IFRS 9: Modification of Financial Assets. Vojvodjanska Banka May 26, 2017

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1 IFRS 9: Modification of Financial Assets Spyridon Ntallas, CFO ASB Bank FinIng, Palic Vojvodjanska Banka May 26, 2017

2 Agenda 1 Modifications Overview 2 Derecognition 3 Purchased or Originated Credit Impaired (POCI) 4 Modification Gain/Loss 5 Corporate Governance

3 Modifications overview

Credit Impaired Financial Assets (POCI) EIR Credit adjusted EIR PD SICR Fair Value Modification gain or loss

4 Why modifications are important? Classification Measurement Disclosures Governance Data - IT SPPI Business Model Purchased or Originated Credit Impaired Financial Assets (POCI) EIR Credit adjusted EIR PD SICR Fair Value Modification gain or loss IAS 1 Presentation of Financial Statements IFRS 7 Financial Instruments: disclosures Decision making process Planning Business decisions Write-offs Accounting vs Customer position Data warehouse

5 Modifications Overview Commercial Modification gain/loss Adjusted gross carrying amount Re-estimated PD (?) NO DERECOGNITION Forbearance Modification gain/loss Adjusted gross carrying amount Re-estimated PD (?) Commercial Fair Value Classification Measurement New original EIR Substantial Modification? DERECOGNITION Forbearance Fair Value Classification (POCI?) Measurement New original EIR

6 Derecognition

7 Modifications Overview Commercial Modification gain/loss Adjusted gross carrying amount Re-estimated PD (?) NO DERECOGNITION Forbearance Modification gain/loss Adjusted gross carrying amount Re-estimated PD (?) Commercial Fair Value Classification Measurement New original EIR Substantial Modification? DERECOGNITION Forbearance Fair Value Classification (POCI?) Measurement New original EIR

8 Derecognition of Financial Assets under IFRS 9 expiry transfer modification Write-off

Derecognition of modified financial assets The derecognition

unchanged Qualitative & quantitative assessment IFRS 9 & IAS 39

modified assets No appetite from IASB members to provide

Interpretations Committee Meeting, Project IFRS 9 Financial

9 Derecognition of modified financial assets The derecognition requirements in IFRS 9 were brought forward from IAS 39 unchanged Qualitative & quantitative assessment IFRS 9 & IAS 39 No specific guidance in IFRS 9 or IAS 39 about derecognition of modified assets No appetite from IASB members to provide guidance on the derecognition of modified assets Source: IFRS Interpretations Committee Meeting, Project IFRS 9 Financial Instruments/IAS 39 Financial Instruments: Recognition and Measurement, November 2015

the original asset (SPPI test, business model); Impairment requirements may differ; significant increases in

10 Does it matter whether modified assets are derecognised? Newly recognised modified financial assets may be classified on a different measurement basis from that of the original asset (SPPI test, business model); Impairment requirements may differ; significant increases in credit risk are determined from the date of initial recognition of the financial asset; Purchased or Originated Credit Impaired (POCI): Life-Time ECL till maturity

11 Derecognition rules: best practices in Europe A restructuring of a financial asset with the same lender on substantially different terms, qualitative and quantitative - generally a 10% difference in the present value of the cash flows - is accounted for as an expiration of the financial asset and recognition of a new financial asset. If an existing financial asset is replaced by another asset from the same counterparty on substantially different terms, or if the terms of the financial asset are substantially modified (due to forbearance measures or otherwise),the existing financial asset is derecognized and a new asset is recognized. Deutsche Bank ABN AMRO HSBC On renegotiation, where the existing agreement is cancelled and a new agreement is made on substantially different terms, or if the terms of an existing agreement are modified such that the renegotiated loan is substantially a different financial instrument, the loan would be derecognised and recognised as a new loan for accounting purposes.

12 Substantial modification? Qualitative analysis Principle based Judgmental Substantial modification? IAS 8, par. 11 Similar to 10% test for liabilities Quantitative analysis Different rules to be implemented by Banks How to enhance comparability for the benefit of investors and other market participants?

13 Qualitative Analysis: a few examples Substantial modifications No substantial modifications Change in Currency Fixed to Floating Floating to Fixed Extension of loan maturity Decrease in interest rate of the loan Debt Equity conversion Change in obligor (third party) Acceptance of collateral Significant change in the Risk and Cash Flow Profile Change to loan covenants Change in obligor (same Group) Depend on market conditions and expectations

14 IFRS 9 disclosures on derecognition Source: IFRS 9 for Banks, illustrative disclosures, PwC, February 2017

15 Modifications and ECL ANALYSIS IFRS 9, par. B5.5.25: 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 ; 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 are met; Exemption: Purchased or Originated Credit-impaired Financial Assets (POCI).

