Methods used for identifying default risks and determining the need for value adjustments and provisions

4 Methods used for identifying default risks and determining the need for value adjustments and provisions

Loans with a total obligation of more than 100,000 Swiss francs must be specifically monitored (watch list) and checked for value adjustments/provisions in the following cases:

Breach of contract (outstanding interest and amortisation for more than 90 days, persistent credit overruns longer than 90 days, loan positions terminated by LUKB)
Disruptions in the relationship of trust with borrowers (e.g. overdue documentation)
Borrower in liquidation
Negative deviations of the underlying factors from the initial credit assessment:
Rating levels 9 and 10 for insufficient collateral or unsecured loans
Insufficient earnings/economic viability issues
Declining income values of investment properties
Unregulated, but pending successor
Other reasons (for example criminal investigation proceedings/criminal charges against the borrower, risk assessments by the client advisor or expert)

Value adjustments and provisions for default risks on impaired loans/receivables and off-balance-sheet transactions

The specific value adjustment or provision is calculated as the difference between the exposure (credit limit or higher debt, including contingent liabilities) and the realisation value of any collateral. The realisation value of the collateral is the liquidation value (estimated realisable value less holding and liquidation costs). The entire exposure of the customer or economic unit must always be taken into account.

Impaired loans/receivables are (co-)managed by Special Financing, which also determines the amount of the specific value adjustment/provision.

Specific value adjustments are recognised for impaired loans/receivables if the underfunding according to the impairment test is higher than 100,000 Swiss francs. For non-performing loans that do not reach this threshold, lump-sum individual value adjustments are calculated based on empirical values. Non-performing loans are:

Loans/receivables with outstanding interest/amortisation or credit breaches for longer than 90 days (if outstanding interest/amortisation arises from a basic claim [e.g. mortgage], the basic claim is also deemed to be non-performing)
Loans/receivables due from debtors in liquidation (judicial or out-of-court)
Loans/receivables for which credit-related interest concessions were made below own refinancing costs

Value adjustments and provisions for inherent default risks on unimpaired loans/receivables and off-balance-sheet transactions

As a Category 3 bank within the meaning of Art. 25para. 1 letter b FINMA AO, LUKB establishes value adjustments and provisions for inherent default risks (including country risks) on unimpaired loans/receivables from banks and loans to customers and off-balance-sheet transactions (contingent liabilities).

To calculate the value adjustments and provisions for inherent default risks, fixed value adjustment and provision rates are derived and reviewed for appropriateness in the first quarter of each year on the basis of experience with actual defaults in the lending business. The basis used is the actual credit losses recognised over the past 30 calendar years, supplemented by the losses expected for the planning period in accordance with the respective financial plan. A floor of 0.12 % is currently used for the value adjustment rate on loans to customers, as the average value over the past 30 years has now been below the floor.

Due to the historically low defaults and the resulting low value adjustment and provision rates, LUKB also applies a market adjustment factor of no more than 2.0 to determine the value adjustments and provisions portfolio. The actual determination takes into account the market situation and FINMA's expectations. As of 31 December 2025, a factor of 1.60 will continue to be applied.

Value adjustments for inherent default risks on non-impaired loans/receivables are calculated at the individual loan level, while they are subsequently posted on an aggregate basis to the respective balance sheet items. Value adjustments are distributed monthly across balance sheet items and recognised under ‘Changes in value adjustments for default risk and losses from interest operations’.

Provisions for inherent default risks on unimpaired contingent liabilities are calculated at the overall position level in Swiss francs using a credit conversion factor (CCF) of 100 % and are recognised in the balance sheet or income statement item ‘Provisions’ or ‘Changes to provisions and other value adjustments and losses’.

Appropriation for intended use

An existing value adjustment/provision is reversed through profit or loss when the loan is amortised or the realisation value and/or the customer's creditworthiness have increased or improved over the long term. Derecognition (appropriation for the intended purpose) takes place when the loss is definitively established.

The existing value adjustments and provisions for inherent default risks can be used to break the pro-cyclicality for the formation of specific value adjustments or provisions for impaired loans/receivables or off-balance-sheet transactions, particularly in a situation where there is an exceptionally high need for specific value adjustments and provisions for default risks (crisis situation). Requirements for specific value adjustments and provisions are considered to be exceptionally high if they exceed 1 % gross of eligible capital or 10 % of the Group's gross interest income (end of previous year level). The CFO decides on the appropriation and informs the Executive Board, the Audit and Finance Committee of the Board of Directors as well as the Board of Directors of the amount of appropriation (including the parameters selected for setting the amount) as well as the planned period for the reconstruction (maximum six years). As a result, the market adjustment factor is temporarily reduced and the resulting value adjustments are used for their intended purpose. After six years at the latest, the market adjustment factor must return to at least 1.0.

Value adjustments for inherent default risks were not used in the reporting year. There is also no shortfall as of 31 December 2025.

The accounting of value adjustments and provisions is governed by Section ‘Detailed provisions’ (on the accounting and valuation principles).