weight under this section.

Exposures to other loans must be assigned a risk weight of 100%.

Except where a different risk weight is assigned to exposures in the form of funds by MIPRU 4.2F.40 R, MIPRU 4.2F.42 R or MIPRU 4.2F.45 R, these exposures must be assigned a risk weight of 100%.

Exposures in the form of funds for which a credit assessment by a nominated ECAI is available must be assigned a risk weight using:

1. (1)

   the table in MIPRU 4.2E.14 R to determine the credit quality step associated with that credit assessment; and

2. (2)

   the table in MIPRU 4.2F.41 R to determine the risk weight to be applied to the rated position, based on the associated credit quality step.

Where a firm considers that a position in a fund is associated with particularly high risks, it must assign that position a risk weight of 150%.

If the eligibility criteria in MIPRU 4.2F.46 R are met, a firm must decide whether to:

1. (1)

   assign a 100% risk weight to its exposures in funds, as required by MIPRU 4.2F.39 R; or

2. (2)

   determine the risk weight for an exposure in funds, as set out in MIPRU 4.2F.47 R to MIPRU 4.2F.48 R.

The eligibility criteria in MIPRU 4.2F.45 R are:

1. (1)

   the fund's prospectus or equivalent document includes:

   1. (a)

      the categories of assets in which the fund is authorised to invest; and

   2. (b)

      if investment limits apply, the relative limits and the methodologies to calculate them; and

2. (2)

   the business of the fund is reported on at least an annual basis to enable an assessment to be made of the assets and liabilities, income and operations over the reporting period.

Where a firm is not aware of the underlying exposures of a fund, it may calculate an average risk weight for the fund in the following manner:

1. (1)

   it will be assumed that the fund first invests, to the maximum extent allowed under its mandate, in the exposure classes attracting the highest capital resources requirement; and

2. (2)

   then continues making investments in descending order until the maximum total investment limit is reached.

A firm may rely on a third party to calculate and report, in accordance with the method in MIPRU 4.2F.47 R, a risk weight for the fund, provided that the correctness of the calculation and report is adequately ensured.

Exposures in the form of funds that are not past due items, that have been assigned a risk weight of 150% or greater, and for which value adjustments have been established, may be assigned a risk weight of:

1. (1)

   100% if value adjustments are no less than 20% of the exposure value gross of value adjustments; or

2. (2)

   50%, if value adjustments are no less than 50% of the exposure value gross of value adjustments

Exposures must be treated as past due in their entirety where any payment due is past its contractual date by more than 90 days.

Where value adjustments are taken against the secured part of an exposure secured by a mortgage on residential property and that is past due, the secured part net of value adjustments must be assigned a risk weight of:

1. (1)

   100% if value adjustments are less than 20% of the secured part of the exposure gross of value adjustments; or

2. (2)

   50% if value adjustments are no less than 20% of the secured part of the exposure gross of value adjustments.

For the purpose of defining the secured part of a past due item other than exposures secured on residential property, credit protection must be eligible for credit risk mitigation purposes under MIPRU 4.2C (Credit risk mitigation).

The unsecured part of any past due item, net of any value adjustments taken against the unsecured part, must be assigned a risk weight of:

1. (1)

   150% if value adjustments are less than 20% of the unsecured part of the exposure gross of value adjustments; or

2. (2)

   100% if value adjustments are no less than 20% of the unsecured part of the exposure gross of value adjustments.