9.7.2 Valuation methodology

The transfer value should be based on the real economic value (REV).1 The valuation of the impaired assets is therefore very important. In that regard, section 5.5 of the IAC2 notes that a correct and consistent approach to valuation is of key importance to prevent undue distortions of competition.3

In cases involving asset relief measures, Member States provide evidence (usually from the national supervisory authority or a contracted valuation expert) explaining how the transfer value was calculated. That valuation and the underlying methodology is scrutinised by the Commission. To this end, the Commission enlists assistance from external valuation experts.

The assessment of the valuation methodology is very technical and the Commission decisions do not contain much information about the precise assessment. Indeed, many decisions only mention that the Member State had appointed an external expert to assess the portfolio (in order to determine the transfer value) and that the national supervisory authority had validated the valuation. In addition, it is usually indicated that the Commission has contracted external experts to scrutinise the valuation.

There are a few decisions that elaborate a bit on the Commission’s assessment of the valuation methodology. For instance, in the decision on Dexia, the Commission indicated that it assessed whether (i) the valuation was based as far as possible on observable inputs, (ii) it made realistic and prudent assumptions about future cash flows, and (iii) it was based on prudent stress-testing at the time that the valuation was carried out.4 Mainly when the Commission has doubts whether the ‘valuation-criterion’ has been met, the (opening) decision elaborates on the valuation method. For instance, in its Opening Decision on LBBW, the Commission noted that its external experts indicated doubts on the establishment of the REV of the guaranteed portfolios, in particular as regards (i) the choice of default probabilities for some assets, (ii) the choice of default correlations, (iii) the choice of some recovery rates, (iv) house price assumptions, and (iv) other valuation issues.5

Of special interest is point 38 of the IAC, which provides that where the valuation of assets appears particularly complex, alternative approaches could be considered such as the creation of a ‘good bank’ (whereby the State would purchase the good rather than the impaired assets) or public ownership of a bank (including nationalisation). In case of a nationalisation, no ex-ante valuation of assets is needed insofar as the valuation is carried out over time in the context of restructuring or liquidation. In its decisional practice, the Commission referred only once to point 38 of the IAC. This only reference can be found in the decision on Northern Rock, which was nationalised in 2008 by the UK State. The Commission considered that “according to the IAC, the objective of valuation is to calculate the amount of aid and thus the level of competition distortion for the purposes of determining how far-reaching the restructuring should be”.6 The Commission considered the restructuring in this case to be very far- reaching. In view of the nationalisation of Northern Rock and the far-reaching restructuring, the Commission concluded that an ex ante valuation was not necessary.7 In my opinion, this decision is quite special in the sense that the assessment of the ‘valuation-criterion’ already mentions the extent of restructuring.

In a few other cases, the Commission came to the conclusion that no ex ante valuation of the assets had been conducted. One of these cases was the case of Dunfermline Building Society, a financial services institution based in the UK. It should be recalled that Dunfermline was split-up: the good part of Dunfermline was transferred to Nationwide (following an open and transparent tender), while the remaining part (“Rump Dunfermline”) was put in wound- down. The transfer of the good part of Dunfermline to Nationwide was facilitated by means of State aid (which the Commission considered to be an impaired asset measure). This State aid measure was unrelated to the REV of the impaired assets remaining in Rump Dunfermline. Rather, it was based on the amount of cash needed to compensate depositors and ensure the sale of the good part of Dunfermline’s business. Consequently, the exposure of the UK to the Rump Dunfermline was not determined objectively ex-ante.8 The Commission therefore concluded that the measure did not meet the valuation-criterion of the IAC. The same consideration can be found in the decision on Quinn Insurance.9 This case was similar to that of Dunfermline, in the sense that the split-up of Quinn Insurance was also treated as an asset relief measure. If there is no valuation, then there is a risk that the transfer value is too high (as compared to the REV). This illustrates the importance of a (correct) valuation.

The ‘valuation-criterion’ of the IAC is quite related to the burden-sharing requirement of the IAC. Indeed, if the valuation is based on assumptions that are too optimistic, then the estimated REV is probably higher than the actual REV.

Consequently, the transfer value (based on the estimated REV) exceeds the actual REV. This would mean that burden-sharing is likely to be insufficient. The issue of burden-sharing will be explored further in the next section.