1. User Guide
  2. Amortization Processes

35 Amortization Processes

This module discusses the procedure for creating and executing the Amortization Process. In the case of Effective Yield amortization, it executes the cash flow process also. When all the required assumptions are defined, Cash Flow Engine Processing performs the calculation and generates a result set with an Effective Interest Rate. The Amortization Process allows you to perform the following tasks:

  • Determine the data that you want to process.
  • Submit to the Cash flow engine the modeling horizon for which you want to calculate cash flows.
  • Submit the Amortization rule based on which amortization takes place.
  • Specify the prepayment, forecast rate, and other assumptions to be used in the process.
  • Execute the Amortization process and generate results.

This allows the financial institutions to amortize the fees, premiums or discounts, and costs associated with the given instrument over the expected life.

Overview of Amortization:

The amortization process is executed post the computation of the Expected Credit Losses (ECL). In IFRS9SCS, ECL is expected to download through stage tables. Only those accounts that are classified as Amortized Costs. In this release, Amortization is covered only for Assets. Only those accounts that are classified as an Amortized Cost will undergo Amortization. Amortization is covered for both Assets and Liabilities. ECL is required only for Assets.

Note:

  • It is mandatory to map each of the leaf node product members to the Account Type attribute. Based on the account type mapping, the Stage Determination, Account Classification, and Amortization Process determines the Asset and Liability indicator of an account.
  • Map each product member to the Account Type attribute by using the Dimension Management feature or load the dimension data by using the Dimension Loader Process.
Assumptions:
  • Amortization is performed by including the account origination date.
  • In the first execution, for accounts that are already opened, it is expected that the current deferred balances must be available as a download as no amortization will be done for these accounts.

Effective Yield Amortization

Movement of Data for Processing:

There are two processing areas, one for processing account-level information and the other for processing transaction-level information. Upon triggering the process, the given set of accounts along with the corresponding instrument information is moved into the account-level processing area.

The Key instrument parameters are as follows:

  • Account Number
  • Account Classification
  • IFRS 9 Stage (Only required for Assets)
  • Carrying Amount (As of Previous MIS Date)
  • Deferred Fees (As of Previous MIS Date)
  • Deferred Premium or Discount (As of Previous MIS Date)
  • Deferred Cost ((As of Previous MIS Date)
  • Prepayment Indicator, Restructured Indicator,
  • Accrual Basis Code
  • Compounding Frequency
  • Actual Interest Accrued till Date (Core Banking Interest)
  • PV of Future Cash Flow Discounted at EIR
  • Account Start Date
  • EIR (%),
  • Expected Credit Loss
  • ECL DOIR
  • Expected Credit Loss (Only required for Assets)
  • POCI Flag (Only required for Assets)
  • Original Book Balance (Only required for Assets- This is Specific to POCI accounts)
  • ECL DOIR (Only required for Assets- This is Specific to POCI accounts)

Identify and Obtain Information from the Last Accrual Date:

For the given Run, the Previous Execution Date is considered the Last Accrual Date. Based on the Last accrual date, the following account-level information is obtained:

  • Ending Net Book Value or the Modified Net Book Value, based on the Modified Flag as of the Last Accrual Date.
  • Compounded Interest
  • Ending Deferred Balances
  • Cumulative EIR Interest recognized till date (till Last Accrual Date)
  • Cumulative Interest Adjustment recognized till date (Last Accrual Date)

If the account is new (originated between the Last Accrual Date and the Current MIS Date), then these values are computed as follows:

  • Ending Net Book Value Book Value =
    • Assets: First Transaction Amount + Deferred Balance (-Fees + Premium or Discount + Cost)
    • Liabilities: First Transaction Amount + Deferred Balance (-Fees - Premium or Discount -Cost)
  • Compounded Interest = 0
  • Ending Deferred Balances =
    • Assets: Deferred Balance (-Fees + Premium or Discount + Cost)
    • Liabilities: Deferred Balance (-Fees - Premium or Discount - Cost)
  • Cumulative EIR Interest recognized till date (till Last Accrual Date) = 0
  • Cumulative Interest Adjustment recognized till date (Last Accrual Date) = 0
  • Transactions with Debit/Credit indicator
    • Assets: Transactions with a Credit indicator are considered Negative while transactions with a Debit indicator are considered Positive.
    • Liabilities: Transactions with a Debit indicator are considered Negative while transactions with a Credit indicator are considered Positive.

Transaction Level Data Population

For the given accounts, the Transaction data is populated from the following Stage - Transaction tables to the Transaction Level Processing table. The following conditions are applied to filter and move the transactions:

  • The transaction value date must fall between the Last Accrual Date and the MIS Date.
  • All transactions with Canceling Indicator = Y and with Reversal Date not null are ignored.
  • Transactions with Debit Credit indicator = C are made Negative while transactions with D are made positive.

