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Agenda 1. NPLs in IFRS terms 2. Practical considerations 3. Harmonisation of IFRS with Banking regulations 4. Important disclosures 5. Looking ahead 6. Conclusion
NPLs in IFRS terms
Financial instruments IAS 32 Financial Instruments: Presentation. A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instruments of another entity A financial asset is any asset that is: cash; an equity instrument of another entity; a contractual right: 1. to receive cash of another financial asset from another entity; or 2. to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity.
Financial instruments (cont d) Common examples of financial assets representing a contractual right to receive cash in future are: trade accounts receivable and payable; notes receivable payable; loans receivable and payable; bonds receivable and payable. Common instruments used by banks for lending loans and advances : Bankers Acceptances; Term loans; Overdrafts Bonds Agrobills, AMA bills
NPLs and IFRS Non performance suggests is an indicators of an impaired loan. Impairment loss events (IAS 39, para 59) include: significant financial difficulty of the issuer or obligor breach of contract (default in interest or principal payments) probable bankruptcy or financial reorganization of the borrower decline in expected future cash flows since inception adverse changes in payment status of borrower national or local economic conditions that correlate with default on the asset
Objective evidence of impairment Impairment requires a loss event (objective evidence of impairment) that occurred after the initial recognition of the asset Provisions for future losses are not allowed The loss event (or events) has an impact on the estimated future cash flows of the (group of) financial asset(s) No impairment provision may be recognised at initial recognition
Impairment loss calculation Difference between: Carrying amount (amortised cost) & Present value of the estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the original effective interest rate Impairment loss to be recognised in profit or loss
Critical impairment loss considerations Expected future cash flows Expected realization period Discounting rate: Original effective interest rate
Expected future cash flows Expected future cash flows How are the cash flows expected to be realized (recovery mode) OR Normal operations Obtain borrower s cash flow projections from ordinary course of business Payment plan BOTH!! Realisation of security Consider valuation and transaction costs
Original Effective Interest Rate Effective interest method calculates amortised cost and allocates interest income or expense over relevant period Effective interest rate exactly discounts estimated future cash flows, without taking account of future credit losses, to the net carrying amount Effective interest rate is calculated on initial recognition Difference between effective interest for a given period and the instrument s coupon and any other cash received is the amortisation
Practical considerations
Practical considerations Significant estimation uncertainty expected future cash flows timing of receipt of cash flows valuation of security (fair value vs forced sale value) time to realization of security Difference between rescheduled and renewed facilities Original effective interest method complexity of calculation (inclusion of other fees) variations in the interest rate may cause significant variances when discounting the expected cash flows e.g. interest rates of up to 40% p.a in 2009/2010 vs interest rates of 13-18% p.a in 2014.
Harmonisation of IFRS and banking regulations
Banking regulations vs IFRS Banking regulations The Bank should ensure that loans are correctly graded and classified in terms of section 22, subsection (c) part (ii) of the Third Schedule of the Banking Regulations, 2000. General provision calculated based on various percentages for each loan classification, as per the Banking Regulations, 2000. IFRS There should be objective evidence that a financial asset measured at amortised cost has been impaired guidance as per para 59 of IAS 39: Financial Instruments Recognition and measurement If any such evidence of impairment exists, the entity shall apply paragraph 63 of IAS 39 to determine the amount of impairment loss based on estimated future cash flows, appropriately discounted.
Banking regulations vs IFRS (cont d) Banking regulations classification of loans can be used to identify impaired loans for IFRS purposes Banking regulations considers recoverable amount from prescribed forms of security only whereas IFRS is based on expected future cash flows Accounting for differences between IFRS provision and regulatory provision IFRS provision > regulatory provision; no further action IFRS provision = regulatory provision; no further action IFRS provision < regulatory provision; full IFRS provision through income statement, difference through general reserve in SCE Similarities in the regulatory risk management disclosures with IFRS
Important disclosures
Disclosures IFRS 7 Financial Instruments: Disclosures applies to all entities for all types of financial instruments as defined by IAS 32, IAS 39 and IFRS 9 Accounting policy on the measurement basis of the financial instruments Reconciliation of changes in credit losses account for each fin. Instrument Fair value of collateral held, including terms and conditions Credit risk, maximum exposure to credit risk, any collateral in place, including age analysis of financial assets Liquidity risk liquidity risk management policies, maturity analysis showing remaining contractual maturities 2011 KPMG, a Zimbabwe partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG Printed in Zimbabwe.
Disclosures (cont d) Disclosure of fair values for each of class of financial assets, including those carried at amortised cost. Where available, the fair value of loans and advances is based on observable market transactions. Where observable market transactions are not available, fair value is estimated using valuation models, such as discounted cash flow techniques. Input into the valuation techniques includes expected lifetime credit losses, interest rates, prepayment rates and primary origination or secondary market spreads. For collateral-dependent impaired loans, the fair value is measured based on the value of the underlying collateral. 2011 KPMG, a Zimbabwe partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG Printed in Zimbabwe. 79
Looking ahead
Moving to IFRS 9 Financial assets to be classified as subsequently measured at either amortised cost or fair value on the basis of; Entity s business model for managing financial assets and Contractual cash flow characteristics of the financial asset. Amortised cost is applied if both of the following conditions are met: The asset is held within a business model whose objective is to holder assets in order to collect contractual cash flows The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding
Moving to IFRS 9 Under the incurred loss model, investments are recognized as impaired when there is no longer reasonable assurance that the future cash flows associated with them will be either collected in their entirety or when due. Entities look for evidence of situations that would indicate impairment, such triggering events include when the entity Under an expected loss impairment model, estimates of future cash flows used to determine the present value of the investment are made on a continuous basis and do not rely on a triggering event to occur. Even though there may be no objective evidence that an impairment loss has been incurred, revised cash flow projections may indicate changes in credit risk. Effective for periods beginning on or after 1 January 2018
Conclusion
NPLs accounted for through application of IAS 32, IAS 39, IFRS 7 and IFRS 9 NPL (regulatory purposes) is equivalent to impaired asset (IFRS) Impairment determination Amortised cost carrying amount PV of expected future cash flows Based on incurred loss model Harmonisation of IFRS and regulatory provision Important disclosures to enable understanding of the fin instruments
Thank you Presentation by : Themba Mudidi Partner, Audit (04) 302600 / 303700 tmudidi@kpmg.com