Revolving credit facilities IFRS 9

Revolving credit facilities IFRS 9 – The 2013 ED specified that the maximum period over which expected credit losses (ECLs) are to be calculated should be limited to the contractual period over which the entity is exposed to credit risk. This would mean that the allowance for commitments that can be withdrawn at short notice by a lender, such as overdrafts and credit card facilities, would be limited to the ECLs that would arise over the notice period, which might be only one day. Revolving credit facilities IFRS 9

However, banks will not normally exercise their right to cancel the commitment until there is already evidence of significant deterioration, which exposes them to risk over a considerably longer period. The IASB responded to the concerns of respondents by setting out further guidance and an illustrative example, addressing such arrangements. [IFRS 9 B5.5.39 – B5.5.40]

The guidance relates to financial instruments that ‘include both a loan and an undrawn commitment component and the entity’s contractual ability to demand repayment and cancel the commitment does not limit the entity’s exposure to credit losses to the contractual notice period.’ It goes on to describe three characteristics generally associated with such instruments:

  • They usually have no fixed term or repayment structure and usually have a short contractual cancellation periodRevolving credit facilities IFRS 9
  • The contractual ability to cancel the contract is not enforced in day-to-day management, but only when the lender is aware of an increase in credit risk at the facility level Revolving credit facilities IFRS 9
  • They are managed on a collective basis Revolving credit facilities IFRS 9

In order to calculate the period for which ECLs are assessed, ”an entity should consider factors such as historical information and experience about: [IFRS 9 B5.5.40]

  1. the period over which the entity was exposed to credit risk on similar financial instruments;
  2. the length of time for related defaults to occur on similar financial instruments following a significant increase in credit risk; and
  3. the credit risk management actions that an entity expects to take once the credit risk on the financial instrument has increased, such as the reduction or removal of undrawn limits.”
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It should be noted that the time horizon is not the period over which the lender expects the facility to be used, but the period over which the lender is, in practice, exposed to credit risk. It is possible that the lender may fully ‘refresh’ its credit lines once a year, assessing them as if they are new, in which case, it would be appopriate to use only the period to this next reassessment. But most credit cards have a longer life and until the facility is next ‘refreshed’ it will only be withdrawn if there is negative information.

This following example illustrates the calculation of impairment for revolving credit facilities, based on Illustrative Example 10 in the Implementation Guidance for the standard (see example below). For the sake of clarity, the assumptions and calculations have been adapted from the IASB example as it is not explicit on the source of the parameters and how they are computed. The example has also been expanded to show the calculation of the loss allowances. However, to simplify the example, the need to discount expected losses has been ignored.

Example – Revolving credit facilities

Bank A provides credit cards with a one day cancellation right and manages the drawn and undrawn commitment on each card together, as a facility. Bank A sub-divides the credit card portfolio by segregating those amounts for which a significant increase in credit risk was identified at the individual facility level from the remainder of the portfolio. The remainder of this example only illustrates the calculation of ECLs for the sub-portfolio for which a significant increase in credit risk was not identified at the individual facility level.

At the reporting date, the outstanding balance on the sub-portfolio is CU6,000,000 and the undrawn facility is CU4,000,000. Bank A determines the sub-portfolio’s expected life as 30 months (using the guidance set out above) and that the credit risk on 25 per cent of the sub-portfolio has increased significantly since initial origination, making up CU1,500,000 of the outstanding balance and CU1,000,000 of the undrawn commitment (see the calculation of the exposure in the table below). Classification measurement and impairment of financial assetsRevolving credit facilities IFRS 9

To calculate its exposure at default, Bank A uses an approach whereby it adds the amounts that are drawn down at the reporting date and additional draw-downs that are expected in the case that a customer defaults. For those expected additional draw-downs, Bank A uses a credit conversion factor that represents the estimate of which percentage of that part of the committed credit facilities that is unused at the reporting date would be drawn by a customer before he defaults. Revolving credit facilities IFRS 9

Using its credit models, the bank determines this credit conversion factor as 95 per cent. The exposure at default on the portion of facilities measured on a lifetime expected credit loss basis is therefore CU2,450,000, made up of the drawn balance of CU1,500,000 and CU950,000 of expected further draw-downs before the customers default. For the remainder of the facilities, the exposure at default, that is measured on a 12-month expected credit loss basis is CU7,350,000, being the remaining drawn balance of CU4,500,000 plus additional expected draw-downs for customers defaulting over the next 12 months of CU2,850,000 (see the calculation for the exposure at default in the table below).

Bank A has estimated that the probability of default for the next 12 months is 5 per cent, and 30 per cent for the next 30 months. The estimate for the loss given default on the credit cards in the sub-portfolio is 90 per cent. That results in lifetime ECLs of CU661,500 and 12-month ECLs of CU330,750 (see calculation for ECLs in the table below).

For the presentation in the statement of financial position, the ECLs against the drawn amount of CU607,500 would be recognised as an allowance against the credit card receivables and the remainder of the ECLs that relates to the undrawn facilities of CU384,750 would be recognised as a liability (see the table below). Revolving credit facilities IFRS 9

Determination made at facility level

Drawn

Undrawn

Total

Facility

CU6,000,000

CU4,000,000

CU10,000,000

Exposure

Subject to lifetime ECLs (25% of the facility has been determined to have significantly increased in credit risk)

CU1,500,0001

CU1,000,0002

CU2,500,000

Subject to 12-month ECLs (the remaining 75% of the facility)

CU4,500,0003

CU3,000,0004

CU7,500,000

Credit conversion factor (CCF)ª

95%

Revolving credit facilities IFRS 9 Revolving credit facilities IFRS 9

Exposure at default (EAD)

Revolving credit facilities IFRS 9 Revolving credit facilities IFRS 9

Subject to lifetime ECLs

CU1,500,000

CU950,000

CU2,450,000

Subject to 12-month ECLs

CU4,500,000

CU2,850,0005

CU7,350,000

Probability of a default (PD)

Revolving credit facilities IFRS 9 Revolving credit facilities IFRS 9 Revolving credit facilities IFRS 9

Exposures subject to lifetime ECLs

30%

30%

Revolving credit facilities IFRS 9

Exposures subject to 12-month ECLs

5%

5%

Revolving credit facilities IFRS 9

Loss given default (LGD)

90%

90%

Revolving credit facilities IFRS 9

ECLs (EAD × PD × LGD)

Exposures subject to lifetime ECLs

CU405,0006

CU256,5007

CU661,500

Exposures subject to 12-month ECLs

CU202,5008

CU128,2509

CU330,750

Revolving credit facilities IFRS 9

Revolving credit facilities IFRS 9

Revolving credit facilities IFRS 9

CU607,500

presented as loss allowance netted against assets

CU384,750

presented as a provision

CU992,250

ª A uniform CCF is used irrespective of deterioration, which reflects that the CCF is contingent on ‘default’ which is the same reference point for a 12-month and lifetime expected credit loss calculation

Revolving credit facilities ifrs 9

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