Transaction Level Processing:

For each account in Account Level, based on the compounding frequency, the Compounding Dates between the Last Accrual Date and Current MIS Dates are identified. For these compounding dates, additional transactions are included in the table with TXN Amount equal to ZERO. Compounding dates arrive from the Financial Year Start date. For example, if an instrument is compounding Monthly and the Financial Year start is 15-MMM-YYYY, the process will create a transaction on the 15th of every month. If the account has originated post the Last accrual date, then the compounding dates are considered between the Account Start date and the current MIS Date.

Note:

  • All financial transactions outflow or inflow are required; those that affect the outstanding and computation of interest.
  • Outflow > Loan Disbursement, Withdrawal, and so on.
  • Inflow > EMI, Prepayment, and so on.
  • If transactions are marked as reversed or canceled, the application.
  • The first transaction of a new account is assumed to be a Disbursement.

These Compounding Dates are marked with Compounding Flag = Y.

Once the transactions for the compounding dates are inserted, for every account, a transaction is included for a given MIS Date, the TXN amount is ZERO.

Note:

If a transaction already exists for a Compounding date, that is, Source TXN Date = Compounding Date, the same transaction is used with only the compounding flag made Y. If the transaction already exists for an MIS Date, that is, Source TXN Date = MIS Date, then no new transaction is included. If there are multiple transactions for a given date, then the values are added up to form a single transaction.

The transactions are then sorted in ascending order of Transaction Dates.

The transactions are now ready for Interest computation. Subsequently, the process parses through each of the transactions, one by one, to compute the Interest amounts for every transaction. To enable this, the process requires the following data:

  • Accrual Basis Code
  • Number of days

For the first transaction; Txn Date - Last Accrual date

For all subsequent transactions: Current Txn date - Previous Txn Date

  • Starting Net Book value (for the first transaction):

If the Modification flag (on Last accrual date) = N; Ending Net Book Value (on Last Accrual date)

If the Modification flag (on Last accrual date) = Y; Modified Net Book Value (on Last Accrual Date)

After these steps, the Effective Interest Amount, Compounded Effective Interest Amount, and Ending Net Book values are computed for each transaction, by taking EIR, Number of Days for Interest accrual, Accrual basis code (for the Number of days in a year), Compounding Flag, Starting Book value, and Transaction amount into consideration.

Once the Ending Book value is computed for a given transaction, the same is used as the Beginning Net Book Value for the next transaction.

The Effective Interest Amount is calculated as follows:

EIR Interest Amount = NBV * Days * (EIR %)

The Compounded Effective Interest Amount is computed by compounding the interest computed for each transaction to the previous compounded amount. If the transaction is marked as a compounding one, that is, the Compounding Flag = Y, then the Compounded interest is made as ZERO. The total compounded interest to date will be added back to the Net Book Value.

The Ending Net Book value for each transaction is computed as:

If Compounding Flag = N, Ending Net Book Value = Starting Net Book Value + Transaction Amount

If Compounding Flag = Y, Ending Net Book Value = Starting Net Book Value + Transaction Amount + Effective Interest amount + Compounded Effective Interest Amount to date.

Note:

The transaction amount must be adjusted for signage depending upon Db Cr Indicator.

Aggregation Account Level and Adjustment Computation

Once the transaction level computations are over, the final computed values are aggregated back to the account level for the final computations. IFRS 9 Stages are relevant for Assets. For liabilities, IFRS 9 stages are not applicable. For the below values, the liabilities calculation is the same as per Stage 1 calculation. The following values are considered:

  • Ending Net Book Value:
    • Stage 1, Stage 2: Value from the last transaction
    • Stage 3, POCI: Value from the last transaction - Expected Credit Loss
  • Effective Interest Amount: Sum of all Effective Interest Amounts across all transactions
  • Compounded Effective Interest Amount: Value from the last transaction

Once the values are aggregated, the final computations to arrive at the Interest Adjustment are done.

  • Step 1: The Cumulative Effective Interest Amount is calculated as the sum of the Current Effective Interest Amount and the Cumulative Effective Interest Amount of the previous MIS Date.
  • Step 2: The Cumulative Interest Adjustment is calculated by subtracting the Actual Interest Accrued to date, Core Banking Interest, from the Cumulative Effective interest accrued to date.
  • Step 3: The Current Interest Adjustment is calculated by subtracting the Cumulative Interest Adjustment of the Previous MIS Date from the Cumulative Interest Adjustment of the Current MIS Date.

This value, Current Interest Adjustment, is the adjustment entry that needs to be passed to the accounting systems and reflects the amount of deferred balance that needs to be amortized for the given period.

Modification Gain or Loss:

In addition to the preceding steps, if an account undergoes a Prepayment or restructuring, the application computes the Modification Gain Loss, as specified by the IFRS 9 guidelines. The Modification Gain Loss is calculated as the difference between the Modified Net Book Value and the Ending Net Book Value. Modified Net Book Value is equal to the Net Present Value of all future Cash Flows discounted at the given Effective Interest Rate.

