ifrs 9 part iii impairment cpd november 2015

IFRS 9 Financial Instruments

Part III: Impairment

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Agenda

• Scope of the impairment requirements• Overview of the impairment requirements• Determining significant increases in credit risk• Measurement of expected credit losses• Interest revenue and credit-impaired financial assets• Reclassified financial assets• Estimates and other judgements• Disclosures (IFRS 7)• Summary• Effective date and transition

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Scope of the impairment requirements

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Scope of the impairment requirements

Scope

Financial assets

measured at FVOCI

Lease receivables

Trade receivables and contract

assets

Loan commitments and financial

guarantee contracts not measured at

FVTPL

Financial assets

measured at amortised cost

Overview of the impairment requirements

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Change in credit risk since initial recognition

Interest revenue

Gross basis

‘Performing’ ‘Under-performing’ ‘Non-performing’

Impairment recognition

12-monthexpected credit losses

Lifetimeexpected credit losses

Overview of the impairment requirements

Stage 1 Stage 2 Stage 3

Lifetimeexpected credit losses

When significant increase in credit risk occurs

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Gross basis Net basis

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12-month & lifetime expected credit lossesDefinitions

What are 12-month ECL? What are lifetime ECL?

Portion of lifetime ECL representing lifetime cash shortfalls that will result if a default occurs in 12 months weighted by

probability of that default occurring

ECL that result from all possible default events over the expected life of a

financial instrument

Expected credit losses (ECL) - weighted average of credit losses with the respective risks of a default occurring as the weights

Credit loss - difference between all contractual cash flows that are due to an entity in accordance with the contract and all the cash flows that the entity expects to receive (ie all cash shortfalls), discounted at the original effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-impaired financial assets)

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When to recognise 12-month expected credit losses?• No significant increase in credit risk since initial recognition; or• Low credit risk (for example, ‘investment grade’)

When to recognise lifetime expected credit losses?

• Underperforming assets, ie a significant increase in credit risk since initial recognition

• Non-performing assets, ie asset is credit-impaired

Expected credit losses will be recognised for all financial instruments in scope at all times

12-month vs lifetime expected credit lossesWhen to recognise

Determining significant increases in credit risk

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Determining significant increases in credit risk

• Change in credit risk over the life of the instrument - ie risk of a default occurring (not changes in expected credit losses)

– No definition of default, but rebuttable presumption that no later than 90 days past due– Maturity matters

• Compare to credit risk at initial recognition– consider reasonable and supportable information, that is available without undue

cost or effort, that is indicative of significant increases in credit risk

• Financial instruments that have low credit risk at the reporting date (eg investment grade) – may assume credit risk has not increased significantly

• More than 30 days past due – rebuttable presumption that credit risk has increased significantly since initial consideration

• Where default patterns are not concentrated at a specific point, changes in risk of default over the next 12 months may be used if they are a reasonable approximation of the changes in the lifetime risk of a default occurring

Expected credit losses are updated at each reporting date for new information and changes in expectations even if deterioration is not significant

Examples of factors to consider when assessing for a significant increase in risk

• Significant change in what would charge for credit risk now because of changes in credit risk since initial recognition

• Changes in external market indicators of credit risk eg CDS levels for obligor

• Actual or expected change in internal or external credit rating• Actual or expected increase in the risk of default on another

facility with the same obligor• An actual or expected significant change in the operating results

of a borrower• Changes in how the bank manages the credit risk on the

instrument• Past due information

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Example 1:* assessing significant increases in credit risk since initial recognitionSignificant increase in credit risk

* Refer to Example 1 in paragraph IE7-IE11 of IFRS 9 Financial Instruments © IFRS Foundation

• Bank X provides a tranche of a senior secured loan facility to Company Y.

• At the time of origination of the loan: – It was expected that Company Y would be able to meet the covenants for the life of

the instrument. – Generation of revenue and cash flow was expected to be stable in Company Y’s

industry over the term of the senior facility. However, there was some business risk related to the ability to grow gross margins within its existing businesses.

