Non-Performing Loan Valuation

From Open Risk Manual


Non-Performing Loan Valuation (NPL Valuation) is the assignment of a monetary amount (value) to a single NPL asset or a portfolio of such assets. NPL Valuation is a special case of more general financial asset Valuation Model applied to Non-Performing Loans.

NPL valuation principles are similar to those of general financial asset pricing methodologies [1] but must be applied in the context and specifics of non-performing lending contracts, in particular capturing the large uncertainty surrounding which (if any) of the Contractual Cash Flows can be realized.

Valuation Methodologies

NPL assets are illiquid assets held by banks or other credit granting institutions as a byproduct of their core lending businesses. Current practices indicate a variety of different approaches to NPL Valuation (see references below).

Broadly speaking NPL valuation is based on evaluating the likelihood and magnitude of future cashflows from NPL either on the basis of:

  • historical performance data for similar NPL assets that are formalized into subjective projections of how NPL specific risk factors will materialize and therefore affect the realisation of contractual cashflows
  • inferred from market observations, where a broader set of opinions as expressed in the value of transactions are (implicitly) polled. This process assigns a value to the expected cashflows. The applicability of a market based approach to NPL valuation rests on the availability of relatively frequent transactions for assets of broadly similar risk characteristics

NPL Asset Types

The precise nature of NPL assets plays a significant role in the valuation approach. This inherits from the borrower or credit product characteristics such as:

  • Product Type: The EBA NPL Asset Classes provide the indicative granularity by which different credit assets can be subdivided for analysis purposes
  • Size: Large individually assessed loans versus collectively assessed (retail) loans
  • A most important distinction in NPL valuation analysis is between Secured and Unsecured Credit (Secured being further typically subdivided into Real Estate and "Other Collateral")

NPL Stage

The stage of obligor in the credit lifecycle, in particular whether it is a Going Concern versus Gone Concern has significant implications.

  • Going Concern Valuation assumes that operational cash flows of the debtor are material and must be taken into account in the valuation methodology
  • Gone Concern Valuation assumes that such cash flows are not applicable / immaterial and focuses on collateral valuation

NPL Risk Factors

NB: In the context of NPL valuation Risk Factors are only the residual uncertainties given the NPL status. Such NPL specific risk factors (uncertainties) can (broadly) be categorized as follows:

  • Risk factors affecting the likelihood, timing and amount of cashflows from going-concern / viable obligors. Such factors may be idiosyncratic (the relative health of the balance sheet and prospects of individuals / firms) or systemic (business sector, economy wide) factors
  • Risk factors affecting the likelihood, timing and amount of cashflows from collateral / securitiy / guarantees or other recovery measures. Again such factors can be linked to individual collateral characteristics or be affected by general asset market characteristics

These general risk factors find specific manifestations per each NPL class. For example: the timing of collectively assessed mortgage loans is sensitive to the legal process being followed, the market conditions for the real estate sub-type etc.

Data Requirements

NPL Valuation requires both current and historical information. An exhaustive set of Data Requirements for performing NPL Valuation is provided by the EBA NPL Template

Regulatory Guidance and/or Research Papers

NB: For easy reference guidance papers and research notes produced by staff are bundled together

1. Date 2. Title 3. Authors 4. Organization 5. URL
Mar 2018 Addendum to the ECB Guidance to banks on non-performing loans: supervisory expectations for prudential provisioning of non-performing exposures ECB Staff ECB ECB Banking Supervision Site
Nov 2017 Overcoming non-performing loan market failures with transaction platforms John Fell, Maciej Grodzicki, Dejan Krušec, Reiner Martin and Edward O’Brien ECB ECB Site
Mar 2017 Guidance to banks on non-performing loans ECB Staff ECB ECB Banking Supervision Site
Apr 2016 What’s the value of NPLs? L. G. Ciavoliello, F. Ciocchetta, F. M. Conti, I. Guida, A. Rendina, G. Santini Banca d'Italia Research Bank of Italy Site
Mar 2014 Asset Quality Review Manual (Phase 2) ECB Staff ECB ECB Site
Feb 2013 Non-Performing Loans - What matters in addition to the economic cycle? R. Beck, P. Jakubik and A. Piloiu ECB Research ECB Site
Sep 2009 An Empirical Study of the Returns on Defaulted Debt and the Discount Rate for Loss-Given-Default Michael Jacobs, Jr. OCC BIS Site

World Bank Conference on NPL

NB: For easy reference links to the World Bank/FinSAC: International Conference on NPL Resolution presentations (May 15-16, 2018 Vienna, Austria)

