Instruction No. 05/2016 of August 8, 2016: Impairment Losses for the Credit Portfolio

INSTRUCTION NO. 05/16 of August 8
SUBJECT: IMPAIRMENT LOSSES FOR THE CREDIT PORTFOLIO

Given the need to establish a set of procedures for the determination of impairment losses for the credit portfolio granted to clients, within the framework of the provisions established in Notice No. 06/2016, of June 22, regarding the general principles to be observed by Banking Financial Institutions in the full adoption of International Accounting Standards/International Financial Reporting Standards.

This Instruction does not intend to make any interpretations of the International Accounting Standards/International Financial Reporting Standards, as these are developed exclusively by the IFRS Interpretations Committee and issued by the International Accounting Standards Board (IASB).

In accordance with the combined provisions of Article 21 and Article 51, both of Law No. 16/10 of July 15 – Law of the Bank of Angola, and Article 93 of Law No. 12/15 of June 17 – Law of the Bases of Financial Institutions.

DETERMINES:

1. Object
   This Instruction establishes the procedures that Banking Financial Institutions must observe for the determination of impairment losses for the credit portfolio granted to clients, as provided for by International Accounting Standard 39 – Financial Instruments: Recognition and Measurement, hereinafter abbreviated as IAS 39.

2. Scope
   The addressees of the provisions contained in this Instruction are Banking Financial Institutions under the supervision of the Bank of Angola, under the terms and conditions provided for in the Law of the Bases of Financial Institutions, hereinafter abbreviated as Institutions.

3. Definitions
   Without prejudice to the definitions established in the Law of the Bases of Financial Institutions, for the purposes of this Instruction, the following are understood:

3.1 Back-testing: comparison between observed values and estimated values for the different risk parameters used in the quantification of impairment losses for the credit portfolio granted to clients, with the objective of assessing the fit of the statistical model used to historical losses recorded.

3.2 Defaulted Credit: corresponds to the set of the following categories:
a) credit with capital or interest installments overdue for more than 90 (ninety) days; and b) credit with capital or interest installments overdue for less than 90 (ninety) days, but on which there is evidence justifying its classification as "defaulted credit," namely bankruptcy, liquidation of the debtor, among others.

3.3 Credits Restructured Due to Client Financial Difficulties: credit operations in which contractual changes occurred motivated by client financial difficulties.

3.4 Credit Conversion Factor: probability of an off-balance sheet credit exposure transforming into an on-balance sheet credit exposure.

3.5 Economic Group: set of companies, resident and non-resident, regardless of their sector of activity, in which there is a relationship of control of one entity over the others.

3.6 Indicators of Impairment: objective evidence that a client/economic group is in impairment.

3.7 Impairment Loss: amount by which the carrying amount of an asset exceeds its recoverable amount.

3.8 Recoverable Amount: present value of estimated future cash flows of the credit exposure, discounted at the original effective interest rate, or considering the original spread, in the case of operations with fixed or variable interest rates, respectively.

3.9 Loan-to-Value (LTV) Ratio: corresponds to the ratio between the amount of financing granted and the value of the collateral received.

3.10 Branch: main establishment, in Angola, of a Banking or Non-Banking Financial Institution with headquarters abroad, or main establishment, abroad, of a Banking or Non-Banking Financial Institution with headquarters in Angola, lacking its own legal personality and which directly carries out, in whole or in part, operations inherent to the company's activity.

3.11 Cure Rate: probability of defaulted credits returning to the state of performing credits, jointly with the simultaneous verification of the following conditions:
a) an improvement in the debtor's situation, being expected, upon analysis of the financial condition, the total repayment according to the original or modified contract conditions; b) the debtor does not present any overdue amount; and c) a quarantine period of one year has elapsed, after the first capital payment, in which the debtor fulfilled its responsibilities regularly, that is, in which the debtor paid off a significant amount of capital and interest of the contract without having presented any overdue exposure for a period exceeding 30 days.

3.12 Effective Interest Rate: rate that exactly discounts estimated future cash payments or receipts during the expected life of the financial instrument or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability.

3.13 Value of Credit-Associated Collateral (Prorated): separation of the value of the collateral received proportionally among all credits granted by the Institution to which the collateral is associated.

