Landeskreditbank Baden-Württemberg - L-Bank

The credit risk of the loan and securities portfolio is continuously assessed with respect to each individual
exposure. Specific provisions are established in the loan portfolio and in the current asset securities portfolio held
as liquidity reserve by writing down the book value of each such item according to its assessed risk
(Einzelwertberichtigung). In addition, a general provision is established for risk that is not individually
identifiable but is inherent in the loan portfolio (Pauschalwertberichtigung). Like specific provisions, general
provisions are deducted from the assets reserved against and are therefore not shown separately on the balance
sheet.
Under U.S. GAAP, general, unspecified reserves are not permitted. For loans that are individually deemed
impaired, specific reserves are determined based on the present value of future cash flows discounted at the
loan’s effective interest rate, or where the loan is collateral based on the fair value of the collateral provided.
Where available, the observable market price of the loan can be used. U.S. GAAP requires recognition of a loss
when (a) information available prior to issuance of the financial statements indicates that it is probable that an
asset has been impaired at the date of the financial statements and (b) the amount of the loss can be reasonably
estimated, even though the particular loans that are not collectible may not be identifiable.
Certain provisions and reserves
There are two provisions in the German Commercial Code (Handelsgesetzbuch), which allow banks to
establish reserves against general banking risks. Pursuant to Section 340g German Commercial Code banks may
carry a special item called “Fund for General Banking Risks” (Sonderposten für allgemeine Bankrisiken) on the
liability side of their balance sheet for protection against general banking risks. However, such a fund may only
be established if, in accordance with reasonable commercial judgment, the special risks inherent in the business
of banks require the establishment of such a fund. Any additions to the Fund for General Banking Risks or any
profits derived from its dissolution must be reflected separately in the bank’s income statement, (see Section
340g(2), German Commercial Code), see “Glossary.” Funds for general banking risks established pursuant to
Section 340g German Commercial Code are counted as part of core capital.
In addition, banks may have contingency reserves for general banking risk, which are permitted by section
340f German Commercial Code. According to this rule, a bank may record on its balance sheet certain
receivables, debt securities and equity securities that are held as part of the “liquidity reserve” at a lower value
than that permitted for industrial and other nonbanking corporations, if this is necessary, in accordance with
reasonable commercial judgment, to safeguard against the special risks inherent in the business of banks. The
reserves created by such recording of lower values may not exceed four percent of the total book value of such
receivables and securities. Banks need not report in their financial statements on the creation and dissolution of
such reserves for general banking risks. With respect to presentation in the income statement, banks are permitted
to offset (without disclosure) profits from the sale of certain securities (in the so-called liquidity portfolio) and
the revaluation of receivables (i.e., payments received on loans previously written-off or write-backs of risk
provisions) against write-downs of the respective receivables and securities. Based on the foregoing, we disclose
the net result from movements in risk provisions and management of the liquidity portfolio.
Assets, liabilities and pending transactions have been valued in accordance with general provisions of
Sections 252 et seq. of the German Commercial Code, taking into account the special rules applying to credit
institutions, Sections 340e et seq. of the German Commercial Code.
Under U.S. GAAP, provisions are only recorded when certain criteria are met. A provision is only
recognized when (a) information available prior to issuance of the financial statements indicates that it is
probable that an asset has been impaired at the date of the financial statements and (b) the amount of the loss can
be reasonably estimated.
Derivative Instruments and Hedge Accounting
Under German GAAP, derivative instruments and embedded derivatives may be included in a financial
institution’s trading book or investment book. Trading derivatives are treated as current assets and accordingly
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