16 Purchased or Originated Credit Impaired (POCI)

POCI Financial Assets 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; Always

17 POCI Financial Assets 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; Always outside general deterioration model Use credit-adjusted effective interest rate No day 1 allowance balance & impairment loss Allowance balance represents changes in LT loss expectations An impairment gain may be recognised affecting the gross carrying amount

18 POCI: example Company A receives a loan from Bank OMEGA Loan origination date: 1 January 2018 Loan: EUR r: 8% n: 10 years Balloon payment upon maturity Financial difficulties of A in Dec 2023 Loan in modified in Dec 2023, without any change in the contractual CFs Bank OMEGA expects to receive EUR at the end of 2025 Loan is credit impaired upon initial recognition due to significant financial difficulties of Company A Bank OMEGA calculates the Fair Value of the Loan and the underlying EIR Bank OMEGA calculates the credit-adjusted EIR based on the expected CFs The credit adjusted EIR should be used for the interest recognition of the new loan

19 POCI: example - continued Fair Value Accounting and Risk estimate the Fair Value (FV) of the loan based on the Contractual CFs (CoCFs) Credit-adjusted EIR Accounting estimate the credit-adjusted EIR using the Expected CFs (ExCFs) FV = (CoCFs ; EIR*) Credit-Adjusted EIR = (FV ; ExCFs) FV = (CoCFs ; 70,1%) Credit-adjusted EIR= (3.000 ; ExCFs) FV = EUR Credit-adjusted EIR = 15,5% * Including cost of risk of the impaired loan

POCI: example - continued Bank OMEGA Reporting periods: 2024-2025 Loan (EUR): 3.

20 POCI: example - continued Bank OMEGA Reporting periods: Loan (EUR): EUR Credit-adjusted EIR: 15,5% Bank OMEGA - Accounting Position Year Carrying amount Interest Income Cash Flow Carrying amount B/fw Credit-adjusted EIR 15,5% C/fw

POCI: example - continued At the end 2024, based on reasonable and supportable evidence, the cash flow expected to be received on the instrument increased to 4.

21 POCI: example - continued At the end 2024, based on reasonable and supportable evidence, the cash flow expected to be received on the instrument increased to EUR (still to be received at the end of 2025) Balance Sheet Income Statement Dr Cr Dr Cr Gross Loan 217 Credit Impairment Losses 217 Bank OMEGA - Accounting Position Year Carrying amount Interest Income Cash Flow Carrying amount B/fw Credit-adjusted EIR 15,5% C/fw

22 POCI & Forbearance: Paradox Purchased or originated creditimpaired (POCI) financial assets should remain at this category till maturity; therefore, will be treated as credit impaired for accounting purposes only at all times; POCI Credit impaired At all times! Under specific conditions, FNPEs may be reclassified as FPEs, if one year has passed since the forbearance measures were extended; Therefore, a loan may be categorized as credit impaired at origination for accounting purposes, and simultaneously classified as FPE or PE.

23 Disclosures IFRS 7 par 35(I) To enable users of financial statements to understand the changes in the loss allowance disclosed in accordance with paragraph 35H, an entity shall provide an explanation of how significant changes in the gross carrying amount of financial instruments during the period contributed to changes in the loss allowance. Source: IFRS 9 for Banks, illustrative disclosures, PwC, February 2017

24 Disclosures-continued IFRS 7 par 35(H)(c) [ ] a reconciliation from the opening balance to the closing balance of the loss allowance, in a table, showing separately the changes during the period for financial assets that are purchased or originated credit-impaired. An entity shall disclose the total amount of undiscounted expected credit losses at initial recognition on financial assets initially recognised during the reporting period. Source: IFRS 9 for Banks, illustrative disclosures, PwC, February 2017

25 Disclosures-continued IFRS 7 par 35(M) [ ] an entity shall disclose, by credit risk rating grades, the gross carrying amount of financial assets and [ ] Source: IFRS 9 for Banks, illustrative disclosures, PwC, February 2017

26 Modification Gain/Loss

27 Modifications Overview Commercial Modification gain/loss Adjusted gross carrying amount Re-estimated PD (?) NO DERECOGNITION Forbearance Modification gain/loss Adjusted gross carrying amount Re-estimated PD (?) Commercial Fair Value Classification Measurement New original EIR Substantial Modification? DERECOGNITION Forbearance Fair Value Classification (POCI?) Measurement New original EIR

Modifications: IFRS 9 vs IAS 39 IFRS 9 5.4.3 [...], an entity shall recalculate the gross carrying amount of the financial asset and shall recognise a modification gain or loss in profit or loss.

