Fair value is the price that would be received to sell an asset or the price paid to transfer a liability in an orderly transaction in the principal (or most advantageous) market at the measurement date, under current market conditions (i.e. the exit price), regardless of the fact that said price is directly observable or that another measurement approach is used.
IFRS 13 establishes a fair value hierarchy based on the extent to which inputs to valuation techniques used to measure the underlying assets/liabilities are observable. Specifically, the hierarchy consists of three levels.
- Level 1: the instrument's fair value is measured based on quoted prices in active markets.
- Level 2: the instrument's fair value is measured based on valuation models using inputs observable in active markets, such as:
- quoted prices for identical or similar assets or liabilities in non-active markets;
- quoted prices for similar assets or liabilities;
- observable inputs such as interest rates or yield curves, implied volatility, default rates and illiquidity factors;
- inputs that are not observable but supported and confirmed by market data.
- Level 3: the instrument's fair value is measured based on valuation models using mainly inputs that are unobservable in active markets.
Each financial asset or liability of the Bank is categorised in one of the above levels, and the relevant measurements may be recurring or non-recurring (see IFRS 13, paragraph 93, letter a).
The choice among the valuation techniques is not optional, since these shall be applied in a hierarchical order: indeed, the fair value hierarchy gives the highest priority to (unadjusted) quoted prices available on active markets for identical assets or liabilities (Level 1 data) and the lowest priority to unobservable inputs (Level 3 data).
Valuation techniques used to measure fair value are applied consistently on an on-going basis.
A.4.1 Fair value levels 2 and 3: valuation techniques and inputs used
In the absence of quoted prices on an active market, the fair value measurement of a financial instrument is performed using valuation techniques maximising the use of inputs observable on the market.
The use of a valuation technique is intended to estimate the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, under current market conditions. In this case, the fair value measurement may be categorised in Level 2 or Level 3, according to what extent inputs to the pricing model are observable.
In the absence of observable prices on an active market for the financial asset or liability to be measured, the fair value of the financial instruments is measured using the so-called "comparable approach" (Level 2), requiring valuation models based on market inputs.
In this case, the valuation is not based on the quoted prices of the financial instrument being measured (identical asset), but on prices, credit spreads or other factors derived from the official quoted prices of instruments that are substantially similar in terms of risk factors and duration/return, using a given calculation method (pricing model).
In the absence of quoted prices on an active market for a similar instrument, or should the characteristics of the instrument to be measured not allow to apply models using inputs observable on active markets, it is necessary to use valuation models assuming the use of inputs that are not directly observable on the market and, therefore, requiring to make estimates and assumptions (non observable input - Level 3). In these cases, the financial instrument is measured using a given calculation method that is based on specific assumptions regarding:
- the trend in future cash flows, possibly contingent on future events whose probability of occurring can be derived from historical experience or based on behavioural assumptions;
- the level of specific inputs not quoted on active markets: for the purposes of estimating them, information acquired from prices and spreads observed on the market shall have a higher priority. If these are not available, entities shall use historical data about the specific underlying risk factor or specialist research on the matter (e.g. reports by ratings agencies or primary market players).
In the cases described above, entities may make valuation adjustments taking into account the risk premiums considered by market participants in pricing instruments. If not explicitly considered in the valuation model, valuation adjustments may include:
- model adjustments: adjustments that take into account any deficiencies in the valuation models highlighted during calibration;
- liquidity adjustments: adjustments that take into account the bid-ask spread if the model calculates a mid price;
- credit risk adjustments: adjustments related to the counterparty or own credit risk;
- other risk adjustments: adjustments related to a risk premium “priced” on the market (e.g. relating to the complexity of valuation of an instrument).
The trade receivables portfolio measured at fair value consists of the on-balance-sheet exposures classified as performing with a residual life exceeding one year (medium-long term). Therefore, all exposures classified as in Default, the ones with a residual life less than one year, and unsecured loans are excluded from the valuation.
