leveraging risk rating capabilities for ifrs 9...
TRANSCRIPT
Leveraging Risk Rating Capabilities for IFRS 9 Impairment Calculations
December 8, 2015Emil Lopez
2Leveraging Risk Rating Capabilities for IFRS 9
Introduction
» Emil Lopez is an Engagement Manager in the ERS Services Group, based in New York, where
he leads risk rating and stress testing modeling projects for DFAST and CCAR institutions, and
spearheads the design of IFRS 9 solutions at Moody’s Analytics.
» Prior to joining the advisory group, Mr. Lopez oversaw operations for Moody's Analytics Credit
Research Database, one of the world's largest private firm credit risk data repositories, and was
the lead author of the semi-annual Middle Market Risk Report.
» Mr. Lopez received his MBA from New York University and received his BS in finance and
business administration from the University of Vermont.
3Leveraging Risk Rating Capabilities for IFRS 9
Agenda
1. IFRS 9 Introduction
2. Key Implementation Challenges
3. Leveraging Existing Capabilities
4. How Moody’s Can Help
4Leveraging Risk Rating Capabilities for IFRS 9
IFRS 9 Introduction1
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» IFRS 9 is IASB’s response to the financial crisis and is intended to improve the accounting and
reporting of financial assets and liabilities. IFRS 9 replaces IAS 39 with a unified standard.
» In July 2014, IASB finalized the impairment methodology for financial assets and commitments.
» The mandatory effective date is January 1, 2018; however, the standard is available for early
adoption. Furthermore, the impact of the institution’s “own credit” changes can be applied early in
isolation.
» IFRS 9 covers three areas with profound implications.
IFRS 9 Objectives
Classification & Measurement
• Introduction of a logical approach for the classification of financial assets driven by cash flow characteristics and the business model in which an asset is held. This single, principle-based approach replaces existing rule-based requirements that are complex and difficult to apply.
Impairment
• Introduction of a new expected loss impairment model that will require more timely recognition of expected credit losses. Specifically, the new standard requires entities to account for expected credit losses from when financial instruments are first recognized, and it lowers the threshold for recognition of full lifetime expected losses.
Hedge Accounting
• The new model represents a substantial overhaul of hedge accounting that aligns the accounting treatment with risk management activities, enabling entities to better reflect these activities in their financial statements.
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IFRS 9 Impairment Model
» One single impairment model that applies to all financial instruments in scope
– Financial assets that are debt instruments measured at amortized cost or FVOCI (loans, debt
securities, trade receivables)
– Lease receivables
– Loan commitments and financial guarantee contracts that are not measured at FVTPL
– Contract assets in the scope of IFRS 15
» A probability-weighted forward-looking expected loss model, instead of “incurred loss”
model in IAS 39
– It is no longer necessary for a credit event to have occurred before credit losses are recognized
– The measurement of allowance of credit loss depends on the instrument’s impairment stages
– An entity is required to base its assessment and measurement of expected credit losses on
historical, current, and forecasted information that is available without undue cost or effort
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Impairment recognition: a forward-looking “expected credit loss” model
Increase in credit risk since initial recognition*
Stage 1 Stage 2 Stage 3
» As soon as a financial
instrument is originated or
purchased
» 12-month expected credit
losses are recognized in P&L
and a loss allowance is
established
» Serves as a proxy for the initial
expectation of credit losses
» If the credit risk increases
significantly from when the
entity originates or purchases
the financial instrument, the
resulting credit quality is not
considered to be low credit risk
» Lifetime expected credit losses
are recognized
» If the credit risk of a financial
asset increases to the point
that it is considered credit
impaired
» Financial assets in this stage
will generally be individually
assessed
» Lifetime expected credit losses
are recognized
*Special measurement requirement applies to purchased or originated credit-impaired financial assets, trade and lease receivables, and contract assets
Lifetime
1yr
ECLLifetime
1yr
ECLLifetime
1yr
ECL
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Credit Loss calculation for IFRS 9
ECL = σPD x LGD x EAD x DF
» Point-in-Time PD required
» PDs needs to be extrapolated
over the remaining expected
lifetime of the asset
» Discount factor calculated
through current market rate or
Effective interest rate (EIR)
method
» Cash-flows through the lifetime of
the asset
» Usage model to determine EAD
through the lifetime of the asset.
