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 - POCI assets Date 2
Classification and Measurement PwC PwC 3
Financial Liabilities IFRS 9 ✓ Changes in own credit risk in OCI for FVTPL liabilities Amortised cost No changes to classification categories Fair value ✓ Can be adopted in Changes in the fair value of isolation to financial liabilities remainder of IFRS 9 measured at fair value to be recognised in profit or loss PwC PwC 4
Financial assets Classification & Measurement: Equity instruments Investments in all equity instruments Held for trading? Yes No OCI option on initial recognition? No Yes FVOCI, with no recycling* FVTPL *Dividends continue to be taken through P&L PwC 5
Classification & Measurement: Debt instruments The model in 1 page… Is the financial asset held to Is objective of the entity’s achieve an objective by both No No business model to hold the collecting contractual cash financial assets to collect flows and selling financial contractual cash flows? assets? Yes Yes No Do contractual cash flows represent solely payments of principal Fair and interest? value Yes Yes through Yes P&L Does the company apply the fair value option to eliminate an accounting mismatch? No No Amortised cost FV-OCI PwC 6
Reclassification 1 • Required if the business model changes Conditions: • Must be significant to entity’s operations • Must be demonstrable to external parties 2 Point of Next reporting period: Dependent on reclassification: frequency of reporting (eg. annually) 3 Prospective Application: 4 Lengthy delay treatment: Period between and (i) existing assets under previous model reclassification: (ii) new assets under new model Expected to be infrequent PwC 7
What level to define the business model? Factors to consider • Existing hierarchy/structure Entity level • Does it make a difference? • Whole economic cycle Division level This is an assessment of fact capable of being evidenced Business unit level Individual desk / asset level PwC PwC 8
Sales • Definition of a sale: accounting vs legal • Integral vs incidental: o Sales due to increase in credit risk o Sales due to other reasons: More than infrequent; and • • More than insignificant o No bright line: need to understand reason(s) why • Practicalities: • What is an “increase in credit risk”? • Pre-defined reasons • Evidence to be obtained • Identifying complete population of sales PwC 9
Classification and measurement of debt instruments Standalone versus group GROUP Hold to 1 1 ENTITY sell originates mortgages Entity MARKET sell (derecognition) Hold to 2 Securitisation collect 2 vehicle (100% owned) PwC 10
Impairment PwC PwC 11
Impairment of financial assets General model Change in credit quality since initial recognition Stage 1 Stage 2 Stage 3 Underperforming Performing (Assets with significant increase Non-performing (Initial recognition*) in credit risk since initial (Credit impaired assets) recognition* ) Recognition of ECL 12 month ECL Lifetime ECL Lifetime ECL Interest revenue Effective interest on Effective interest on Effective interest on amortised cost carrying gross carrying amount gross carrying amount amount (i.e. net of credit allowance) *except for purchased or originated credit impaired assets PwC Slide 12
Sophistication and proportionality 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: Entity level factors Portfolio level factors Size of portfolio, relative Complexity of Extent of systemic or Level and volatility of to total balance sheet products in the regulatory supervision historical credit losses. and credit exposures portfolio Size of balance sheet Sophistication of lending Extent of relevant data Status as a public and off-balance sheet related modelling available for the interest entity credit exposures methodologies portfolio Listing status and Level of historical Level and volatility of distribution of credit losses potential future credit ownership of issued experienced losses debt and equity securities PwC 13
Impairment Assessment of a significant increase in credit risk Maximum credit risk for a portfolio Absolute probabilities Counterparty are not assessment sufficient Variation Actual or Significant between expected increase in reporting date significant and initial credit risk change in recogntion credit ratings PwC 14
Impairment Information to take into account for assessing increases in credit risk Changes in Changes in Fair value of external business and Changes in Collateral market economic internal indicators conditions price indicators Other qualitative Changes in inputs Changes in credit operating ratings results 30 days past due rebuttable However…. presumption PwC 15
Impairment Operational Simplifications 12-month Option ECL Policy choice Is the asset ‘low credit risk’ at reporting date? Has there been Lifetime a significant Yes ECL increase in credit risk? PwC 16
Some Challenges Faced PwC PwC 17
Common IFRS 9 Challenges Lifetime Expected Credit Loss Estimation Staging criteria Forward looking view Controls and governance Extensive Disclosure Readiness of data Requirements and systems Implication on financial performance and business strategy 18
Some Challenges Faced Determining Probability of Default PwC PwC 19
Determining PD Summary of historical data [from PD listing] [from total loans listing] YEARS AFTER Value of Grand Grade loans 1 2 3 4 5 6 7 Total 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 • Estimating an economic cycle (7 years) • Start with issued loans rather than loans on book IFRS 9 – Financial Instruments 20
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% • Comparing like with like – new loans vs defaults • Defining “default” (90 days) • Applying the PD (years since issue vs remaining life) IFRS 9 – Financial Instruments 21
Determining PD – Simplified Model Point in Time Aging 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 vs Historical Experience 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 IFRS 9 – Financial Instruments 22
Some Challenges Faced Unrated Debt Securities PwC PwC 23
24 Unrated Debt Securities Establish PD Establish LGD Classify Securities - Gather historical - Unsecured debt data - Expected - Business - rating models, recovery model - Transition matrix - Historical - SPPI testing studies Determine Determine Forward Staging EAD Looking PDs - Multiple PDs - Relevant factors - Define SICR - Forecast NBVs - Correlation - Determine - Probability - Forecast staging weight - Probability - Impact IFRS 9 – Financial Instruments PwC
Some Challenges Faced Considering Multiple Scenarios PwC PwC 25
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