Prepayments and Restructuring are identified based on the Prepayment Date or Restructured Date. Application checks if these dates fall between the Last Accrual Date and the Current Date, FIC MIS DATE. Modification Gain/Loss will be calculated on the respective date.

Modification Gain/Loss= Modified Net Book value – Ending NBV

1. Ending NBV is the outstanding amount when the account gets flagged as “Restructured" or there is a prepayment”.

2. For the computation of Modified Net Book Value (Net Present Value of all Future Cash Flows), As of Date (AOD), Future Cash Flow is required. Future Cash Flow is discounted with the latest EIR. The following are functional use cases to get this EIR.

  • When Restructured/Prepayment Event and Repriced Event are different: For a Fixed Rate or Floating Rate Instrument, if the latest repriced EIR is available then the application uses it else it uses origination EIR to discount the Future Cash Flow.
  • Note: The latest repriced event should be earlier than Restructured/Prepayment Event.
  • When Restructured/Prepayment Event and Repriced Event are the same: For a Fixed Rate or Floating Rate Instrument, the latest EIR is available just before the (Restructured/Prepayment/Repriced) Events get used to discount the Future Cash Flow.
  • Sign convention for Modification Gain/Loss:
    • Assets: A positive number indicates gain, and a Negative number indicates loss.
    • Liabilities: A positive number indicates loss and a Negative number indicates gain.

Amortization of Individual Components of Deferred Balance - Fee, Premium or Discount, and Cost

As a continuation of Aggregation Account Level and Adjustment Computation and Ending Deferred Balance, the Interest Adjustment and the Ending Deferred balances are split up to compute the ending balances of the individual components. These components are, considered for the computation of Effective Interest Rate as well:

  • Fee
  • Premium or Discount
  • Cost

The application first computes the ratio of Fee, Premium or Discount, and Cost based on their values as of the date of initial recognition of the given account. Using this ratio, the application then splits the Interest Adjustment into individual components. The result of this split is the individual adjustment values:

  • Fee Adjustment
  • Premium or Discount Adjustment
  • Cost Adjustment

Post the computation of the individual adjustment values, the individual componentized ending deferred balances are computed by subtracting the individual beginning balances from their corresponding adjustment amounts.

Ending Deferred Balance

The Ending Deferred Balance for the current MIS Date: Cost Balance Ending + Premium/ Discount Balance Ending - Fees Balance Ending.

Note:

Whenever the ending deferred balance becomes zero, the computation of interest adjustments is stopped forthwith.

Amortization Cost:

Amortization cost is calculated for all accounts and below is the formula:

  • Stage 1, Stage 2: NBV End- Expected Credit Loss
  • Stage 3, POCI: NBV End

Interest Unwinding:

Interest Unwinding is only calculated for Assets.

To calculate the interest unwinding which is specifically to track any stage 3 accounts moved to stage 1 or stage 2, the below measures have been calculated.

  • Transaction Level Processing: NBV Start Unwinding, EIR Interest Unwinding, Current EIR Interest Unwinding Delta, NBV End Unwinding, Beginning Compounded EIR Interest Unwinding, Ending Compounded EIR Interest Unwinding.
  • Account Level Processing: NBV End of Period Unwinding, Current EIR Interest Unwinding, Current EIR Interest Unwinding Delta, Compounded EIR Interest Unwinding

Straight Line Method Amortization:

The following section details the Straight-Line Method Amortization:

Similar to Effective Yield Amortization, Straight Line Amortization also has two processing areas; one for processing account-level information and the other for processing transaction-level information. On triggering the process, the given set of accounts along with the corresponding instrument information is moved into the account-level processing area.

In this amortization method, most of the components are the same as Effective Yield Amortization. The Straight-Line method is generally used for noncash flow-based instruments, so all amortization calculations are not based on the Effective Interest Rate.

Interest Recognition

  • Interest Recognition is a new component that is calculated for Straight line method amortization only.
  • Assets:
    • If the instrument is at a discount: Accrued Interest Current+ Fees Adjustment- Cost Adjustments+ Premium_Discount Adjustments
    • If the instrument is at a premium: Accrued Interest Current+ Fees Adjustment- Cost Adjustments- Premium_Discount Adjustments
  • Liabilities:
    • If the instrument is at a discount: Accrued Interest Current+ Fees Adjustment- Cost Adjustments- Premium_Discount Adjustments
    • If the instrument is at a premium: Accrued Interest Current+ Fees Adjustment- Cost Adjustments+ Premium_Discount Adjustments

Modification Event:

  • Like Effective yield amortization, in this method also modification event is flagged as yes if a pre-payment or restructured event is triggered.
  • Modification Gain/Loss is not calculated in this method.
  • Amortization is adjusted based on revised contractual agreements.
  • Amortization is adjusted based on revised contractual agreements.