MIPRU 4.2F 1Exposures and risk weights

Application

MIPRU 4.2F.1R

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).

Purpose

MIPRU 4.2F.2R

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.

Organisation

MIPRU 4.2F.3G

This section is broadly organised according to the type of exposure class.

  1. (1)

    Exposures secured by mortgages on residential property (MIPRU 4.2F.4 R to MIPRU 4.2F.36 R)

  2. (2)

    Exposures secured by mortgages on commercial property (MIPRU 4.2F.37 R)

  3. (3)

    Exposures to other loans (MIPRU 4.2F.38 R)

  4. (4)

    Exposures to funds (MIPRU 4.2F.39 R to MIPRU 4.2F.49 R)

  5. (5)

    Exposures to past due items (MIPRU 4.2F.50 R to MIPRU 4.2F.56 G)

Exposures secured by mortgages on residential property

MIPRU 4.2F.4R

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.

MIPRU 4.2F.5R

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.

MIPRU 4.2F.6R

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.

Exposures secured by mortgages on residential property: lifetime mortgages

MIPRU 4.2F.7R
  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:

    MIPRU-4.2F.7

    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.

MIPRU 4.2F.8G
  1. (1)

    For the purposes of MIPRU 4.2F.7R (2), a firm may use the FTSE UK gilt 10-year yield index which the Council of Mortgage Lenders makes available to its members.

  2. (2)

    If a firm offers a variable interest rate on a lifetime mortgage, it should calculate an average interest rate in a way which is consistent with the calculation of the discount rate.

  3. (3)

    To determine the projected number of years to maturity of the exposure, a firm may use the standard mortality tables published by the Institute of Actuaries or the Faculty of Actuaries.

  4. (4)

    For internal risk management purposes, the firm should use factual data or seek actuarial advice to determine how the information in these tables may be adjusted to take account of regional and other relevant variations.

Exposures secured by property leasing transactions

MIPRU 4.2F.9R

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.

MIPRU 4.2F.10G

An Ijara mortgage is an example of an exposure described in MIPRU 4.2F.9 R.

Conditions for mortgages

MIPRU 4.2F.11R
  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.

Legal certainty

MIPRU 4.2F.12R

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.

MIPRU 4.2F.13G

The term ‘protection agreement’ in MIPRU 4.2F.12R (3) refers to the contract or deed by which the mortgage or charge is established.

Monitoring of property values

MIPRU 4.2F.14R
  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.

MIPRU 4.2F.15G

A property will need to be revalued over time to ensure that the original purchase price does not overstate the degree of security provided by the property. Ijara providers should undertake revaluations in the same way as providers of conventional mortgages.

MIPRU 4.2F.16G

For MIPRU 4.2F.14R (1)(a), the monitoring of property values should be an ongoing part of risk managing and tracking the portfolio. The requirement to monitor property values does not include the physical assessment of each property in the portfolio.

MIPRU 4.2F.17G

For MIPRU 4.2F.14R (1)(d) and MIPRU 4.2F.14R (1)(e), the review of a property valuation is more in-depth than the normal monitoring process required by MIPRU 4.2F.14R (1)(a). This requirement is likely to include a review of the property value on an individual exposure basis. Where an exposure is secured by multiple properties, the review can be undertaken at the level of the exposure, rather than at the level of each individual property.

MIPRU 4.2F.18G

The review of property values required by MIPRU 4.2F.14R (1)(e) may lead to an amendment of the value assigned to the property under MIPRU 4.2F.29 R.

MIPRU 4.2F.19G

For MIPRU 4.2F.14R (2), necessary qualifications need not be professional qualifications, but the firm should be able to demonstrate that the person has the necessary ability and experience to undertake the review.

Documentation

MIPRU 4.2F.20R

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.

Insurance

MIPRU 4.2F.21R

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.

MIPRU 4.2F.22G

For MIPRU 4.2F.12 R, a firm should, as a minimum, ensure that it is a requirement of each loan that the property taken as collateral must have adequate buildings insurance at all times, which should be reviewed when any new loan is extended against the property.

MIPRU 4.2F.23G

A firm may deal with the risk that insurance on properties taken as protection may be inadequate by taking out insurance at the level of the portfolio.

