The Group`s interim accounts have been prepared in accordance with International Financial Reporting Standards (IFRS), implemented by the EU as at 31 March 2018. The interim report has been prepared in compliance with IAS 34 Interim Reporting and in accordance with accounting principles and methods applied in the 2017 financial statements, except for IFRS 9 entering into force as of 1 January 2018.
Accounting principles for classification in accordance with IFRS 9 are presented in Note 5. Tables showing the transition effects of the implementation of IFRS 9 are presented in Note 2.6 in the Annual report 2017. The methodology for measuring expected credit losses (ECL) in accordance with IFRS 9 is explained in the following. In addition, reference is made to the Annual report 2017 for further description of accounting principles.
The accounts are presented in Norwegian kroner (NOK), which is also the Parent Bank`s and the subsidiaries` functional currency.
Expected credit loss (ECL) according to IFRS 9
Sparebanken Møre applies a three-stage approach when assessing ECL on loans to customers, loan commitments and financial guarantees subject to the IFRS 9 impairment rules:
- At initial recognition and if there's no significant increase in credit risk, the commitment is classified in stage 1 with 12-months ECL.
- If a significant increase in credit risk since initial recognition is identified, the financial instrument is transferred to stage 2 with lifetime ECL measurement.
- An increase in credit risk reflects both customer-specific circumstances and developments in relevant macro risk drivers for the segment where the customer belongs. The assessment of what is considered to be a significant increase in credit risk is based on a combination of quantitative and qualitative indicators and backstops.
- If credit risk deteriorates further and the commitment is either defaulted, subject to forbearance or credit-impaired, the commitment is moved to stage 3. Credit-impaired commitments are subject to an individual assessment of losses. Commitments with forbearance or which are defaulted, are subject to a lifetime ECL measurement. As opposed to stage 1 and 2, the effective interest rate is calculated on amortised cost (gross carrying amount less loss allowance) instead of gross carrying amount.
The loan loss measurement is based on the following principles:
- The loss provision for commitments which are not credit-impaired is calculated as the present value of exposure at default (EAD) multiplied by the probability of default (PD) multiplied by loss given default (LGD). PD, LGD and EAD use the IRB framework as a starting point, but are converted into being point-in-time and forward-looking as opposed to through the cycle and conservative.
- Past, present and forward-looking information is used to estimate ECL. For this purpose, Sparebanken Møre’s loan portfolio is divided into 7 segments based on field of operation. All customers within a segment are exposed to the same risk drivers.
- For credit-impaired financial instruments in stage 3, individual assessments are performed.
The model used for calculating ECL follows four steps: Segmentation, determination of macro adjustments, staging/migration and calculation of ECL.
Segmentation and macro adjustments
The assessment of significant increase in credit risk and the calculation of ECL incorporates past, present and forward-looking information. Segmentation of the portfolio is based on the customers’ fields of operation, and each segment is subject to separate macro adjustments.
Theory of cyclical cycles has been used to model macro factors to estimate lifetime ECL in the model. A trend curve is prerequisite to show long-term GDP growth. Based on an assessment by the Chief Economist and the corporate unit managers in SBM, key indicators have been selected for the retail market and the various corporate sectors. Indicators issued by Statistics Norway (SSB) have been used to a large extent. Volatility in the indicators is taken into account when calculating the macro-factors. Standard deviations are calculated for each indicator, which entails that high/low volatility indicators will cause a higher/lower impact on the macro factor.
Calculation of expected credit loss
The determination of a significant increase in credit risk and the measurement of ECL are based on parameters already used in credit risk management and for capital adequacy calculations: PD, LGD and EAD. The parameters have been adjusted in order to give an unbiased estimate of ECL.
Probability of default (PD)
Sparebanken Møre applies several different models to determine a customer’s PD. The choice of model depends on whether it is a retail or corporate customer. PD models are key components both in calculating the ECL and in assessing whether a significant increase in credit risk has occurred since initial recognition. These models fulfil the IFRS 9 requirement to provide an unbiased probability-weighted estimate of ECL. Sparebanken Møre has been granted permission to use internal ratings based approach (IRB) models for determining PD in capital adequacy calculations. In order to apply these PDs for IFRS 9, modifications have been made to allow that the PDs used for IFRS 9 reflect management’s current view of expected cyclical changes and that all PD estimates are unbiased.
Loss given default (LGD)
LGD represents the percentage of EAD which the Group expects to lose if the customer fails to meet his obligations, taking the collateral provided by the customer, future cash flows and other relevant factors into consideration.
Similar to PDs, Sparebanken Møre uses IRB LGDs for capital adequacy calculations. In order to convert the IRB LGDs to IFRS LGDs, modifications have been made to remove the margin of conservatism to produce unbiased projections rather than downturn projections as well as removing the effect of regulatory floors.
These modifications imply that the LGDs used for IFRS 9 should reflect management’s current view and that all LGD estimates are unbiased.
Exposure at default (EAD)
EAD is the share of the approved credit that is expected to be drawn at the time of any future default. The EAD is adjusted to reflect contractual payments of principal and interest. The proportion of undrawn commitments expected to have been drawn at the time of default is reflected in the credit conversion factor.
Significant increase in credit risk
The assessment of a significant increase in credit risk is based on a combination of quantitative and qualitative indicators and backstops. A significant increase in credit risk has occurred when one or more of the criteria below are met.
A significant increase in credit risk is determined by comparing the PD at the reporting date with the PD at initial recognition. If the actual PD is higher than initial PD, an assessment is made of whether the increase is significant.
Significant increase in credit risk since initial recognition is considered to have occurred when either
- PD has increased by 100 % or more and the increase in PD is more than 0.5 percentage points, or
- PD has increased by more than 2.0 percentage points
Qualitative information is normally reflected in the respective PD models for each group of customers.
Backstops are used and a significant increase in credit risk has occurred if:
- the customer’s contractual payments are 30 days past due
- the customer has been granted forbearance measures due to financial distress, though it is not severe enough for the financial instrument to be classified as credit-impaired.
Definition of default, forbearance and credit-impaired in stage 3
A commitment is defined to be in default if a claim is more than 90 days overdue and the overdue amount exceeds NOK 1 000.
A commitment is defined to be subject to forbearance if the bank agrees to changes in the terms and conditions because the debtor is having problems meeting payment obligations, and this is assumed to significantly reduce the value of the cash flow.
A commitment is defined to be credit-impaired if the commitment, as a result of a weakening of the debtor's creditworthiness, has been subject to an individual assessment, resulting in an individual impairment. The principles and estimation techniques for credit-impaired financial instruments are not affected by IFRS 9. Please refer to the description of individual impairment in note 7 of the Annual Report 2017 for more details.
Expert credit judgement
The new rules require significant professional judgement of the input parameters in the ECL-measurement. The assessment of the macro prognoses and their impact are key judgements and Sparebanken Møre has established an advisory forum to address this. The forum’s purpose is to assess if the predicted macro prognoses for each segment reflect the management’s view on the expected future economic Development.
The ECL model is subject to annual validation and review.