• At initial recognition, Bank X considers that the loan is not an originated credit-impaired loan.

• Subsequent to initial recognition: – Company Y has underperformed on its business plan for revenue generation and net cash flow

generation due to macroeconomic changes.– Company Y has increased its leverage ratio – Company Y is now close to breaching its covenants– Trading prices for Company Y’s bonds have decreased, market spreads have increased, not

explained by changes in the market environment – Bank X expects a further deterioration in the macroeconomic environment

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Example 2:* assessing significant increases in credit risk since initial recognitionNo significant increase in credit risk

• Company C, is the holding company of a group that operates in a cyclical production industry.– The group structure is complex and has been subject to change, making it difficult for investors to analyse

the expected performance of the group and to forecast cash available at holding company level.

• Bank B provided a loan to Company C when prospects for the industry were positive.• However, a potential decrease in sales was anticipated due to the point in the cycle. • At the time that Bank B originates the loan:

– Creditors are concerned about Company C’s ability to refinance its debt. – Company C’s leverage was in line with that of other customers with similar credit risk. – Headroom on its coverage ratios before triggering a default is high.

• On initial recognition, Bank B determines that the loan is subject to considerable credit risk, has speculative elements and uncertainties affecting Company C including the group’s uncertain prospects for cash generation which could lead to default.

– Loan not considered by Bank B to be originated credit-impaired. • Subsequent to initial recognition, Company C has announced that three of its five key subsidiaries

had a significant reduction in sales volume but were expected to improve in following months. – Sales of the other two subsidiaries were stable.

• Company C announced a corporate restructure, which will increase the flexibility to refinance existing debt and the ability of the operating subsidiaries to pay dividends to Company C.

* Refer to Example 2 in paragraph IE12-IE17 of IFRS 9 Financial Instruments

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Example 3:* assessing significant increases in credit risk since initial recognition (low credit risk)Highly collateralised financial asset

• Company H owns real estate assets → financed by a five-year loan from Bank Z.– Loan-to-value (LTV) ratio = 50%. – secured by a first-ranking security over the real estate assets. – At initial recognition, the loan is not considered to be originated credit-impaired.

• Subsequent to initial recognition: – Revenues and operating profits of Company H have decreased due to an economic

recession. – Expected increases in regulations have the potential to further negatively affect revenue and

operating profit. – These negative effects could be significant and ongoing.

• As a result, Company H’s free cash flow is expected to be reduced to the point that the coverage of scheduled loan payments could become tight. Bank Z estimates that a further deterioration in cash flows may result in Company H missing a contractual payment on the loan and becoming past due.

• Recent third party appraisals have indicated a decrease in the value of the real estate properties, resulting in a current LTV ratio of 70%.

* Refer to Example 3 in paragraph IE18-IE23 of IFRS 9 Financial Instruments © IFRS Foundation

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Determining significant increases in credit riskCollective and individual assessment basis

• Assessment of significant increases in credit risk since initial recognition may be performed on a collective basis – eg retail loans

• Use relevant, reasonable and supportable forward-looking information (if available without undue cost or effort) to assess changes in credit risk

• If no reasonable and supportable information available without undue cost or effort to measure lifetime expected credit losses on an individual instrument basis – measure on a collective basis

• Grouping financial instruments for collective assessment – examples of shared credit risk characteristics:

– instrument type, credit risk ratings, collateral type, date of initial recognition, remaining term to maturity, industry, geographical location of the borrower, the value of collateral relative to the financial asset if it has an impact on the probability of a default occurring (for example, non‐recourse loans in some jurisdictions or loan-to-value ratios).

