IFRS 9: Spike in Loss Allowance expected for Big 6 Canadian Banks!

By Musabbir Mazhar

The Big 6 Canadian Banks should begin to show increased Loss Allowance for Expected Credit Losses in the Q2 2020 Earnings release scheduled starting tomorrow, 26th May 2020.

If there is anytime when the significant Accounting Standard changes brought by IFRS 9, Financial Instruments, would be felt most, it is now!

One of the changes introduced a forward looking Expected Credit Loss model by which:

1) 12-month expected credit losses have to be recognized as loss allowance where there has not been a significant increase in credit risk since initial recognition; and

2) Lifetime Expected Credit Losses have to be recognized for a financial instrument if the credit risk has increased significantly since initial recognition.

However, I believe the full extent of the head wind due to retail loan portfolio deterioration would be felt in later quarters in 2020 and in early 2021 due to the Governmental and Regulatory Mortgage 6 month Mortgage Deferral Program introduced early on for COVID19 – this was pure genius from a policy standpoint that has really dodged some bullets, albeit temporarily perhaps. The Office of the Superintendent of Financial Institutions (OSFI) would treat these deferred loans as performing loans, and hence would not be considered impaired.

Although the Canadian bank stocks have fallen 27% since the 1st case of COVID19 in Canada was recognized in 27-Jan-2020, there should be more pain in the coming quarters for these stocks.

It should be noted that these banks should be able to sustain their dividends due to their relative prudent risk management approaches as well as OSFI’s measures during crisis period.

One of the measures taken by OSFI to strengthen these Domestic Systemically important banks (D-SIBs) was to reduce the Domestic Stability Buffer by 1.25% to 1.00% from 2.25% of Risk-Weighted Assets (RWA), effective 13th March 2020. This would allow for more than $300Billion in supplemental lending capability for the banks to provide much needed capital in the economy amidst the pandemic.