Sparebanken Møre applies a three-stage approach when assessing ECL on loans to customers and financial guarantees in accordance with IFRS 9.
Stage 1: At initial recognition and if there’s no significant increase in credit risk, the commitment is classified in stage 1 with 12-months ECL.
Stage 2: If a significant increase in credit risk since initial recognition is identified, but without evidence of loss, the commitment is transferred to stage 2 with lifetime ECL measurement.
Stage 3: If the credit risk increases further, including evidence of loss, the commitment is transferred to stage 3 with lifetime ECL measurement. The commitment is considered to be credit-impaired. As opposed to stage 1 and 2, effective interest rate in stage 3 is calculated on net impaired commitment (total commitment less expected credit loss) instead of gross commitment.
Staging is performed at account level and implies that two or more accounts held by the same customer can be placed in different stages.
An increase in credit risk reflects both customer-specific circumstances and development in relevant macro factors for the particular customer segment. The assessment of what is considered to be a significant increase in credit risk is based on a combination of quantitative and qualitative indicators, as well as “backstops” (see separate section regarding “backstops”)
Quantitative criteria
A significant increase in credit risk is determined by comparing the PD at the reporting date with 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 per cent or more and the increase in PD is more than 0.5 percentage points, or
- PD has increased by more than 2 percentage points
A 12-months PD is used to determine whether the credit risk has increased significantly.
Qualitative criteria
In addition to the quantitative assessment of a changes in the PD, a qualitative assessment is made to determine whether there has been a significant increase in credit risk, for example, if the commitment is subject to special monitoring.
“Backstops”
Credit risk is always considered to have increased significantly if the following events, “backstops”, have occurred:
- 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 to be individually assessed in stage 3
Significant reduction in credit risk – recovery
A customer migrates from stage 2 to stage 1 if:
- The criteria for migration from stage 1 to stage 2 is no longer present, and
- This is satisfied for at least one subsequent month (total 2 months)
A customer migrates from stage 3 to stage 1 or stage 2 if the customer no longer meets the conditions for migration to stage 3:
- The customer migrates to stage 2 if more than 30 days in default.
- Otherwise, the customer migrates to stage 1.
Customers who are not subject to the migration rules above are not expected to have significant change in credit risk and retain the stage from previous month.
Definition of default, credit-impaired and forbearance
A commitment is defined to be in default and credit-impaired (non-performing) if a claim is more than 90 days overdue and the overdue amount exceeds NOK 1 000.
A commitment is also defined to be credit-impaired (non-performing) if the commitment, as a result of a weakening of the debtor's creditworthiness, has been subject to an individual assessment, resulting in a lifetime ECL in stage 3.
A commitment is defined to be subject to forbearance (payment relief due to payment difficulties) if the bank agrees to changes in the terms and conditions as a result of the debtor having problems meeting payment obligations. Performing forbearance (not in default) is placed in stage 2 whereas non-performing (defaulted) forbearance is placed in stage 3.
Management override
Quarterly review meetings evaluate the basis for the accounting of ECL losses. If there are significant events that will affect an estimated loss which the model has not taken into account, relevant factors in the ECL model will be overridden.
Consequences of Covid-19 and measurement of expected credit loss (ECL) for loans and guarantees
Pursuant to the accounting rules (IAS 34), interim financial reports must provide an explanation of events and transactions that are significant to an understanding of the changes in financial position and performance of an entity since the last annual report. The information related to these events and transactions must take into account relevant information presented in the most recent annual report.
The interim report for Q4 2020 has been prepared in a period when the economic outlook differs from that in the annual financial statements for 2019.
The Bank’s loss provisions reflect expected credit loss (ECL) pursuant to IFRS 9. When assessing ECL, the relevant conditions at the time of reporting and expected economic developments are taken into account.
Covid-19 has resulted in an extraordinary situation for the Bank’s customers. Many corporate and retail customers have seen their income reduced in the short term, and the level of uncertainty associated with estimating the future cash flows and debt servicing capacity of these customers is high. On the other hand, other industries have had a positive economic development throughout 2020.
Changes in economic conditions have had consequences for macroeconomic scenarios and weightings in the Group’s calculations of expected credit loss (ECL) in 2020. In the first quarter of 2020, the probability of the pessimistic scenario occurring was increased from 10 to 40 per cent, while for the base case scenario it was reduced from 80 to 50 per cent.
During the fourth quarter, the outlook was more positive and clearer. Macroeconomic conditions improved. A public vaccination programme started. There was very few bankruptcies and the level of default was relatively low. The authorities announced new stimulus packages aimed at the hardest hit industries. In addition, oil prices rose markedly during the fourth quarter.
The Bank granted payment relief in the first and second quarters of 2020 due to the consequences of Covid-19. Customers who applied were granted 6-month interest-only periods until the second half of 2020. Most of the customers granted interest-only periods are now paying their installments in line with their original agreement.
As part of the process of granting payment relief, a specific, individual assessment is made of whether the application for payment relief is ‘forbearance’ and whether the loan should thus migrate to stage 2 (performing) or stage 3 (non-performing) in the Group’s ECL model.
This has been further supplemented with a more portfolio- or segment based (hotels, tourism, travel industry, personal services industry) approach to assess significantly increased credit risk and migration to stage 2. This is due to the fact that changes in future prospects are not fully captured by the ECL model.
The positive changes in economic conditions have been reflected in the macro economic scenarios and weightings as of 31.12.2020 compared to the third quarter of 2020. The probability of a pessimistic scenario occuring is reduced from 40 to 20 per cent, while the base case scenario is increased from 50 per cent to 70 per cent probability. Best case scenario is kept unchanged at 10 per cent.