This article focuses on developing an approach to determine the impact of COVID 19 on credit portfolios.
In recent months, credit institutions (banks, credit unions and FinTechs) have seen disruption in a large portion of their credit portfolios due to COVID19. For most part, these organizations managed COVID-trigerred disruption of interest and principal repayments by either deferring principal repayments or by capitalizing both interest and principal repayments. In some cases, the retail portfolios were allowed a 1- month payment reprieve and the non-retail borrowers were authorized a 3-months period to normalize.
As economic activity begins to resume and some businesses begin to reopen under the new normal, a large cross-section of the economy still remains closed or is operating well below capacity, e.g., hospitality, entertainment and shared accommodation.
Regulatory authorities now require organizations to provide additional information covering the
impact of COVID 19, such as:
- Credit risk: Impact of COVID 19 on credit risk due to payment deferrals
- Business risk: Revision in growth assumptions, business or capital plans as future earnings will be reduced due to the low interest environment
The following worksteps can help us develop probabilities of cure, restructuring and default for the
deferred loan obligations:
- Non-retail: A 90 day payment skip can qualify a loan for IFRS9's Stage 3, however, there is limited clarity on this by accounting bodies. Nonetheless, it is important for credit institutions to determine what percentage of loans with deferred/capitalized payments would be cured (i.e., become performing again), what percentage of loans would be restructured and what percentage of loans become non-performing. A RATS-based (rate, amortization, terms) restructuring can be considered for highly collateralized, low risk loans. For example, loan obligations with low LTV can be considered as strong candidates for restructuring. On the other hand, all things being equal, the likelihood of cure for highly leveraged loans would remain low. RMs and credit adjudication teams need to analyze each and every loan in the payment deferrals bucket using this lens
- Retail: A 30 day payment skip implies that the obligor migrates to Stage 2 under the IFRS 9 requirements, with a corresponding rating downgrade. However, by keeping track of loan vintages, in conjunction with the state of economy, we are able to forecast the impact of payment deferrals on retail loan portfolios. This impact can then be organized into two states, probability of cure and default
At BankingBook Analytics (https://www.bba.to), we work closely with our clients to determine the impact of COVID19 on their capital position, assist with refreshing strategy and improving collections and recoveries. Our software solution, Scenario Frontier (https://www.bba.to/ScenarioFrontier/) helps businesses incorporate more severe scenarios both in terms of the scale and duration of the impact, helps develop budgets, forecasts and also quantifies risks. We meet our clients anywhere they are in their journey to become data-driven, implement the solution in the sandbox, and get clients' buy-in, and offer support 24X7.
Author - Sohail Saad
To learn more about BBA’s Scenario Frontier, please visit us here.