Overview & Practical Challenges ICATT IFRS Seminar September - - PowerPoint PPT Presentation
IFRS 9 Overview & Practical Challenges ICATT IFRS Seminar September 2019 Agenda 1. Overview C&M (30 mins) 2. Overview Impairment (30 mins) 3. Common Challenges (30 mins) - determining PD - unrated debt - multiple scenarios
IFRS 9 Overview & Practical Challenges
September 2019
ICATT IFRS Seminar
1. Overview C&M (30 mins) 2. Overview Impairment (30 mins) 3. Common Challenges (30 mins)
Agenda
Date 2
PwC PwC
Classification and Measurement
3
PwC PwC
Financial Liabilities
4
Changes in the fair value of financial liabilities measured at fair value to be recognised in profit or loss
No changes to classification categories
Changes in own credit risk in OCI for FVTPL liabilities Can be adopted in isolation to remainder of IFRS 9
IFRS 9
Fair value Amortised cost
PwC
Financial assets Classification & Measurement: Equity instruments
Investments in all equity instruments Held for trading? OCI option on initial recognition? FVOCI, with no recycling* FVTPL
Yes Yes No No
*Dividends continue to be taken through P&L
5
PwC
Amortised cost FV-OCI Fair value through P&L
Do contractual cash flows represent solely payments of principal and interest? Does the company apply the fair value option to eliminate an accounting mismatch? Yes Yes No No No No Yes No Yes Yes
Classification & Measurement: Debt instruments
The model in 1 page…
Is objective of the entity’s business model to hold the financial assets to collect contractual cash flows? Is the financial asset held to achieve an objective by both collecting contractual cash flows and selling financial assets?
6
PwC
Reclassification
7
Next reporting period: Dependent on frequency of reporting (eg. annually)
Point of reclassification:
Prospective
Application:
Lengthy delay treatment: (i) existing assets under previous model (ii) new assets under new model
Period between and reclassification:
Expected to be infrequent
Conditions:
1 2 3 4
PwC PwC
What level to define the business model?
8
Entity level Division level Business unit level Individual desk / asset level
Factors to consider
This is an assessment of fact capable of being evidenced
PwC
Sales
9
PwC
Classification and measurement of debt instruments
Standalone versus group
10
Entity
mortgages MARKET
Securitisation vehicle
(100% owned) sell (derecognition) ENTITY
Hold to sell
GROUP
Hold to collect
1 1 2 2
PwC PwC
Impairment
11
PwC
Impairment of financial assets
General model
Slide 12
Effective interest on gross carrying amount
Lifetime ECL 12 month ECL Recognition of ECL Interest revenue
Change in credit quality since initial recognition
Stage 1 Stage 2 Stage 3 Performing (Initial recognition*) Underperforming (Assets with significant increase in credit risk since initial recognition* ) Non-performing (Credit impaired assets)
*except for purchased or originated credit impaired assets
Lifetime ECL
Effective interest on gross carrying amount Effective interest on amortised cost carrying amount (i.e. net of credit allowance)
PwC
Sophistication and proportionality
13
Application of IFRS 9 is subject to the concept of materiality. Materiality of portfolios and the related risks are a factor in selection of an approach and the design of related internal controls. No one size fits all. To determine the level of sophistication required for a portfolio, the following factors may be considered: Extent of systemic or regulatory supervision Listing status and distribution of
debt and equity securities Status as a public interest entity Size of balance sheet and off-balance sheet credit exposures Level and volatility of historical credit losses. Entity level factors Portfolio level factors Size of portfolio, relative to total balance sheet and credit exposures Sophistication of lending related modelling methodologies Extent of relevant data available for the portfolio Complexity of products in the portfolio Level of historical credit losses experienced Level and volatility of potential future credit losses
PwC
Impairment
Assessment of a significant increase in credit risk
Significant increase in credit risk
Variation between reporting date and initial recogntion Absolute probabilities are not sufficient Maximum credit risk for a portfolio Counterparty assessment Actual or expected significant change in credit ratings
14
PwC
Impairment
Information to take into account for assessing increases in credit risk
Changes in external market indicators Changes in credit ratings Changes in internal price indicators Changes in business and economic conditions Changes in
results Other qualitative inputs 30 days past due rebuttable presumption However…. Fair value of Collateral
15
PwC
Impairment
Operational Simplifications
16
Is the asset ‘low credit risk’ at reporting date?
Policy choice Has there been a significant increase in credit risk?