28 Modifications: IFRS 9 vs IAS 39 IFRS [...], an entity shall recalculate the gross carrying amount of the financial asset and shall recognise a modification gain or loss in profit or loss. IAS 39 AG8 If an entity revises its estimates of payments or receipts, the entity shall adjust the carrying amount of the financial asset [ ]. The entity recalculates the carrying amount [ ]. The adjustment is recognised in profit or loss as income or expense.

B/fw Interest Income EIR 10% Cash Flow Carrying amount C/fw t0 1.

29 Modifications: example Loan (EUR) EIR 10% n 5 years Accounting Position Year Carrying amount B/fw Interest Income EIR 10% Cash Flow Carrying amount C/fw t t t t t t

Modifications: example - continued Modification for commercial purposes at the end of year 2 NEW interest rate: 7% Balance Sheet Income Statement Dr Cr Dr Cr Modification

30 Modifications: example - continued Modification for commercial purposes at the end of year 2 NEW interest rate: 7% Balance Sheet Income Statement Dr Cr Dr Cr Modification loss 34 Gross Loan 34 Accounting Position Year Carrying amount Interest Income Cash Flow Carrying amount B/fw EIR 10% NEW C/fw

instrument in accordance with paragraph 5.

31 SICR: modified assets IFRS : [.] an entity shall assess whether there has been a significant increase in the credit risk of the financial instrument in accordance with paragraph by comparing: Reporting Date (a) the risk of a default occurring at the reporting date (based on the modified contractual terms); Initial Recogniton (b) the risk of a default occurring at initial recognition (based on the original, unmodified contractual terms).

32 Disclosures IFRS 7.35(F)(f) How the requirements in paragraph of IFRS 9 for the modification of contractual cash flows of financial assets have been applied, including how an entity: i. determines whether the credit risk on a financial asset that has been modified while the loss allowance was measured at an amount equal to lifetime expected credit losses, has improved to the extent that the loss allowance reverts to being measured at an amount equal to 12-month expected credit losses in accordance with paragraph of IFRS 9; and ii. monitors the extent to which the loss allowance on financial assets meeting the criteria in (i) is subsequently re-measured at an amount equal to lifetime expected credit losses in accordance with paragraph of IFRS 9.

33 Disclosures - continued IFRS 7.35(I)(b) [...] the modification of contractual cash flows on financial assets that do not result in a derecognition of those financial assets in accordance with IFRS 9.

34 Disclosures - continued Source: IFRS 9 for Banks, illustrative disclosures, PwC, February 2017

35 Disclosures - continued IFRS 7.35(J) [...], an entity shall disclose: (a) the amortised cost before the modification and the net modification gain or loss recognised for financial assets for which the contractual cash flows have been modified during the reporting period while they had a loss allowance measured at an amount equal to lifetime expected credit losses; and (b) the gross carrying amount at the end of the reporting period of financial assets that have been modified since initial recognition at a time when the loss allowance was measured at an amount equal to lifetime expected credit losses and for which the loss allowance has changed during the reporting period to an amount equal to 12-month expected credit losses.

36 Disclosures - continued Source: IFRS 9 for Banks, illustrative disclosures, PwC, February 2017

37 Corporate Governance

Frequent interaction with the Board of Directors and Audit Committee

38 Governance: general principles Early involvement with auditors and interaction with regulators on key decisions Corporate Governance Frequent interaction with the Board of Directors and Audit Committee Clear decision-making criteria, within project committee and other corporate governance bodies

39 Corporate Governance: Basel Committee The lending staff promptly notifies the accounting function when exposures are modified to ensure appropriate accounting for the change For more complex restructurings and modifications, regular communication between the lending staff and the accounting function is warranted

40 Promoting a ONE-TEAM Culture IFRS 9 represents a transformational change for financial institutions; Promoting a ONE TEAM culture and continuous communication are key for overcoming all implementation challenges; Risk and Finance as integrated functions should work closely more than ever.

Financial Instruments. October 2015 Slide 2

Financial Instruments. October 2015 Slide 2 Presented by: Cost transaction price (in general) Amortised Cost (B/s) EIR - Effective interest method (I/s) OCI - Other Comprehensive Income FVTPL Fair value through profit or loss FVOCI Fair value through