4. Measurement

4.1 Impairment losses must be recognized when incurred, and expected losses resulting from future events are not recognized. Impairment losses are considered incurred if there is objective evidence of impairment loss as a result of one or more events that occurred after the initial recognition of the financial asset (or group of financial assets).

4.2 Impairment losses correspond to the difference between the value of the credit exposure at the reporting date and the present value of estimated future cash flows, which must be discounted at the original effective interest rate of the credit exposure, or considering the original spread thereof, in the case of credit exposures with fixed or variable interest rates, respectively. Impairment losses are recognized in profit or loss.

4.3 Regarding specifically credits restructured due to client financial difficulties, as provided for in number 5 of this Instruction, impairment losses must be determined based on the effective interest rate of the credit exposure that was in effect before the credit restructuring, with the exception of situations where the effective interest rate increases upon credit restructuring.

4.4 The process of estimating the amount of an impairment loss may result in either a single amount or a range of possible amounts. In the latter case, the Institution must recognize an impairment loss equal to the best estimate within the range considering the relevant information available before the financial statements are issued regarding the conditions existing at the balance sheet date.

5. Credits Restructured Due to Client Financial Difficulties

5.1 Institutions must proceed to identify and mark, in their respective information systems, credits restructured due to client financial difficulties.

5.2 For the purposes of the previous point, Institutions must be in compliance with the provisions of Annex I of this Instruction.

6. Objective Evidence of Impairment Losses

Institutions must assess whether there is any objective evidence of impairment losses of financial assets or group of financial assets at the end of each reporting period, adopting for this purpose conservative and appropriate principles, and must consider, at a minimum, the indicators of impairment presented in Annex II of this Instruction.

7. Exposures Analyzed Individually

7.1 Without prejudice to the provisions of number 9 of this Instruction, the assessment of impairment loss must be carried out on an individual basis for credit exposures considered individually significant, and on an individual or collective basis for credit exposures that are not individually significant.

7.2 In situations where an Institution determines that there is no objective evidence of impairment loss for a credit exposure assessed individually, it must be included in a group of credit exposures with similar credit risk characteristics, which are assessed collectively, as provided for in number 8 of this Instruction.

7.3 For the purposes of selecting credit exposures to be analyzed on an individual basis, Institutions must observe the requirements established in Part 3 of Annex III of this Instruction.

7.4 The analysis of credit exposures on an individual basis must be carried out taking into account the total credit exposure at the economic group level.

7.5 Institutions must adopt conservative assumptions and estimates regarding the estimation of future cash flows and the valuation of received collateral, taking into account the provisions of Part 4 of Annex III of this Instruction.

7.6 Institutions must estimate the recoverable amount of credit exposures taking into account the requirements established in Part 1 of Annex III of this Instruction.

7.7 Institutions must consider in the analysis of each client and/or economic group the provisions of Part 2 of Annex III of this Instruction.

7.8 Institutions must consider in the analysis of off-balance sheet exposures the requirements defined in Part 5 of Annex III of this Instruction.

8. Exposures Analyzed Collectively

8.1 Institutions must ensure an adequate level of conservatism in the methodologies used in the measurement of impairment losses of credit exposures analyzed collectively.

8.2 Without prejudice to the provisions of number 9 of this Instruction, credit exposures analyzed on a collective basis must be grouped into homogeneous groups taking into account the quality of their assets/credit risk characteristics.

8.3 Institutions must consider in the determination of homogeneous risk groups the requirements established in Part 1 of Annex IV of this Instruction.

8.4 Institutions must estimate the future cash flows of a group of credit exposures subject to collective analysis based on the historical loss experience of Institutions for credit exposures with similar credit risk characteristics, and the information on historical losses must be applied to groups of assets consistent with the groups used for the determination of historical losses.

8.5 Institutions must adjust the impairment loss model to reflect current economic conditions (conditions prevailing in the last year) that did not affect the historical period on which the said model is based and excluding the effects of conditions in the historical period that are not currently verified ("point-in-time" methodology) as provided for in Part 4 of Annex IV of this Instruction.

