Covid-19 vs the financial crisis: Why the bank bad debts can’t be compared

As at their most recent reporting periods, the country’s five largest retail banks have a total of nearly R80 billion in so-called ‘Stage 3’ expected credit losses from their loan books. This may sound very high, but total retail advances across these banks is somewhere around R2 trillion.

Now, what makes current Covid-19/lockdown-related impairments difficult (impossible?) to compare with those booked by the banks in the aftermath of the global financial crisis in 2008/2009, is that the way banks recognise credit losses in their financial statements changed from January 1, 2018.

Previously, banks were required to recognise any losses only when the “evidence of a loss was apparent” explains the Bank for International Settlements (BIS).

Under IFRS 9, however, an ‘expected credit loss’ (ECL) framework is used when recognising the impairment. This means “banks are required to recognise ECLs at all times, taking into account past events, current conditions and forecast information, and to update the amount of ECLs recognised at each reporting date to reflect changes in an asset’s credit risk”.

Under this framework, loan impairments are recognised in three stages.

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Stage 1

The BIS says banks need to recognise any possible expected credit losses within 12 months at the point the loan is disbursed. This same philosophy applies on “subsequent reporting dates”, where the 12-month view applies to “existing loans with no significant increase in credit risk since their initial recognition”. Advances in this category could be considered “performing”, with a typically modest impairment charge booked. Interest revenue is calculated on the “loan’s gross carrying amount”.

Stage 2

It is in stage 2 where things become complicated. Here, if a “loan’s credit risk has increased significantly since initial recognition” and is no longer “considered low”, lifetime expected credit losses are recognised (not just the next 12 months). By definition, credit loss ratios for this category of loan are significantly higher than those in Stage 1 as there is either medium or temporary risk. Interest revenue is calculated in the same way as Stage 1.

Stage 3

These are loans where the credit risk has “increased to the point where it is considered credit-impaired”. Nedbank describes this as “any advance or group of loans and advances that has triggered the Basel III-definition of default criteria, in line with the SA banking regulations”. It adds that: “At a minimum a default is deemed to have occurred where a material obligation is past due for more than 90 days or a client has exceeded an advised limit for more than 90 days. A Stage 3 impairment is raised against such a credit exposure due to a significant perceived decline in the credit quality.” In this case, “interest revenue is calculated based on the loan’s amortised cost” (in other words, the “gross carrying amount less the loss allowance”).

With the impact of Covid-19, as well as the relief provided by banks, classifying loans into these various categories has been critical for banks. At the release of its interim results, Standard Bank summarised how it has treated credit across its retail book, based on “IFRS 9, Covid-19 client relief and restructures guidance notes and internal models”, with a simple decision tree.

Under this framework, a full loss of income due to Covid-19 is actually simple to classify and account for. Similarly, performing loans under Stage 1 are equally simple to classify and account for. All other loans, with either temporary or medium risk, are generally then classified as Stage 2.

Unsurprisingly, Capitec provides the most detailed disclosure of its loan book across both Stage 2 and Stage 3. In its case, it has loans in Stage 2 that are up to one month in arrears, those that have been rescheduled under the bank’s Covid-19 relief schemes (but are up-to-date), and those that are up-to-date but have shown a significant increase in credit risk and where clients have applied for debt review. Loans in Stage 3 include:

• Those that have been rescheduled under the bank’s Covid-19 relief plans, but that are up to date;
• Those that are between two and three months in arrears;
• Those that are up-to-date after being rescheduled;
• Those that are up-to-date after being in arrears; and
• Those that are more than three months in arrears.

Across the five major retail banks, Capitec’s credit loss ratio for Stage 3 loans is at 71%, while the remaining four are between 38% and 48%.

Capitec’s provisioning may seem high, but it has always been the most aggressive.

Its total credit loss ratio (net impairment charge to average gross loans and advances) is 8.1% for the six months ended August 31. At the end of February, it was 6.3%.

Retail business banking		Absa	Capitec	FirstRand*	Nedbank	Standard Bank
Stage 1	Advances	R427.6bn	R37.3bn	R330bn	R292.1bn	R480bn
	Provision (ECL**)	R4.581bn	R3.303bn	R3.7bn	R2.635bn	R3.3bn
	Credit loss ratio	1.07%	8.9%	1.1%	0.90%	0.7%
Stage 2	Advances	R57.4bn	R10.3bn	R35bn	R43.3bn	R76bn
	Provision (ECL)	R6.497bn	R3.111bn	R4.28bn	R3.263bn	R7.4bn
	Credit loss ratio	11.32%	30%	12.2%	7.54%	9.7%
Stage 3	Advances	R48.6bn	R15.88bn	R33bn	R29.5bn	R44bn
	Provision (ECL)	R21.744bn	R11.352bn	R14.25bn	R11.22bn	R21.2bn
	Credit loss ratio	44.75%	71%	43.2%	38%	48.3%

* FirstRand calculations are author’s own from financial statements; includes FNB home loans, Wesbank Vehicle & Asset Finance, FNB Card, personal loans

** ECL = expected credit loss

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