For the purposes of measuring performing loans at fair value, given the absence of prices directly observable on active and liquid markets, entities shall use valuation techniques based on a theoretical model meeting the requirements of IASs/IFRSs (Level 3). The approach used to determine the fair value of receivables is the Discounted Cash Flow Model, i.e. the discounting of expected future cash flows at a risk free rate for the same maturity, increased by a spread representative of the counterparty’s risk of default.
As for the Distressed Retail Loan portfolio, i.e. the portfolio of receivables generated by the NPL business area, which purchases and manages non-performing receivables mainly due from individuals, the Discounted Cash Flow Model is used to calculate fair value. In this case, the expected net cash flows are discounted at a risk free rate for the same maturity. Cash flows are discounted without considering a credit spread, since the credit risk of the individual counterparties is already incorporated in the statistical model used to estimate future cash flows with regard to collective management (non-judicial operations). Based on historical evidence concerning the recovery of positions in the Bank's portfolio, the model projects the relevant cash flows. As far as individual management (judicial operations) is concerned, the manager defines the projections of future cash flows for individual positions. The cash flows are net of expected collection costs, since these are required to achieve the estimated return. The Bank projected the average historical costs incurred over the last twelve months, calculated based on the party collecting the debt (external debt collection agencies, in-house agent network, attorneys, call centre): it estimates them at an average 13.5% of the amounts collected. As for purchased tax receivables, the Bank believes their amortised cost can be used as an approximation of fair value. The only element of uncertainty concerning these receivables due from tax authorities is the time required for collecting them; currently, there are no significant differences in the time it takes for the tax authorities to repay their debts. It should also be noted that Banca IFIS is one of the leading players in this operating segment, which makes it a price maker in the case of sales.
In general, for the purposes of non-recurring Level 3 fair value measurement of assets and liabilities, reference is made to:
- risk free rates calculated, according to market practice, using money market rates for maturities less than one year, and swap rates for greater maturities;
- Banca IFIS’s credit spread, which, since there are no bond issuances to be used as a reference, was calculated using bond issuances of counterparties considered equivalent as a reference;
- financial statements and information from business plans.
A.4.2 Measurement processes and sensitivity
In compliance with IFRS 13, for fair value measurements categorised within level 3, the Group tests their sensitivity to changes in one or more unobservable inputs used in the fair value measurements. Specifically, a negligible amount of the Group's financial assets measured at fair value are categorised within level 3, except for DRL loans: in light of their specific nature, Banca IFIS adopted a "comparable" approach, i.e. it assumes it would sell them at market prices calculated on the basis of the average value of the transactions carried out over the last twelve months.
A.4.3. Fair value hierarchy
Concerning recurring fair value measurements of financial assets and liabilities, the Banca IFIS Group transfers them between levels of the hierarchy based on the following guidelines.
Debt securities are transferred from level 3 to level 2 when the inputs to the valuation technique used are observable at the measurement date. The transfer from level 3 to level 1 is allowed when it is confirmed that there is an active market for the instrument at the measurement date. Finally, they are transferred from level 2 to level 3 when some inputs relevant in measuring fair value are not directly observable at the measurement date.
Equity securities classified as available for sale financial assets are transferred between levels when:
- observable inputs became available during the period (e.g. prices for identical assets and liabilities defined in comparable transactions between independent and knowledgeable parties). In this case, they are reclassified from level 3 to level 2;
- inputs directly or indirectly observable used in measuring them are no longer available or current (e.g. no recent comparable transactions or no longer applicable multiples). In this case, the entity shall use valuation techniques incorporating unobservable inputs.
