9.3.2 Expected future cash flow

Credit institutions should estimate discounted cash flow in a prudential manner and in line with applicable accounting standards.

Calculation of discounted cash flow should take into account cases where:

• a) the operating cash flow of the borrower continues and can be used to repay the financial debt, and collateral may be exercised to the extent that it does not influence operating cash flow; and
• b) the operating cash flow of the borrower ceases and collateral is exercised.

When the estimation is based on the assumption that the operating cash flow of the borrower will continue, including cash flow being received from the collateral, updated and reliable information on cash flow is required.

When the estimation is based on the assumption that the operating cash flow of the borrower will cease, the future sale proceeds from collateral execution should be adjusted to take into account the appropriate liquidation costs and market price discount.

In addition to the above liquidation costs, a market price discount, if appropriate, should be applied to the updated valuation as outlined below.

The property price at the time of liquidation should take into account current and expected market conditions.

Time-to-sale considerations in connection with the disposal of mortgaged properties should also be included, based on debt enforcement practices and experiences from judicial proceedings at national level and on empirical evidence, and back-tested accordingly. These considerations should include any operational costs or capital expenditures to be incurred before the time of sale.

The execution of collateral may include both consensual and non-consensual (forced) liquidation strategies.

The liquidation cost discount should reflect the manner of collateral execution, i.e. whether it is consensual or non-consensual.

The market price discount should reflect the liquidity of the market and the liquidation strategy. It should not reflect fire sale conditions unless the anticipated liquidation strategy actually involves a fire sale.

Credit institutions should apply adequate market price discounts for the purposes of IFRS 9, for the calculation of regulatory capital and for risk control purposes. A market price discount may be close to zero only for highly liquid and non-distressed collateral types that are not affected by any significant correlation risks.

All credit institutions should develop their own liquidation cost and market price discount assumptions based on observed empirical evidence. If insufficient empirical evidence is available, discount assumptions should be based on, at a minimum, liquidity, passage of time, and the quality/ageing of the appraisal. If a credit institution faces the situation of a frozen property market and only a small number of properties have been sold or the sales history has to be considered insufficient, a more conservative market price discount should apply.