Measuring the Impact of IFRS 9 A Case Study Carlo Gabardo 30 November 2016 Experian and the marks used herein are service marks or registered trademarks of Experian Limited. Other products and company names mentioned may be the trademarks of their respective owners. No part of this copyrighted work may be reproduced, modified, or distributed in any form or manner without prior written permission of Experian Limited. Experian Public.
Our Simulation Objectives and Assumptions OBJECTIVES ASSUMPTIONS Measure the amount of underperforming loans (Stage 2) according to the new IFRS 9 requirements Measure the impact on provisions in the banking sector Define solutions to mitigate the impact on provisions of the new standards Wide sample of Residential Real Estate loans and Commercial Real Estate Loans (the latter secured and unsecured) from the Experian Italian Credit Bureau open as of 31/12/ Life-time PD using Markov s chains LGD using a benchmark model* Estimates under different macroeconomic scenarios (*) Provided by our partner CERVED GROUP Experian. Public. 2
Our Simulation The Sample (from Basel STD banks) RESIDENTIAL COMMERCIAL 80,000 9 BL Accounts Exposure 45,000 (30,000 unsecured) 7 BL (70% secured) 17 years average term at origination 13 years average time to maturity Term 8 years average term at origination 7 years average time to maturity Experian. Public. 3
Our Simulation The Macro Scenarios* We have used two scenarios to simulate the impact on lifetime loss and provisions The scenarios can be customises and much more articulated Baseline Scenario 2016 2017 2018 GDP 0,7% 1,1% 1,3% 1,6% Interbank Rate 3,7% 3,0% 2,6% 2,6% Inflation 0,1% 1,0% 1.9% 2,8% Unemployment 11,9% 11,8% 11,6% 11,1% Stress Scenario 2016 2017 2018 GDP 0,7% -0,5% -1,0% -0,1% Interbank Rate 3,7% 3,9% 3,6% 3,5% Inflation 0,1% 0,1% -0,1% 0,4% Unemployment 11,9% 11,9% 13,1% 13,9% (*) Provided by our partner CERVED GROUP Experian. Public. 4
Impact of IFRS 9 (Residential RE) Staging (Portfolio Split Across the 3 Buckets ) Stage 2 is ca. 6% of the total exposure 2,5% 3,4% 6,1% 6,3% 91,4% 90,3% Stage 3 Stage 2 Stage 1 3 delinquent instalments 1 or 2 delinquent instalments Credit Bureau Score (Delta PD>5%) Regular/ Performing Accounts Exposure Source: Experian. Situation at 31.12. Experian. Public. 5
Impact of IFRS 9 (Residential RE) Impact on Provisions (vs. IAS39) For stage 2, there is a 178% increase in provisions Stage 2 Stage 1 + Stage 2 +178% +62% IAS39 IAS39 Experian. Public. 6
Impact of IFRS 9 (Residential RE) Macro Scenarios Under a stressed macroeconomic scenario the impact is much larger Stage 2 Stage 1 + Stage 2 +274% +95% +178% +62% IAS39 baseline stress IAS39 baseline stress Experian. Public. 7
Impact of IFRS 9 (Commercial RE) Staging (Portfolio Split Across the 3 Buckets ) Stage 2 is ca. 16% of the total exposure 8,6% 11,7% Stage 3 3 delinquent instalments 17,3% 15,7% Stage 2 1 or 2 delinquent instalments Score CGS-x (Delta PD>5%) 74,1% 72,6% Stage 1 Regular/Performing Accounts Exposure Source: Experian and Cerved. Situation at 31.12. Experian. Public. 8
Impact of IFRS 9 (Commercial RE) Macro Scenarios Large increase in provisions under both baseline and stressed scenarios Stage 1 + Stage 2 +134% Main reasons for such larger impact on corporate loans: +118% Stage 2 is 16% of total exposure vs. 6% for Residential IAS39 baseline stress Much higher LGD (up to 75% for unsecured Commercial RE loans vs. ca. 30% for Residential mortgages) Experian. Public. 9
Mitigation (Residential RE) Intercepting the Risk of Rolling to Stage 2 For Residential RE loans CB scores were able to early intercept a very large share of the accounts still regular with their bank but becoming underperforming after 3 or 6 months 1,6 56,3% 1,2 58,1% 100 Regular with the Bank At least 1 ins. past due Share of exposures with low Credit Bureau Score (6 months earlier) 100 Regular with the Bank At least 1 ins. past due Share of exposures with low Credit Bureau Score (3 months earlier) 30/06 31/12 30/09 31/12 Experian. Public. 10
Mitigation (Commercial) Intercepting the Risk of Rolling to Stage 2 Also for Commercial RE loans, CGS-X* scores were able to early intercept a very large share of the accounts still regular with their bank but becoming underperforming after 3 or 6 months 4,2 61,1% 3,2 69,5% 100 Regular with the Bank At least 1 ins. past due Share of exposures with low Credit Bureau Score (6 months earlier) 100 Regular with the Bank At least 1 ins. past due Share of exposures with low Credit Bureau Score (3 months earlier) 30/06 31/12 30/09 31/12 (*) Includes commercial payments, public company info, financial info, CB scores etc. Experian. Public. 11
Overall Impact of IFRS 9 Sum of Residential RE and Commercial RE The overall impact on provisions is large (even though is consistent with IAS Board s members expectations) +134% Stage 2 Stage 1 + Stage 2 +99% IAS39 IAS39 Experian. Public. 12
Possible mitigation Residential RE + Commercial RE Improvement of credit management and monitoring process can significantly reduce the impact Stage 1 + Stage 2 +44% +99% Assuming that early interception of underperforming accounts can successfully reduce their rolling over to stage 2, the impact of on provisions could potentially be reduced by more than 50% Such conclusion seems to be supported from the high share of underperforming loans going back to regular within 12 months IAS39 Experian. Public. 13
Conclusions Methodology matters : design and methodology used in the framework have relevant impact on the final outcome Heavy requirements for data and modelling (especially to players under BIS II Standard Approach) Very large increase in provisions for non-defaulted accounts with relatively minor payment issues Expected paradigm shift in credit management and monitoring practices Experian. Public. 14