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Example 4:* assessing significant increase in credit risk on a collective basis

Bank ABC provides mortgages to finance

residential real estate in a specific area

The area includes a mining community - largely

dependent on the export of coal and related products

Significant decline in coal exports occurs and the closure of several coal

mines is expected

The risk of a default occurring on mortgage

loans to borrowers who are employed by the coal mines

is determined to have increased significantly

* Refer to Example 5 in paragraph IE38 of IFRS 9 Financial Instruments

Bank ABC segments its mortgage portfolio on the basis of industries of borrowers’ employment – ie a shared credit risk characteristic

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Modified financial assets

Compare:

Risk of default at reporting date

(based on modified contractual terms)

andRisk of default at initial recognition

(based on original, unmodified contractual terms)

Assess whether there has been a significant increase in credit risk

Contractual cash flow renegotiated or modified and not derecognised

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Exceptions to the general model

Trade receivables

Contract assets within the scope

of IFRS 15

Loss allowance = lifetime

expected credit losses

(simplified approach)

Trade receivables and lease

receivables

Contract assets within the scope

of IFRS 15

Accounting policy choice: simplified

approach or monitor

significant increase in credit

risk

• Simplified approach for trade receivables, contract assets and lease receivables

Do not contain significant financing component

Contain significant financing component

• Assets credit-impaired on initial recognition Use credit-adjusted effective interest rate Allowance balance represents changes in lifetime losses since initial recognition

Measurement of expected credit losses

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Measurement of expected credit losses (ECL)

ECL are a probability-weighted estimate of credit losses (ie the present value of all cash shortfalls) over the expected life of the financial instrument:

• Maximum period is the maximum contractual period of exposure to credit risk o Include cash flows expected from collateral and other credit enhancements that are part of contractual terms

• Unbiased and probability-weighted outcome: must consider possibility that credit loss will/will not occur

Past events Current conditions Future economic conditions

• Time value of money – discount at effective interest rate or an approximation thereof

+ +

Particular measurement methods are not prescribed

ECL shall be measured in a way that reflects:

• Reasonable and supportable information: available without undue cost or effort at the reporting date, reflecting:

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Loan commitments and financial guarantees• Undrawn loan commitments: credit loss = present value of difference between

– contractual cash flows due to the entity if loan commitment drawn and– cash flows expected if the loan is drawn down

• For loan commitments & financial guarantee contracts - maximum period to consider = contractual period over which an entity has a present contractual obligation to extend credit

• But, if financial instrument has both a loan and an undrawn commitment component and contractual ability to demand repayment and cancel undrawn commitment (ie revolving credit facilities, such as credit cards and overdraft facilities)

– measure expected credit losses beyond contractual period during which exposed to credit risk and would not be mitigated by credit risk management actions

• Financial guarantee contract– cash shortfalls = expected payments to reimburse the holder for a credit loss that it

incurs less any amounts that the entity expects to receive – If the asset is fully guaranteed - estimation of cash shortfalls would be consistent

with the estimations of cash shortfalls for the asset subject to the guarantee

• Include information about past events, current conditions and forecasts of future economic conditions.

• Borrower-specific factors: changes in operating results of borrower, technological advances that

affect future operations, changes in collateral supporting obligation

• Macroeconomic factors: house price indexes, GDP, household debt ratios

• The data sources could be:• Internal data - credit loss experience and ratings

• External data - ratings, statistics or reports

23Reasonable and supportable information

Historical information can be used as a base but must be updated to reflect current conditions and future forecasts

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Example 5:* recognition and measurement of expected credit losses12-month expected credit loss measurement using an explicit ‘probability of default’ approach


• Assume recognition of lifetime expected credit losses appropriate • Entity B acquires a portfolio of 1,000 five-year bullet loans for CU1,000 each

(ie CU1million in total). – average 12-month PD = 0.5% for the portfolio. – Entity B uses changes in the lifetime PD to determine whether the

credit risk of the portfolio has increased significantly since initial recognition because the loans have significant payment obligations beyond the next 12 months.

• Entity B determines → no significant increase in credit risk since initial recognition and estimates that the portfolio has an average LGD of 25%.

