Loan loss coverage: reconcile NPLs, allowances and write-offs
An improving nonperforming-loan ratio can coexist with credit losses. Rebuild the stock of problem loans and the allowance separately, then examine write-offs and recoveries. The question is whether apparent improvement came from borrower cures, disposal, denominator growth or removal of balances already judged difficult to collect.
Establish two definitions
IFRS 7 concerns financial instrument risk disclosures, while IFRS 9 governs relevant accounting impairment. A regulator’s nonperforming-loan definition is not automatically identical to IFRS credit impairment. US GAAP allowance calculations also require a different accounting framework. Put the issuer’s definitions beside each ratio before combining them.
Use gross loans for a gross NPL ratio if that is the published definition. Check whether accrued interest, purchased loans, held-for-sale assets and off-balance-sheet commitments are included. Coverage calculated with a broad allowance and a narrow NPL balance can look reassuring for purely definitional reasons.
Hypothetical credit clean-up
Assume opening gross NPLs of 120 million. New problem loans add 45, cash recoveries remove 15, genuine cures remove 10, sales remove 20 and write-offs remove 40. Closing NPLs are 80. If total gross loans rise from 2,000 to 2,500, the NPL ratio falls from 6% to 3.2%.
The ratio more than halves, but there were still 45 of new problem loans. Of the 85 removed from the NPL stock, 60 came from sales and write-offs. That is a different operating story from widespread repayment. A sale may transfer exposure successfully, but its price and any retained guarantees determine the economic result.
Suppose the allowance moves from 90 to 100 through a 50 charge and 40 of write-offs. Coverage rises from 75% to 125%. The increase does not establish that expected recoveries improved: the denominator fell substantially. The example uses hypothetical amounts and omits currency movements to make the mechanisms auditable.
Build the linked worksheet
The first panel reconciles NPL stock: opening, inflows, cures, collections, sales, write-offs and closing. The second panel reconciles allowance: opening, impairment charge or release, acquisition effects, currency, write-offs and closing. A third panel records recovered cash, sale proceeds and collateral realizations.
For loan sales, preserve the removed carrying amount, proceeds and retained risk separately. Removing a balance from NPLs does not establish an equal cash recovery.
Add a row for the issuer’s treatment of recoveries on previously written-off assets. They may appear outside the gross-loan movement. Never count a recovery both as a reduction in current NPLs and as a separate reduction in losses unless the note supports both effects.
Read collateral as a separate claim
Collateral value is not the same as recoverable cash. Record valuation date, senior liens, enforcement jurisdiction, expected costs and time to realization. A property valuation may already influence the allowance estimate; adding it again as additional coverage double counts the protection.
Useful follow-up observations include the new NPL formation rate, vintage performance after restructuring, and recoveries against earlier assumptions. If a loan is labeled cured after a modification, inspect the required performance period and whether payments actually resumed. Missing vintage data should remain an explicit limitation, rather than becoming evidence that restructurings worked.
FAQ
Is coverage above 100% proof that all losses are funded?
No. It compares an accounting allowance with one defined stock of problem loans. Future deterioration, commitments and recovery uncertainty remain. It is also not a segregated cash fund available to pay depositors.
Does a write-off mean the bank stopped collection?
Not necessarily. Accounting removal and legal collection rights are different matters. Read the write-off policy and subsequent recovery disclosures. The research conclusion should describe what was removed and what cash was realized, without assuming a legal outcome.