SFIL Annual financial report 2018

4 I Annual financial statements in accordance with French GAAP 118 SFIL Annual Financial Report 2018 1.2.6. Derivative transactions SFIL concludes derivative transactions that can be broken down into two categories: Micro-hedge transactions and Isolated open positions. The valuation and accounting treat- ments of these financial instruments depends on the chosen category. The notional amount of these transactions is recognized off-balance sheet over the maturity of the instruments, i.e. from the date the contract is signed (including forward con- tracts ) up to maturity. The amount recognized is adjusted to reflect any changes in notional amounts so as to represent the current or future maximum commitment. Payments made at the inception of financial instruments are amortized over their maturity for the time remaining according to a quasi-actuarial method. 1.2.6.1. Micro-hedge transactions Derivatives are booked as micro-hedges when they are designed to hedge against the interest rate risk or the for- eign exchange risk related to an item or a set of homogene- ous items identified from the outset. Expense and income on these transactions are recognized in the income statement the same way as income and expense on the hedged item or set of homogeneous items. Termination fees received or paid because of the early inter- ruption of the hedging instrument are recognized in the income statement at the termination date. 1.2.6.2. Isolated open positions SFIL acts as an intermediary between Caisse Française de Financement Local, its subsidiary, and certain banking coun- terparties. These transactions with its subsidiary constitute isolated open positions. Expense and income on these transactions are recognized in the income statement prorata temporis, respectively as Interest expense and Interest income . The counterpart is recognized in accruals until the payment date. A provision is recognized in respect of any unrealized losses. Unrealized gains are not recognized. 1.2.7. Foreign currency transactions SFIL recognizes foreign currency transactions in accounts opened and denominated in each of the currencies used. Specific foreign exchange position accounts and foreign exchange position equivalent accounts are opened in each currency. At each closing date, differences between on the one hand the amounts resulting from a market price valuation at clos- ing date of the foreign exchange position accounts and on the other hand the amounts recognized in the foreign exchange position equivalent accounts are recognized in the income statement. 1.2.8. Foreign exchange transactions In the course of systematic hedging of its foreign exchange risk, SFIL enters into currency swaps. These currency swaps are initiated to eliminate the risk of foreign exchange rate fluctuations that might affect an asset or liability as soon Redemption and issue premiums are amortized according to a quasi-actuarial method over the maturity of the securities concerned prorata temporis . They are recognized on the balance sheet in the same categories as the corresponding debt. Amortization of these premiums is recognized in the income statement as Interest expense. If securities are issued above par, amortization of issue premiums is deducted from Interest expense. Interest is recognized in the net interest margin for accrued amounts calculated prorata temporis . Issuance costs and commissions related to issued securities are amortized according to a quasi-actuarial method over the maturity of the related debts and are recognized in the net interest margin. Bonds issued which are denominated in foreign currencies are accounted for using the same method as foreign cur- rency transactions (see below). 1.2.5. Provisions Provisions are recognized based on their discounted value when the three following conditions are met: •  SFIL has a present legal or constructive obligation as a result of past events; • i t is probable that an outflow of resources represent- ing economic benefits will be required to settle the obligation; •  a reliable estimate of the amount of the obligation can be made. Collective provision covers the risk of loss in value among the population of loans, bonds and loan commitments not yet covered by any specific loss allowance at closing date. Among this population, counterparties that are reviewed in watchlist committee or might be reviewed in a foreseeable future are identified through the use of automatic criteria (based in particular on internal ratings and warning indica- tors for rating migration determined to be risky) and ad-hoc analysis based on the use of professional judgment and expert opinion: outstanding on these counterparties forms the base of the collective provision. Losses on these coun- terparties are estimated on the basis of past events (use of historical patterns), current economic environment and expectations on future economic environment. For this pur- pose, SFIL uses a credit risk model based on an approach derived from Basel approach; this model is subject to regu- lar back-testing. On January 1, 2018, SFIL expanded the scope of calcula- tion of collective provision so as to include some of the exposures which have experimented a significant increase in credit risk since initial recognition. For these expo- sures, the characterization of such an increase in risk is realized for the IFRS accounts in compliance with IFRS 9, and their provisioning in the annual accounts is compliant with the principle of prudence under which is based the recognition under French GAAP of collective provision, base of which is portfolios of homogeneous and perform- ing exposures. This expansion of the scope of collective provision corresponds to a development of judgment and hypothesis when applying impairment accounting method, which constitutes a change in accounting esti- mates under ANC Regulation, n°2018-01 issued on April 20, 2018; as such it resulted in the recognition of an incremental loss allowance in cost of risk during the 2018 reporting period.