Financial guarantee contract

[hubertd]

According to IFRS 9 given financial guarantee contract needs to be initially recognised at fair value. If we provide a financial guarantee for 100 million and guarantee fee is 1% annually of undrawn amount with cover for 5 years I can calculate pv of fee cashflows and recognise this amount as finaancial liability. What will be my debit entry? Subsequently the liability needs to be amortised in line with IFRS 15 and this compared with ECL. My financial lisbility is a pv of 5 year fees, let’s say 4.3m whereas I’m going to receive 5 million as a fee income. How would I account for a difference between 4.3m and 5m of actual cash?

Thanks

[Ketan Marwah]

Hi,

May I ask if this is an intra group guarantee? If answer is yes, refer this: https://ifrscommunity.com/knowledge-bas ... tatements/. If answer is no, then account for the difference according to its substance under other applicable IFRS (IFRS 9.B5.1.1).

[Ketan Marwah]

What will be my debit entry?

You would debit the 5mm cash to be received so currently a financial asset for you.

[hubertd]

Hi,

May I ask if this is an intra group guarantee? If answer is yes, refer this: https://ifrscommunity.com/knowledge-bas ... tatements/. If answer is no, then account for the difference according to its substance under other applicable IFRS (IFRS 9.B5.1.1).

No, it’s not an inter-company

[hubertd]

What will be my debit entry?

You would debit the 5mm cash to be received so currently a financial asset for you.

I don’t think it’s just a receivable. This amount will be changing depending on the utilisation of the guarantee. It’s 5m at inception assuming guarantee wil not be drawn. Let’s say aftera year 50m is drawn. At this point my expected fees are only 0.5m for next 4 years.

[Ketan Marwah]

Hi, ok. So then you would subsequently remeasure your financial asset as circumstances change and adjust against the line where you originally plotted the difference between financial asset and liability.

[DJP]

This arrangements doesn't seem to make much sense from a commercial stand point. While the facility is undrawn, there is no debt instrument. However, it seems that the guarantor will receive less premium once the facility is drawn and the debt crystalises. What sense does this make? Are you sure the 1% is only over the undrawn amount, or is it over the entire facility?

[hubertd]

This arrangements doesn't seem to make much sense from a commercial stand point. While the facility is undrawn, there is no debt instrument. However, it seems that the guarantor will receive less premium once the facility is drawn and the debt crystalises. What sense does this make? Are you sure the 1% is only over the undrawn amount, or is it over the entire facility?

Once the guarantee is drawn in becomes a mezzanine loan in a project and gets paid interest just like a normal lending arrangement.

[DJP]

I get that, but that's not the point. According to the fact pattern you're presenting, the guarantor receives a premium only on the undrawn part of the facility. If that is indeed the case, the guarantor will receive less premium when the facility is drawn. That doesn't make much sense given that in principle the credit risk should be higher when the facility is drawn.

[IFRS2020]

I have a query in relation to financial guarantee accounting.

At initial recognition – a financial guarantee is initially recognised at FV, producing entries:

Debit: Premium receivable/Cash
Credit: Deferred Premium

Subsequent measurement – it is measured at the higher of:

- IFRS 9 ECL on the financial guarantee; and
- Fair Value of the financial guarantee on day 1 less, when appropriate, the cumulative amount of income recognised in accordance with the principles of IFRS 15

My questions are:

- If ECL is higher at the subsequent measurement, what happens to the unamortised deferred premium? Would it get released to P&L and be replaced with the ECL value? or
- Is the incremental ECL value added to the unamortised deferred premium? For instance, if the unamortised deferred premium is £500 and ECL is £700, is it £200 that gets added to the deferred premium to reflect the FG liability at £700? or is the entire deferred premium of £500 replaced with the ECL amount of £700? If ECL replaces the deferred premium, what happens to the deferred premium balance of £500?
- If the subsequent measurement is at ECL, does the amortisation of the deferred premium still take place? How is the comparison drawn between the ECL value and FG day 1 value less amortisation in accordance with IFRS 15?

[Ketan Marwah]

Hi,

While I would respond to your queries but I would appreciate if you may take this to a new thread in case you have follow up questions. I don’t want this topic to drag out in this thread as I may then get into trouble with the admin

To begin with we are addressing financial guarantee which is a financial liability and not deferred premium. Deferred income is usually not a financial liability because it represents an obligation to deliver a good or service rather than cash or other assets in settlement.

Secondly, with the replacement of IFRS 4 Insurance Contracts by IFRS 17 Insurance Contracts, the accounting for these contracts may change significantly. Companies now need to apply either IFRS 17 or IFRS 9 Financial Instruments to these contracts. I am continuing in this thread with the assumption that you are exploring the application under IFRS 9.

Now to your questions:

My questions are:

- If ECL is higher at the subsequent measurement, what happens to the unamortised deferred premium? Would it get released to P&L and be replaced with the ECL value? or

: You would subsequently remeasure the financial liability I.e. financial guarantee.

- Is the incremental ECL value added to the unamortised deferred premium? For instance, if the unamortised deferred premium is £500 and ECL is £700, is it £200 that gets added to the deferred premium to reflect the FG liability at £700? or is the entire deferred premium of £500 replaced with the ECL amount of £700? If ECL replaces the deferred premium, what happens to the deferred premium balance of £500?

: You would amortize the amount of your financial guarantee in line with IFRS 15 Revenue from Contracts with Customers and as mentioned above that at the end of subsequent reporting period you would remeasure the financial guarantee at the higher of the two inputs which are also mentioned in your post in line with IFRS 9.4.2.1(c)

- If the subsequent measurement is at ECL, does the amortisation of the deferred premium still take place? How is the comparison drawn between the ECL value and FG day 1 value less amortisation in accordance with IFRS 15?

: This would be quite a broad explanation but let me try:

1) Yes you continue with the amortization. You would carry an amortized amount at the end of the reporting period which you would then subsequently remeasure applying the principles of IFRS 9.4.2.1(c)
2) At initial recognition, If the guarantee is issued to an unrelated party on a commercial basis, the initial fair value is likely to equal the premium received. If no premium is received (which is often the case in intra-group situations), the fair value must be determined using a method that quantifies the economic benefit of the guarantee to the holder.
3) Subsequently, for ECL measurement the amount of the loss allowance at each subsequent reporting period equals the 12-month expected credit losses. However, where there has been a significant increase in the risk that the specified debtor will default on the contract, the calculation is for lifetime expected credit losses. It is important to note that the simplified impairment approach available for trade receivables cannot be used for financial guarantee contracts.

Expected credit losses for a financial guarantee contract are the cash shortfalls adjusted by the risks that are specific to the cash flows. Cash shortfalls are the difference between:

The expected payments to reimburse the holder for a credit loss that it incurs, and
Any amount that an entity expects to receive from the holder, the debtor or any other party.

Hope is clear otherwise see you in a new post;-)

[IFRS2020]

Ketan, I have started a new post, thanks

[hubertd]

I get that, but that's not the point. According to the fact pattern you're presenting, the guarantor receives a premium only on the undrawn part of the facility. If that is indeed the case, the guarantor will receive less premium when the facility is drawn. That doesn't make much sense given that in principle the credit risk should be higher when the facility is drawn.

Sorry for a late reply - I was on holiday.

I think you're right. It's a new product for us an we were not sure how to set the guarantee fees in the contract. It's still to be done but I think we need to charge the fees on full facility (drawn+undrawn).

I'll be sending some further questions later today as it's getting interesting our side and I would appreciate some views here.