8.6 Institutions must observe the procedures established in Part 2 of Annex IV of this Instruction regarding the classification of credits and respective measurement of impairment losses on a collective basis.

8.7 For the purposes of determining the relevant risk factors for impairment loss determination models, Institutions must collect historical information on credit portfolio behavior for a minimum period of 5 (five) years.

8.8 The methodologies and assumptions used to estimate the future cash flows relevant for the determination of impairment losses must be reviewed with a minimum annual frequency.

8.9 Institutions must update the risk factors used in the quantification of impairment losses with a minimum annual frequency.

8.10 Institutions must ensure with a minimum annual frequency the performance of "back-testing" procedures on the statistical models used in the determination of impairment losses for credits analyzed collectively, taking into account the requirements established in Part 3 of Annex IV of this Instruction.

9. Exemption from Provisioning for Impairment Losses

9.1 The following credit exposures are exempt from provisioning for impairment losses:
a) assumed by the Angolan State, including its central and provincial administrations; b) assumed by central administrations or central banks of countries included in group 1, international organizations, or multilateral development banks, as defined in Instruction No. 1/15, regarding country classification, Multilateral Development Banks, and International Organizations; c) fully guaranteed by cash deposits or deposit certificates constituted or issued by the lending Institution or by Institutions in a relationship of control or group with the lending Institution and having headquarters in Angola or a country included in group 1, as defined in Instruction No. 1/15, regarding country classification, Multilateral Development Banks, and International Organizations, provided that the credit exposure and the deposit or certificate are denominated in the same currency; d) fully guaranteed by cash deposits or deposit certificates constituted or issued by the lending Institution or by branches of the lending Institution, not covered by the previous letter, provided that the credit exposure and the deposit or certificate are denominated in the same currency; e) fully guaranteed by bonds or obligations issued by the Angolan State or by the Bank of Angola.

9.2 Credit exposures fully linked to collateral, eligible as provided for in Notice No. 10/2014, of December 10, regarding collateral received for prudential purposes, granted by the entities mentioned in letters a) and b) of point 9.1, are exempt.

9.3 The deposits mentioned in letters c) and d) of point 9.1 must respect the conditions provided for in Notice No. 10/2014, of December 10, regarding collateral received for prudential purposes, for eligibility as real collateral.

Without prejudice to the provisions in the previous points, credit exposures of the operations provided for in letters a) and b) in point 9.1 are exempt from provisioning for impairment losses, even in circumstances of observing delay in payment of the capital or interest installment.

10. Documentation

10.1 Institutions must ensure the adequate formalization of the process for determining impairment losses for the credit portfolio granted to clients, including, at a minimum, the aspects defined in Annex V of this Instruction.

10.2 The governing body of the Institution is responsible for approving the methodology for determining impairment losses for the credit portfolio and ensuring that the methodology in force at each reporting date proves to be adequate.

The methodologies for determining impairment losses for the credit portfolio granted to clients must be submitted for approval of the Bank of Angola according to the format in the terms and conditions to be defined. Any changes to the methodologies for determining impairment losses for the credit portfolio granted to clients must be subject to prior approval of the Bank of Angola.

11. Monitoring and Validation of Information

Institutions must implement specific mechanisms for monitoring the underlying information used, and a set of validations must be carried out to ensure the consistency/reliability of the data used, as per Annex VI of this Instruction.

12. Disclosures

Without prejudice to the provisions of Instruction No. 06/16, regarding disclosures related to financial instruments, which establishes additional disclosure requirements to those provided for in this Instruction, Institutions must disclose, among others they consider relevant, the information enumerated in Annex VII of this Instruction.

13. Transitional Provisions

13.1 Institutions that comply with at least one of the criteria provided for in number 2 of Article 5 of Notice No. 06/2016, of June 22, regarding the full adoption of International Accounting Standards/International Financial Reporting Standards, must be in compliance with the provisions of this Instruction from the 2016 fiscal year, inclusive.

13.2 Institutions that do not meet the conditions provided for in the previous point must observe the provisions of number 3 of Article 5 of Notice No. 06/2016, of June 22, regarding full adoption of International Accounting Standards/International Financial Reporting Standards.