12-month ECL Lifetime ECL Yes
Option
PwC PwC
Some Challenges Faced
17
18
Common IFRS 9 Challenges
Lifetime Expected Credit Loss Estimation Forward looking view Controls and governance Staging criteria Extensive Disclosure Requirements Implication
performance and business strategy Readiness of data and systems
PwC PwC
Some Challenges Faced
19
Determining Probability of Default
IFRS 9 – Financial Instruments 20
Determining PD Summary of historical data
[from PD listing] [from total loans listing] YEARS AFTER Grand Total Grade Value of loans 1 2 3 4 5 6 7 A 4,000 4 1 5 B 3,800 24 11 1 2 38 C 1,000 52 12 9 1 1 75 D 700 57 48 32 14 3 3 1 158 E 125 30 28 12 8 78 Grand Total 9,625 167 100 54 25 4 3 1 354
IFRS 9 – Financial Instruments 21
Determining PD Summary of historical data
Probability of default 1 2 3 4 5 6 7 0.100% 0.025% 0.000% 0.000% 0.000% 0.000% 0.000% 0.632% 0.289% 0.026% 0.053% 0.000% 0.000% 0.000% 5.200% 1.200% 0.900% 0.100% 0.100% 0.000% 0.000% 8.143% 6.857% 4.571% 2.000% 0.429% 0.429% 0.143% 24.000% 22.400% 9.600% 6.400% 0.000% 0.000% 0.000%
IFRS 9 – Financial Instruments 22
Determining PD – Simplified Model
Point in Time Aging Historical Experience vs
Accounts Receivable
0-30 30-60 60-90 90-180 180-365 >365 Total
Aging at 31 December 2018
$ 7,500,000 $ 1,000,000 $ 500,000 $ 300,000 $ 200,000 $ 500,000 $ 10,000,000 75% 10% 5% 3% 2% 5% 100% ECL % (default / balance OS) 10.0% 40.0% 66.7% 100.0% 100.0% 100.0% Provision $ 750,000 $ 400,000 $ 333,333 $ 300,000 $ 200,000 $ 500,000 $ 2,483,333
AR Payment History
0-30 30-60 60-90 90-180 180-365 >365 Total
3 Years to 31 December 2018
$ 70,000,000 $ 20,000,000 $ 5,000,000 $ 3,000,000 $ 1,000,000 $ 500,000 $ 100,000,000 70% 20% 5% 3% 1% 1% 100% ECL % (default / balance OS) 5% 15% 47% 100% 100% 100% Aging at 31 December 2018 $ 7,500,000 $ 1,000,000 $ 500,000 $ 300,000 $ 200,000 $ 500,000 $ 10,000,000 Provision $ 339,195.98 $ 152,542.37 $ 236,842.11 $ 300,000.00 $ 200,000.00 $ 500,000.00 $ 1,728,580
PwC PwC
Some Challenges Faced
23
Unrated Debt Securities
PwC
Unrated Debt Securities
Classify Securities
model
Determine Staging
staging Determine EAD
weight
24 IFRS 9 – Financial Instruments
Establish LGD
recovery
studies Forward Looking PDs
Establish PD
data
PwC PwC
Some Challenges Faced
25
Considering Multiple Scenarios
PwC
Considering Multiple Scenarios
Definitions Scenario analysis The process of analyzing possible future events by considering alternative possible outcomes Base case scenario Most likely observable economic scenario, assessed based on the external forecast sources (i.e.. CBTT publications or other economic data etc.). Upside scenario Optimistic forecast of possible outcomes of the base case scenario Downside scenario Pessimistic forecast of possible outcomes of the base case scenario Scorecard Collection of most relevant economic variables/ indicators that are considered in a scenario. Weight Different weights may be assigned to component indicators of the scorecard in order to reflect their economic significance on the particular portfolio assessed. Multiplier The macroeconomic variables included in the base case scenario are graded as being in a Positive, Stable or Negative state. Each graded state is assigned a corresponding multiplier Score Composite indicator calculated as weighted average of the grades & weightings assigned for all indicators in the scenario. Threshold indicator of the maximum risk accepted vs risk at origination for each specific pool
PwC
Considering Multiple Scenarios
Multiplier Loan Portfolio State Multiplier Indicators' weight Loans portfolio
0.5 Positive 0.6 GDP growth 0.3 Stable 1.1 Interest rate 0.1 Negative 2 Tourism 0.1
1 Probability of impact/occurrence - Scenarios of PDs seasoning Scenarios' weight Loans portfolio Base case 80% Upside 10% Downside 10% Total 100%
PwC
Considering Multiple Scenarios
LOANS PORTFOLIO SCORECARD Base case scenario Variables State Multiplier Weight Score Unemployment rate Negative 2 0.5 1.0 GDP growth Stable 1.1 0.3 0.3 Interest rate Stable 1.1 0.1 0.1 Tourism Stable 1.1 0.1 0.1 SCORE 1.6 Probability of impact 80% Upside scenario Variables State Multiplier Weight Score Unemployment rate Positive 0.6 0.5 0.3 GDP growth Positive 0.6 0.3 0.2 Interest rate Stable 1.1 0.1 0.1 Tourism Positive 0.6 0.1 0.1 SCORE 0.7 Probability of impact 10% Downside scenario Variables State Multiplier Weight Score Unemployment rate Negative 2 0.5 1.0 GDP growth Negative 2 0.3 0.6 Interest rate Stable 1.1 0.1 0.1 Tourism Negative 2 0.1 0.2 SCORE 1.9 Probability of impact 10% Weighted average adjustment factor : 1.50
PwC PwC
Some Challenges Faced
29
Purchased / Originated Credit Impaired assets
The Government of Barbados defaulted on its debt instruments in June 2018, when principal and interest payments were suspended. In September 2018, the Government launched an exchange offer for holders of Barbados dollar denominated debt. In June 2019, the Government issued the latest Creditor Update regarding the restructuring terms of the US dollar denominated debt.