ECB Guidance to banks on NPLs Sharon Finn, European Central Bank
IFRS 9: Impact on banks Tony Clifford, Ernst & Young, EMEIA Financial Services, UK
Regulatory developments - EBA perspective Oleg Shmeljov, European Banking Authority
Prudential policy considerations of NPLs and expected loss provisioning Katia D’Hulster, Finance, Competitiveness & Innovation (FCI), The World Bank Group
A holistic approach to NPL resolution Karlis Bauze, FinSAC, The World Bank Group
NPL resolution at bank level – the Slovenian experience with MSME NPL resolution Darko Torkar, Banking Supervision, Bank of Slovenia
The Workout Unit a practitioner’s perspective Teodora Petkova, UniCredit Bulbank, Bulgaria
International experiences with AMCs Caroline Cerruti, Finance, Competitiveness & Innovation (FCI), The World Bank Group
NPL resolution Danaharta, Malaysia Hamidy Hafiz, Corporate Debt Restructuring Committee (CDRC), Malaysia
Lessons learned from the work of DUTB Speaker: Imre Balogh, Bank Asset Management Company, Slovenia
Importance of Legal aspects of NPL resolution (collective and individual, collateral enforcement, auctioning process) Andres F. Martinez, Finance, Competitiveness & Innovation (FCI), The World Bank Group
The expected impact of the proposal for Restructuring and Second Chance Directive on NPLs Ondrej Vondracek, European Commission
Out of Court Restructuring Principles and alliance with Legal Framework Theodore Athanassopoulos, Alpha Bank, Greece
Collateral valuation - an appraisers’ perspective Krzysztof Grzesik, The European Group of Valuers Associations (TEGOVA)
Valuation methods in financial markets – a regulatory perspective Speaker: Sharon Finn, European Central Bank
Spanish Mortgage collaterals appraisal system: methodology, reporting, appraisal companies, and supervision Miguel Angel Lopez Gomez, Bank of Spain
NPL markets in ECA - state of play Andreea Moraru, Financial Institutions, EBRD
Prerequisites for developing markets for distressed assets Anete Daukste, KPMG, UK
NPL servicing platforms. Effectiveness of debt collection agencies in the region Martin Machon, APS Holding
Practical lessons from the NPL resolution in Latvia Elmars Zakulis, Bank of Latvia
Lessons learned from the NPL Working Group in Serbia Milan Kovač, Ministry of Finance of Serbia and Marija Ranđelović, National Bank of Serbia
Collateral aluation in the CESEE region Prepared by Karlis Bauze
FinSAC, The World Bank Group
Public AMCs international experiences Prepared by Caroline Cerruti
Finance, Competitiveness & Innovation Global Practice, The World Bank Group
Regulatory and supervisory developments for NPLs Prepared by Katia D’Hulster
Finance, Competitiveness & Innovation Global Practice, The World Bank Group

Research Papers / White Papers

This list of Non-Performing Loan valuation resources is provided as-is without any implied endorsement or validation of the suitability, originality, accuracy or completeness of said resources for any purpose. A related resource is the NPL Glossary, a collection of term definitions relevant for the implementation of the standard, along with pointers to further content and discussions.

1. Date 2. Title 3. Authors 4. Organization 5. URL
Mar 2018 A risk-neutral approach for the evaluation of NPLs D. Tilloca Unicredit SSRN
Jan 2018 Risk reduction through Europe’s distressed debt market A. Lehmann Bruegel Bruegel Website
Jun 2017 The value of Italian non-performing loans T. Humblot BNP Paribas BNP Website
Jan 2017 Loan Fair Value Approaches Revisited J. Skoglund SAS Institute SSRN
Sep 2015 A Strategy for Resolving Europe’s Problem Loans Aiyar et al. IMF IMF Website
Sep 2006 Discount Rate for Workout Recoveries: An Empirical Study Brady et al. Diverse SSRN

Accounting Standards

Publications from Accounting Bodies (IASB, FASB) with a focus on those most relevant for NPL valuation purposes.

1. Date 2. Title 3. Authors 4. Organization 5. URL
Feb 2016 IFRS Standard 9: Financial Instruments (Stage 3 Assets) IFRS Staff IFRS eIFRS (Registration Required)
Dec 2015 Collateral and other credit enhancements and the measurement of ECL IFRS Staff IASB IFRS Site
Dec 2015 Inclusion of cash flows expected from the sale on default of a loan in the measurement of ECL IFRS Staff IASB IFRS Site
Dec 2015 Measurement of the loss allowance for credit-impaired financial assets IFRS Staff IFRS IFRS Site

Relationship with other methodologies

  • NPL valuation is closely related bus distinct to the Provisioning of NPL by financial institutions. Substantial differences may be induced by accounting standard specific requirements (see e.g. Stage 3 Assets, IFRS 9) that do not pertain, for example, to a valuation of an NPL portfolio in a market transaction
  • Methodologies for NPL valuation are also technically related to Loss Given Default models used by financial institutions for internal risk management and regulatory capital calculations. Again, specific regulatory requirements versus methodology (e.g. degree of conservatism) imply that such methodologies might not be applicable directly to the NPL valuation problem.


  1. Cochrane, Asset Pricing, 2005