Timing challenges and diverging regulatory approaches to IFRS 9 have led to variations in Nordic banks' expected loan losses in their first-quarter results, making it difficult to compare how vulnerable they are to the coronavirus crisis.

One inherent feature of IFRS 9, an accounting standard implemented in 2018, is that it requires banks to take a forward-looking view and apply macroeconomic forecasts when estimating expected credit losses, or ECL. This leaves room for interpretation, particularly given there is uncertainty about what impact the crisis will have on the economy, said Anders Torgander, a financial services partner at KPMG in Sweden.

"The consequence will be deviations in the numbers. It will mean that two banks with the same portfolio may have different ECL provisions," he said in an interview. "On top of that, the banks had so little time to deal with this when preparing this year's Q1 reports. So on the basis of published Q1 reports, it's a bit difficult to interpret how the different banks think different parts of their portfolios will be affected in the long term."

While first-quarter loan loss provisions increased for most Nordic banks, the extent varies. Finland-headquartered Nordea Bank Abp, the largest lender in the Nordics, reported credit impairments of €154 million, a cost of risk of 19 basis points, according to S&P Global Market Intelligence data.

The region's second-largest bank, Denmark-based Danske Bank A/S, recorded impairments of 4.34 billion Danish kroner and a cost of risk more than four times that of Nordea, at 83 bps. This accounted for 162% of Danske's pre-impairment operating profit.

Both Nordea and Danske made provisions for specific sectors that are vulnerable to COVID-19 disruptions, such as hotels and restaurants, retail and transportation, but their macroeconomic outlooks differ.

Danske updated its macroeconomic assumptions under the IFRS 9 ECL model, which included a 25% likelihood of a "severe downside scenario" with substantial increases in unemployment and decreases in house prices.

The macroeconomic adjustments amounted to 40% of Danske's loan loss provisions for the quarter. It reflects a decision by the bank to adopt IFRS 9 in the "timely, early type of fashion that IFRS 9 was originally designed for," CFO Stephan Engels told S&P Global Market Intelligence.

Danske "front-loaded the potential severe negative impact of the pandemic on asset quality," said Vitaline Yeterian, senior vice president for the global financial institutions group at DBRS Morningstar.

Nordea did not update its macroeconomic outlook under IFRS 9, as it felt it was too early to assess the crisis's full impact, according to Chief Risk Officer Matthew Elderfield, speaking to analysts April 29. He said the bank would make those adjustments in the second quarter.

Instead, Nordea's first-quarter impairment charges covered the "likely near-term increase in loan losses expected following the COVID-19 outbreak," according to its interim report.

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Timing, regulation

The timing of the pandemic made first-quarter calculations particularly challenging, said Tuomas Ilveskoski, a financial services partner at KPMG Finland.

"COVID-19 emerged in the Nordics in mid-March, which meant that banks had practically two weeks' time to make decisions around how to calculate IFRS 9 figures ... It was quite little time to understand the situation, which was evolving day by day," he said.

Different approaches among regulators also likely affected accounting decisions, Yeterian said.

With Finland being part of the eurozone, the European Central Bank supervises Nordea, while in Denmark, which is outside the monetary union, banks including Danske are supervised by the Danish financial supervisory authority, Finanstilsynet.

The ECB has sought to ease the impact of the IFRS 9 rules by asking banks to "avoid excessively procyclical assumptions in their expected credit loss estimations" during the pandemic.

"What Nordea has been doing is reflecting what the ECB encouraged it to do. This is what most European banks did in the end," Yeterian said.

In Denmark, the financial supervisor has traditionally had a "prudent interpretation of the impairment rules," said Lars Rhod Søndergaard, head of financial services at EY Denmark.

Finanstilsynet said April 2 that "applying a short-term perspective alone will not be in compliance with IFRS 9."

"[The regulator] told the banks to look at the macroeconomic forecasts from the Danish central bank and said it expects their calculations to not deviate significantly from that," said Søndergaard. "It has also been in touch with all the major banks in Denmark to align expectations in relation to impairments."

While this approach is not a problem in isolation, it causes some comparison challenges, said Jakob Legård Jakobsen, economic executive director at industry body Finance Denmark, speaking at a May 14 briefing.

"Of course it makes it challenging to make an international comparison of the expected loan losses, as we have a slightly different way of doing this in Denmark compared to the eurozone and elsewhere," he said.

Oil-price hit

Banks' real risk exposure to the crisis will become clearer in the coming quarters, Ilveskoski said.

Nordea's approach means it will likely see "materially higher" loan losses in the second quarter, according to a UBS analyst note released April 30.

Record-low oil prices is another aspect that will continue to impact the Nordic banks' credit losses, having already caused the cost of risk for Norway's DNB to jump far above that of its peers in the first quarter. Of DNB's 5.8 billion Norwegian kroner loan loss provisions in the period, 45% related to oil and gas.

Handelsbanken's oil exposure is low, with just 3% of its first-quarter loan loss provisions relating to this sector, helping it to keep a low cost of risk. Additionally, the bank has, like Nordea, not yet adjusted its macro assumptions.

"Looking forward, I think there's more to see from COVID-19 than from the decline in oil price," Yeterian said. Low oil prices affect a more limited group of companies, making it easier for banks to estimate the potential future impact on their portfolios, she said.

As of May 22, US$1 was equivalent to 6.85 Danish kroner and 10.52 Norwegian kroner.