30
POCI - GOB Example Background
June 2018 September 2018
June 2019
June 2019
IMF support
IFRS 9 - Appendix B - Application guidance B5.5.25 In some circumstances, the renegotiation or modification of the contractual cash flows of a financial asset can lead to the derecognition of the existing financial asset in accordance with this Standard. When the modification of a financial asset results in the derecognition of the existing financial asset and the subsequent recognition of the modified financial asset, the modified asset is considered a ‘new’ financial asset for the purposes of this Standard.
31
POCI - GOB Example Modification
B3.3.6 For the purpose of paragraph 3.3.2, the terms are substantially different if the discounted present value of the cash flows under the new terms, including any fees paid net of any fees received and discounted using the original effective interest rate, is at least 10 per cent different from the discounted present value of the remaining cash flows of the original financial liability.
Criteria?
32
POCI - GOB Example Day 1 Accounting
Derecognize
Recognize new instrument
Net Carrying Amount Fair value
Profit and Loss
* Assumption: modification leads to derecognition
IFRS 9 - Appendix B - Application guidance B5.5.26 Accordingly the date of the modification shall be treated as the date of initial recognition of that financial asset when applying the impairment requirements to the modified financial asset. This typically means measuring the loss allowance at an amount equal to 12-month expected credit losses until the requirements for the recognition of lifetime expected credit losses in paragraph 5.5.3 are met. However, in some unusual circumstances following a modification that results in derecognition of the original financial asset, there may be evidence that the modified financial asset is credit-impaired at initial recognition, and thus, the financial asset should be recognized as an originated credit-impaired financial asset. This might occur, for example, in a situation in which there was a substantial modification of a distressed asset that resulted in the derecognition of the original financial asset. In such a case, it may be possible for the modification to result in a new financial asset which is credit- impaired at initial recognition.
33
POCI- GOB Example Derecognision
Credit-impaired financial asset IFRS 9 - Appendix A - Defined terms A financial asset is credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred. Evidence that a financial asset is credit-impaired include observable data about the following events: f) the purchase or origination of a financial asset at a deep discount that reflects the incurred credit losses.
34
POCI- GOB Example Definition
* Assumption: the restructured debt is credit impaired
5.5 Impairment - Purchased or originated credit-impaired financial assets 5.5.13 Despite paragraphs 5.5.3 and 5.5.5, at the reporting date, an entity shall only recognize the cumulative changes in lifetime expected credit losses since initial recognition as a loss allowance for purchased or originated credit-impaired financial assets. 5.5.14 At each reporting date, an entity shall recognize in profit or loss the amount of the change in lifetime expected credit losses as an impairment gain or loss. An entity shall recognize favorable changes in lifetime expected credit losses as an impairment gain, even if the lifetime expected credit losses are less than the amount of expected credit losses that were included in the estimated cash flows on initial recognition. B5.5.45 For purchased or originated credit-impaired financial assets, expected credit losses shall be discounted using the credit-adjusted effective interest rate determined at initial recognition.
35
POCI- GOB Example Lifetime ECL
Credit-adjusted effective interest rate (credit adjusted EIR) Appendix A Defined terms The rate that exactly discounts the estimated future cash payments or receipts through the expected life of the financial asset to the amortized cost of a financial asset that is a purchased or originated credit-impaired financial asset. When calculating the credit-adjusted effective interest rate, an entity shall estimate the expected cash flows by considering all contractual terms of the financial asset (for example, prepayment, extension, call and similar options) and expected credit losses.
36
POCI- GOB Example Credit-Adjusted Effective Interest Rate
37
POCI- GOB Example Credit-Adjusted Effective Interest Rate
Contractual terms of the financial asset Estimated future cash payments Expected credit losses Credit-adjusted effective interest rate
Period Contractual cash flows Expected credit losses Expected cash flows (700) (700) 1 70 70 2 70 70 3 70 (20) 50 4 70 (20) 50 5 1,070 (170) 900 EIR 16% CA – EIR 12%
Thank you!
Disclaimer: This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
Dwayne Rodriguez-Seijas dwayne.rodriguez- seijas@pwc.com