• The 12-month PD remains at 0.5% at the reporting date. • Entity B measures the loss allowance on a collective basis at an amount

equal to 12-month expected credit losses based on the average 0.5% 12‐month PD.

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Example 6:* Practical expedientProvision matrix

• Company M, a manufacturer, has a portfolio of trade receivables of CU30 million in 20X1 and operates only in one geographical region.

• The customer base consists of a large number of small clients.• Trade receivables are categorised by common risk characteristics reflecting

customers’ abilities to pay all amounts due in accordance with the contractual terms.

• The trade receivables do not have a significant financing component. • Loss allowance = lifetime time expected credit losses. • A provision matrix is used to determine the expected credit losses for the

portfolio, based on its historical observed default rates over the expected life of the trade receivables and is adjusted for forward-looking estimates.

– In this case, it is forecast that economic conditions will deteriorate over the next year.


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Current 1–30 dayspast due

31–60 days past due

61–90 days past due

More than 90 days

past due

Default rate 0.3% 1.6% 3.6% 6.6% 10.6%

* Refer to Example 12 in paragraph IE74 of IFRS 9 Financial Instruments

Example 6:* Practical expedientProvision matrix (continued)

Company M estimates the following provision matrix:

Gross carrying amount Default rate Lifetime ECL allowanceCU CUA B AxB

Current 15,000,000 0.3% 45,000

1–30 days past due 7,500,000 1.6% 120,00031–60 days past due 4,000,000 3.6% 144,00061–90 days past due 2,500,000 6.6% 165,000More than 90 days past due 1,000,000 10.6% 106,000

30,000,000 580,000

Interest revenue and credit-impaired financial

assets

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Interest revenue and credit-impaired financial assets

Interest calculated on the gross carrying amount (ie before adjusting for

any loss allowance)(Stages 1 and 2)

Change to net basis (ie amortised cost amount adjusted

for any loss allowance) for financial assets that

subsequently become credit-impaired (Stage 3)

Financial assets are credit-impaired when one or more events that have a detrimental impact on estimated future cash flows have occurred

Interest on gross carrying amount if financial assets no

longer credit-impaired

(Stages 1 and 2)

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Credit-impaired financial assetsEvidence

Significant financial difficulty of the issuer or the borrower

Breach of contract, eg default or past due event

Borrower granted a concession that the lender(s) would not otherwise consider

Probable that the borrower will enter bankruptcy or other financial reorganisation

Disappearance of an active market for that financial asset because of financial difficulties

Purchase or origination of a financial asset at a deep discount that reflects the incurred credit losses

Single event or combined effect of several events

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Reclassified financial assetsMeasurement of expected credit losses (ECL)

Reclassification to

Fair value through profit or loss

Fair value through OCI Amortised cost

Reclassification from

Fair value through profit or loss

Consider only changes in credit risk since date of reclassification

Fair value through OCI

Not applicable – financial assets

measured at FVTPL do not carry a loss allowance

• Use same effective interest rate Measurement of ECL unchanged

• Loss allowance = adjustment to gross carrying amount

Amortised cost

• Use same effective interest rate • Measurement of ECL

unchanged• Derecognise loss allowance • Any adjustment to the gross

carrying amount → recognise as an accumulated impairment in OCI and disclose at reclassification date

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Example 7:* reclassification of financial assets from FVTPL to amortised cost

• Entity A purchases a portfolio of bonds: FV (gross carrying amount) = CU500,000.• Business model for managing the bonds changes – Entity A reclassifies into the amortised

cost measurement category• FV of the portfolio of bonds at the reclassification date = CU490,000.• 12-month expected credit losses at reclassification date = CU4,000.

* Refer to Example 15 in paragraph IE104-IE107, IE110 of IFRS 9 Financial Instruments

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Debit Credit

Bonds (gross carrying amount of the amortised cost assets)

CU490,000

Bonds (FVPL assets) CU490,000

Impairment loss (P&L) CU4,000

Loss allowance CU4,000

The impairment requirements apply to the bond from the reclassification date.