» Point-in-time LGD required; not
LGD using downturn scenario
» LGD term structure over the
lifetime of the asset
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Key Implementation Challenges2
10Leveraging Risk Rating Capabilities for IFRS 9
Key Implementation Challenges
» The standard is silent on some topics in the new requirements, e.g. discount rate,
definition of “undue cost or effort”
» Finding the right balance between high quality and practicality
» Dynamic and granular portfolio segmentation
» Transfer criteria for significant credit risk
» Measuring expected credit losses
» Including forward-looking information in the impairment model
» Data requirements
» Systems, processes & automation
» Underwriting & limits systems
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Leveraging Existing Capabilities3
12Leveraging Risk Rating Capabilities for IFRS 9
Essential Activities for Successful Deployment of IFRS 9 Impairment Framework
• Existing practices
• Portfolio segmentation
• Stage classification
• Modeling approach for Lifetime EL
Segmentation, Modeling &
Transferring Criteria
• Forward looking adjustments
• Model acquisition, development, or enhancement
• Model validation
Model Deployment
• IFRS9 Provision Construction
• Sensitivity Analysis
Provision Simulation
• Management Communication
• Implementation Recommendation
Change Management/
Implementation
Phase 1 Phase 2 Phase 3 Phase 4
~8 weeks ~6-8 weeks
Roadmap Design
~12-24 weeks ~4-6 weeks
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Roadmap Design Activities
» Model availability (i.e.,
Basel models, stress test
models) across different
portfolios
» Default definition and
modeling approach
» Existing provision
policies and processes
» Existing provision levels
Review Existing
Practices
» Size and complexity of
the institution
» Materiality of the
segments
» Availability of risk
modeling tools
» Data availability
» Credit risk profile
Evaluate Portfolio
Segmentation
» Existing credit policies
» Rating model risk drivers
» Rating granularity
» Monitoring and forbearance
detection processes
» Rebuttable presumption of
30-days past due
» External benchmarks of
“low risk”
» Alternatives definitions of
“significant” increase in
credit risk (relative,
absolute, etc.)
Evaluate Stage
Classification
Approaches
» Segment materiality
» Existing model
soundness,
effectiveness, and
degree of alignment with
IFRS 9 requirements
» Availability of
commercial solutions
» Data availability
» Existing credit policies
Evaluate EL
Modeling
Approaches
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Illustrative Stage Classification Framework
Starting point
Bank-specific assessment
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Potential Methodologies for Estimating Expected Credit Losses
The proposed guidance allows for portfolio-specific methodologies for estimating expected credit losses
Discounted Cash
Flow Model (DCF)
» Forecast future cash flows (or cash shortfalls) over the remaining term
» Discount the cash flows at the effective interest rate
» ECL is the Amortized Cost Basis less the PV of expected Future Cash Flows
Loss Rate
» Apply a historic loss rate percentage, usually at the segment and risk-grade level
» Update/adjust for current conditions and supportable forecasts
» Provision matrices where loss rates are applied to aging category (e.g., trade receivables)
Roll Rate
» Most common for retail portfolios
» The percentage of accounts or dollars that “roll” from one stage of delinquency to the next
» Update/adjust for current conditions and supportable forecasts
PD, LGD, and EL
» Widely used
» Provides the greatest insight into the ECL estimate
» Typically delivered through single-obligor models or scorecards for wholesale portfolios
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Evaluating Loss Modeling Approaches
Segment / Model
Decision
Sustain Enhance DevelopBuy
“Fine as is” “Adjust existing
model”
“Acquire vended
model”
Borrow
“Use Stress
Testing model”
“Build new
model”
Deployment Timeline/Cost
LOW HIGHAlignment with IFRS 9 Requirements
Illustrative Loss Modeling Decision Tree
» Such a decision tree will help ensure the institutions are leveraging existing rating
and stress testing capabilities to the extent possible
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How Moody’s Can Help4
18Leveraging Risk Rating Capabilities for IFRS 9
Moody’s Offering for Modelling IFRS 9
Advisory Services offer a
comprehensive solution to
identify the best IFRS 9 models for
the Institution
Moody’s is a market leader for
point-in time PD and LGD models.
Models can be used for
benchmarking as well as
forecasting IFRS 9 impairment.
Moody’s provides with a
comprehensive set of
Macroeconomic Scenarios for
all the IFRS 9 needs
Moody’s manages a vast set of
data for modelling purposes
providing historical and full
segment coverage.
Scenario
Analyzer
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» IFRS 9 EL Benchmarking provides PD, LGD, and EL estimates for user defined
cohorts. It provides client’s a benchmark to their own internal data or can
supplement for areas where data is limited. Need Data?
Have Internal
Rating?
» EL Calculator for IFRS 9 provides a link between a Moody’s rating and an IFRS 9
compliant PD/LGD/EL term structure. In addition the tool has forecast
capabilities for IFRS 9 requirements based on one or many scenarios.
Need Rating
Models?
» Our PD and LGD models cover major asset classes including commercial and
industrial (C&I), commercial real estate (CRE), and various retail segments (auto,
mortgage, etc.). The models can deployed off the shelf or calibrated to the
collective experience of member institutions.
Need Repeatable
Calculation
Platform?
» Scenario Analyzer is a software platform that can be utilized to automate the
IFRS 9 calculations and can link directly into different accounting systems.
Moody’s Analytics Tools to Support IFRS 9 Impairment Calculation
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Stage Classification and Loss Estimation Services
Risk Measure Conversion/ Adjustment
Portfolio Segmentation
Stage Classification
Criteria
PD/LGD Modeling &
Benchmarking
EAD Modeling
Cash Flow Modeling
Multi-Year EL Calculation
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