13.3 For the purposes of the provisions of Part 2 of Annex VII, Institutions covered by point 13.1 must present the following disclosures from the 2017 fiscal year, inclusive, although their presentation from the 2016 fiscal year, inclusive, is permitted:
a) loan-to-value ratio of the segments of Companies, Construction and Real Estate Promotion, and Housing; and b) detail of the fair value and net book value of real estate received in lieu of payment or foreclosure due to antiquity.

14. Final Provisions

14.1 This Instruction does not dispense with the consultation of International Accounting Standards/International Financial Reporting Standards or International Accounting Standards/International Financial Reporting Standards, designated as IAS/IFRS.

14.2 Whenever there are discrepancies between this Instruction and the IAS/IFRS, the standards issued by the IASB shall prevail.

15. Doubts and Omissions

Doubts and omissions resulting from the interpretation and application of this Instruction will be resolved by the Bank of Angola.

16. Entry into Force

This Instruction enters into force on the date of its publication.

PUBLISH
Luanda, on August 8, 2016.

THE GOVERNOR
VALTER FILIPE DUARTE DA SILVA

ANNEX I
CREDITS RESTRUCTURED DUE TO CLIENT FINANCIAL DIFFICULTIES

1. Institutions must identify and mark, in their respective information systems, credits restructured due to client financial difficulties. Credits restructured due to financial difficulties are understood as those in which contractual changes occurred and in which clients are in financial difficulties.

2. For the purposes of determining impairment losses, Institutions must consider that the restructuring of an operation due to client financial difficulties is a reflection of the increase in the credit risk profile.

3. Institutions must report to the Credit Risk Information Center (CIRC) the credits restructured due to client financial difficulties.

4. A client is considered to be in a situation of financial difficulty when:
   a) it has recorded payment delays exceeding 30 days on any of its financial obligations to the Institution in the last 12 (twelve) months; b) existence of payment delays exceeding 30 days in the banking system, according to CIRC information in the last 12 (twelve) months; c) record of returned checks at CIRC; d) use of renewable credit operations, namely current accounts and overdrafts, permanently for a minimum period of 12 (twelve) months in at least 95% of the limit initially authorized by the Institution; e) significant reduction in internal risk classification, based on monitoring reports prepared and/or to be prepared by areas independent of commercial areas; f) delivery of assets in lieu of payment; g) existence of unauthorized overdrafts or authorized overdrafts above the formally contractualized limit with clients in the last 12 (twelve) months; h) expectation of insolvency; i) knowledge by the Institution of the existence of tax and/or Social Security debts; j) overdue salaries; k) attachment of bank accounts; and l) absence of accounting documents, duly audited by an independent entity whenever current legislation so requires, whose reference date is older than 18 (eighteen) months.

5. For the purposes of number 1, contractual changes are considered to exist whenever at least one of the following situations occurs:
   a) alteration of contractual conditions to the benefit of the client, motivated by client financial difficulties, namely through extension of the repayment term, introduction of capital and/or interest grace periods, capitalization of interest, reduction of interest rates, forgiveness of interest and/or capital, alteration of the frequency of interest payment and capital repayment, or delivery of assets in lieu of payment; b) granting of new credits by the Institution or by an entity belonging to the economic group in which the Institution is integrated, to the client or to any entity of the economic group to which the client belongs, for the settlement (total or partial) of the existing debt, and the granting of new operations in a date close to the settlement of the initial debt must be considered as sufficient evidence of the same. In this situation, both the new credit operation and the one that was subject to partial or total settlement must be marked as credit restructured due to client financial difficulties.

6. Institutions must include and maintain in their information systems the record of contractual changes of credit operations for a minimum period of five years after their unmarking, the following elements:
   a) date of the contractual change; b) type of contractual change, namely, increase in the repayment term, introduction of capital and/or interest grace periods, capitalization of interest, reduction of interest rates, forgiveness of interest and/or capital, alteration of the frequency of interest payment and capital repayment, or delivery of assets in lieu of payment; c) identification of the contractual changes that were motivated by client financial difficulties and the justification for those that were not marked as credit restructured due to client financial difficulties; d) the link, in the Institution's information systems, between the original operation and the new operation, in case the Institution grants new credits to settle the debt.