Valuation rules

MIPRU 4.2F.24G

The valuation provisions in MIPRU 4.2F.11R (4) are set out in MIPRU 4.2F.25 R to MIPRU 4.2F.29 R.

MIPRU 4.2F.25R

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.

MIPRU 4.2F.26G

For MIPRU 4.2F.25 R:

  1. (1)

    reliable standards for the valuation of residential property include internationally recognised valuation standards, in particular those developed by the International Valuation Standards Committee (IVSC), the European Group of Valuers’ Associations (EGoVA) or the Royal Institution of Chartered Surveyors (RICS) as well as the standards in MIPRU 4.2F.27 R to MIPRU 4.2F.29 R; and

  2. (2)

    the requirement to use reliable standards of valuation of residential property is not limited to on-site inspections where it is possible to demonstrate that any risks posed have been adequately assessed through the overall collateral management process.

MIPRU 4.2F.27R
  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.

MIPRU 4.2F.28R
  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.

MIPRU 4.2F.29R

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.

Treatment of secured and unsecured portions of residential mortgages

MIPRU 4.2F.30R

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.

MIPRU 4.2F.31G
  1. (1)

    The application of MIPRU 4.2F.30 R may be illustrated by an example. If a firm has a mortgage exposure of £100,000 secured on residential property in the United Kingdom that satisfies the criteria listed in MIPRU 4.2F.4 R to MIPRU 4.2F.9 R and the value of that property is £100,000, then £80,000 of that exposure may be treated as fully and completely secured and risk weighted at 35%. The remaining £20,000 should be risk weighted at 75%. A diagrammatic illustration of this example is in MIPRU 4.2F.31G (2).

  2. (2)

    A diagrammatic illustration of the example in MIPRU 4.2F.31G (1).

    Unsecured component risk weighted at 75%

    Example

    Secured component risk weighted at 35%

    £100,000 loan secured on residential property valued at £100,000

    First £80,000 (i.e. 80% LTV) risk weighted at 35%

    Remaining £20,000 (i.e. above 80% LTV) risk weighted at 75%

    Overall risk weight is 43%

  3. (3)

    The same approach applies to exposures described in MIPRU 4.2F.9 R. On inception, a risk weight of 35% should be applied to the first 80% of the principal/"purchase price" outstanding, with a risk weight of 75% being applied to the remainder of the principal exposure.

MIPRU 4.2F.32G

If a firm has more than one exposure secured on the same property they should be aggregated and treated as if they were a single exposure secured on the property for the purposes of MIPRU 4.2F.4 R, MIPRU 4.2F.9 R and MIPRU 4.2F.30 R.

MIPRU 4.2F.33R

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%.

MIPRU 4.2F.34G
  1. (1)

    The application of MIPRU 4.2F.33 R may be illustrated by an example. Where a first-charge mortgage exposure of £50,000 from another lender is secured on residential property in the United Kingdom that satisfies the criteria in MIPRU 4.2F.4 R to MIPRU 4.2F.29 R and the value of that property is £100,000, then a firm with a second-charge mortgage of £60,000 on the same property may treat £30,000 of that exposure as fully and completely secured and risk weight it at 35%, treat a further £20,000 as unsecured and risk weight it at 75%, and risk weight the remaining £10,000 at 100%. A diagrammatic illustration of this example is in (2).

  2. (2)

    A diagrammatic illustration of the example in (1)

    Property value

    Exposure and risk weightings

    Example

    £10,000 of second-charge - risk weighted at 100%

    • Remaining second-charge mortgage, i.e. £10,000

    £100,000

    £20,000 of second-charge - risk weighted at 75%

    • Second-charge mortgage up to maximum of 100% of property value, i.e. £20,000

    £30,000 of second-charge - risk weighted at 35%

    • Second-charge mortgage up to maximum of 80% of property value, i.e. £30,000

    First-charge mortgage (£50,000)

    • Other lender has first-charge over property with outstanding loan balance of £50,000

MIPRU 4.2F.35G

If an exposure is secured on property that is used partly for residential purposes under MIPRU 4.2F.4 R and partly for commercial purposes (such as a farm, public house, guest house or shop) it may be treated as secured by residential real estate if the firm can demonstrate that:

  1. (1)

    the property's main use is, or will be, residential; and

  2. (2)

    the value of the property is not significantly affected by its commercial use.