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Main judgements and estimates in applying IFRS 9

Impairment • Determining whether there is a significant

increase in credit risk since initial recognition • Measurement of expected credit losses (ECL)

• Determining whether loans will be paid as due – and, if not, how much might be recovered and when

• Probability-weighting different scenarios• Appropriately incorporating forward-looking

information into the assessment of changes in credit risk and measurement of ECL• Determining whether a collective or individual and

collective assessment is needed for portfolios of shared risk characteristics

• Determining the appropriate period over which to measure ECL for revolving credit facilities

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Disclosures (IFRS 7)

Quantitative Qualitative

• Reconciliation of allowance accounts showing key drivers for change

• Basis of inputs, assumptions and estimation techniques used to:

o Measure 12-month and lifetime expected credit losses

o determine ‘significant increase in credit risk’ o determine ‘credit-impaired’

• Explanation of gross carrying amounts showing key drivers for change

• How forward-looking information has been incorporated

• Gross carrying amount by credit risk rating grades

• Changes in estimation techniques or significant assumptions made and reasons for changes

• Maximum exposure to credit risk (net of collateral) and collateral for credit impaired financial assets

• Basis for grouping if expected credit losses were measured on a collective basis

• Modification to contractual cash flows • Entity’s default definition and reasons for selecting those definitions

• Contractual amount outstanding for assets written off but still subject to enforcement activity

• Write off policies, modification policies, collateral

Objective: enable users of financial statements to understand the effect of credit risk on the amount, timing and uncertainty of future cash flows

Credit risk disclosures → refer to IFRS 7 Financial Instruments: Disclosures paragraphs 35F–35N.

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Application of the impairment requirements on a reporting dateSummary

Is the financial instrument a purchased or originated credit-impaired financial asset?

Is the simplified approach for trade receivables, contract assets and lease

receivables applicable?

Does the financial instrument have low credit risk at the reporting date?

Has there been a significant increase in credit risk since initial recognition?

Recognise lifetime expected credit losses

Is the financial instrument a credit-impaired financial asset?

Calculate a credit-adjusted effective interest rate and always

recognise a loss allowance for changes

in lifetime expected credit losses

Is the low credit risk simplification applied?

Recognise 12-month expected credit losses and calculate interest

revenue on gross carrying amount

Calculate interest revenue on amortised

cost

Calculate interest

revenue on the gross carrying amount

No

No

No

Yes

And

Yes

Yes

No

No

YesNo

Yes

Yes

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• Retrospective application required but transition reliefs provided• On transition determine if instruments are at stages 1,2 or 3 unless not

possible to determine initial credit risk without undue cost or effort– If initial credit risk not used, recognise lifetime expected credit losses unless

low credit risk

• Permit but not require restatement of comparatives– Restate if, and only if, it is possible without the use of hindsight

• Disclose information that would permit the reconciliation of the ending impairment allowances in accordance with IAS 39 and the provisions in accordance with IAS 37 to the opening loss allowances determined in accordance with IFRS 9

• ‘Impracticable’ exemption for interim periods

Effective date and transition

Annual periods beginning on or after 1 January 2018 (early application of completed (whole) version permitted)

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Transition Resource Group for Impairment of Financial Instruments (‘ITG’)

• New expected credit loss model = a fundamental change• Significant implementation implications• ITG provides a public forum for stakeholders to learn about the new impairment

requirements from others involved with implementation• ITG discusses questions from stakeholders about the new impairment

requirements• Members = financial statement preparers & auditors • ITG informs the IASB about implementation issues

– Help the IASB determine what, if any, action will be needed to address those issues

• ITG does NOT issue guidance• ITG was established in 2014 and will have a limited life during the

implementation period

See: http://www.ifrs.org/About-us/IASB/Advisory-bodies/ITG-Impairment-Financial-Instrument/Pages/Home.aspx

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