A.4.5 - Fair value hierarchy
A.4.5.1 Assets and liabilities measured at fair value on a recurring basis: breakdown by fair value level
|Financial assets/liabilities measured at fair value||31.12.2015||31.12.2014|
|1. Financial assets held for trading||-||-||259||-||-|
|2. Financial assets at fair value||-||-||-||-||-||-|
|3. Available for sale financial assets||3.216.832||-||4.701||229.355||-||13.970|
|4. Hedging derivatives||-||-||-||-||-||-|
|5. Property, plant and equipment||-||-||-||-||-||-|
|6. Intangible assets||-||-||-||-||-||-|
|1. Financial liabilities held for trading||-||-||21||-||-|
|2. Financial liabilities at fair value||-||-||-||-||-||-|
|3. Hedging derivatives||-||-||-||-||-||-|
L1= Level 1 fair value of a financial instrument quoted in an active market;
L2= Level 2: fair value measured using valuation techniques based on observable market inputs other than the financial instrument's price;
L3= Level 3: fair value calculated using valuation techniques based on inputs not observable in the market.
A.4.5.2 Annual changes in financial assets measured at fair value on a recurring basis (level 3)
|Financial assets held for trading||Financial assets at fair value||Available for sale financial assets||Hedging derivatives||Property, plant and equipment||Intangible assets|
|1. Opening balance||-||-||13.970||-||-||-|
|2. Increases||259||- --||3||-||-||-|
|2.1 Purchases||259||- -||3||-||-||-|
|2.2 Profit taken to:||-||-||-||-||-||-|
|2.2.1 Income statement||-||-||-||-||-||-|
|-of which: capital gains||-||-||-||-||-||-|
|2.3 Transfers from other levels||-||-||-||-||-||-|
|2.4 Other increases||-||-||-||-||-||-|
|3.3 Losses taken to:||-||-||8.717||-||-||-|
|3.3.1 Income statement||-||-||8.717||-||-||-|
|- of which capital losses||-||-||8.717||-||-||-|
|3.4 Transfers to other levels||-||-||-||-||-||-|
|3.5 Other reductions||-||-||-||-||-||-|
|4. Closing balance||259||-||4.701||-||-||-|
Level 3 available for sale financial assets refer entirely to equity interests.
A.4.5.3 Annual changes in liabilities measured at fair value on a recurring basis (level 3)
|Financial liabilities held for trading||Financial liabilities at fair value||Hedging derivatives|
|1. Opening balance||-||-||-|
|2.2 Losses taken to:||-||-||-|
|2.2.1 Income statement||-||-||-|
|-of which: capital losses||-||-||-|
|2.3 Transfers from other levels||-||-||-|
|2.4 Other increases||-||-||-|
|3.3 Profit taken to:||-||-||-|
|3.3.1 Income statement||-||-||-|
|- of which capital gains||-||-||-|
|3.4 Transfers to other levels||-||-||-|
|3.5 Other reductions||-||-||-|
|4. Closing balance||21||-||-|
A.4.5.4 Assets and liabilities not measured at fair value or measured at fair value on a non-recurring basis: breakdown by fair value level
|Assets and liabilities not measured at fair value or measured at fair value on a non-recurring basis||31.12.2015||31.12.2014|
|1. Held to maturity financial assets||-||-||-||-||4.827.363||4.961.033||-||-|
|2. Due from banks||95.352||-||-||95.352||274.858||-||-||274.858|
|3. Loans to customers||3.437.136||-||-||3.452.700||2.814.330||-||-||2.920.547|
|4. Property, plant and equipment held for investment||720||-||-||926||720||-||-||926|
|5. Non-current assets and disposal groups classified as held for sale||-||-||-||-||-||-||-||-|
|1. Due to banks||662.985||-||-||662.985||2.258.967||-||-||2.258.967|
|2. Due to customers||5.487.476||-||-||5.491.311||5.483.474||-||-||5.484.413|
|3. Debt securities issued||-||-||-||-||-||-||-|
|4. Liabilities associated with non-current assets||-||-||-||-||-||-||-||-|
BV= book value
L1= Level 1
L2= Level 2
L3= Level 3