MIPRU 4.2F.36R

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 secured by mortgages on commercial property

MIPRU 4.2F.37R

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

MIPRU 4.2F.38R

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

Exposures to funds

MIPRU 4.2F.39R

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%.

MIPRU 4.2F.40R

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.

MIPRU 4.2F.41R

Table: Exposures in the form of funds for which a credit assessment by a nominated ECAI is available

This table belongs to MIPRU 4.2F.40 R.

Credit quality step

1

2

3

4

5

6

Risk weight

20%

50%

100%

100%

150%

150%

MIPRU 4.2F.42R

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%.

MIPRU 4.2F.43G

A firm should consider a fund as being high risk where there is no external credit assessment from an eligible ECAI and where the fund has specific features (such as high levels of leverage or lack of transparency).

MIPRU 4.2F.44G

Other examples of high-risk funds are:

  1. (1)

    those in which a substantial element of the fund's property is made up of items that would attract a risk weight of over 100%; and

  2. (2)

    those whose mandate (as referred to in MIPRU 4.2F.46 R would permit it to invest in a substantial amount of items that would attract a risk weight of over 100%.

MIPRU 4.2F.45R

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.

MIPRU 4.2F.46R

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.

MIPRU 4.2F.47R

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.

MIPRU 4.2F.48R

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.

MIPRU 4.2F.49R

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 to past due items

MIPRU 4.2F.50R

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

Exposures to past due item: treatment of secured part of mortgages on residential property

MIPRU 4.2F.51R

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.

MIPRU 4.2F.52G

A firm may treat the secured part of an exposure covered by a mortgage indemnity product that meets the relevant eligibility criteria for credit risk mitigation as secured for the purposes of MIPRU 4.2F.51 R.

Exposures to past due items: treatment of secured part of other exposures

MIPRU 4.2F.53R

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).

MIPRU 4.2F.54G
  1. (1)

    For MIPRU 4.2F.53 R, the secured part of a past due item is dealt with under MIPRU 4.2C (Credit risk mitigation).

  2. (2)

    The risk weight to be applied to the secured part is determined under MIPRU 4.2C.6 R, and MIPRU 4.2C.29 R to MIPRU 4.2C.30 R.

  3. (3)

    The risk weight of the unsecured part of the past due item is determined in accordance with MIPRU 4.2F.55 R.

Treatment of unsecured part: all exposures

MIPRU 4.2F.55R

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.

Example: mortgages on residential property

MIPRU 4.2F.56G

The application of value adjustments to either the secured or the unsecured component of an exposure secured on residential property may be illustrated on the basis of a £110,000 loan on a property valued at £100,000, where £80,000 of the loan is secured, £30,000 of the exposure is unsecured and a value adjustment of £20,000 is taken.

  1. (1)

    Value adjustment applied to unsecured component:

    1. (a)

      Value adjustment of £20,000 taken on £30,000 unsecured exposure.

    2. (b)

      Value adjustment exceeds 20%, so the firm should risk weight the remaining £10,000 unsecured exposure at 100% (as per MIPRU 4.2F.55 R).

    3. (c)

      The risk weight to be applied to the secured exposure of £80,000 is 100% (as per MIPRU 4.2F.51 R).

  2. (2)

    Value adjustment applied to secured component:

    1. (a)

      Value adjustment of £20,000 taken on £80,000 secured exposure.

    2. (b)

      Value adjustment exceeds 20%, so the firm should risk weight the remaining £60,000 secured exposure at 50% (as per MIPRU 4.2F.51 R).

    3. (c)

      The risk weight to be applied to the unsecured exposure of £30,000 is 150% (as per MIPRU 4.2F.55 R).

  3. (3)

    A diagrammatic illustration of how MIPRU 4.2F.56G (1) and MIPRU 4.2F.56G (2) operate is as follows:

    Value adjustment applied to unsecured component (MIPRU 4.2F.51 R)

    Risk weightings

    Exposure

    Risk weightings

    Value adjustment to secured component (MIPRU 4.2F.55 R)

    £20,000

    Unsecured component of £30,000

    £30,000 risk weighted at 150%

    £10,000 risk weighted at 100%

    £80,000 risk weighted at 100%

    Secured component of £80,000

    £20,000

    £60,000 risk weighted at 50%