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1、Credit Risk ManagementEnhancing Your Bottom Line,Ebrahim ShabudinManaging Director Deloitte & Touche LLP,The AFP 23rd Annual Conference New OrleansNovember 3-6, 2002,Credit Risk ManagementEnhanci,Credit Background,Thorough identification and accurate measurement of credit risk, supported by strong r
2、isk management can help improve the bottom line.An uncertain and volatile economic environment significantly impacts this ability.The desire to grow and turn in outstanding results has a tendency to put pressure on the checks and balances within businesses,Credit BackgroundThorough iden,Value Propos
3、ition,Credit plays a critical role in “selling” products and servicesExpands revenue opportunities with creditworthy, incremental customersUtilizes innovative structures to support business relationshipsEffective credit risk management limits credit losses and provides stable cash flows and earnings
4、Marketplace rewards companies exhibiting earnings and cash flow stability with higher P/E multiplesMarketplace penalizes credit induced volatility and “surprises”Raises questions about quality of management,Value Proposition,Corporate Credit Risk,Companies are exposed to significant levels of credit
5、 risk emanating from different sourcesAccounts Receivables Other Notes ReceivablesBuyer and Franchise FinancingWith Recourse FinancingProject FinanceStructured TransactionsLeases with RecourseDerivatives Exposures FX, Interest Rate Risk, Commodities etc.Collateral RiskParent or Third Party Guarantee
6、s Commercial and Standby Letters of CreditNote also that Critical Suppliers to the company may pose specific credit risk,Corporate Credit RiskCompanies,DSO Impact an example,DSO Impact an exampleActualC,Credit as a Facilitator,Credit risk management is important Credit is a facilitator of business g
7、rowth and performanceHigh business margins tend to attract lower quality clients and therefore higher risk profile to manageClients (buyers) may be concentrated in selected industries and provide limited portfolio diversification opportunityPoor credit risk management resulting in negative impact to
8、 bottom-line is heavily penalized by markets,Credit as a FacilitatorCredit,Credit Strategy & Risk Tolerance,Specific Quantifiable ObjectivesManagement Review Methodology,Credit Strategy Statement and Risk ToleranceCoordination with Business Plan,The business strategies and objectives drive the estab
9、lishment of creditpolicies and procedures. Measurement and reporting as well as the use of current technologies enhance credit decision-making and improve risk management. The entire process is continually re-evaluated and improved.,Credit Strategy & Risk Toleran,Credit Risk Areas to Consider,Credit
10、 PolicyCredit Approval AuthorityLimit SettingPricing Terms and ConditionsDocumentation: Contracts and CovenantsCollateral and SecurityCollections, Delinquencies and Workouts,Exposure ManagementAggregationControlPeriodic Account ReviewsPayments/AgingCredit ConditionCompliance with Covenants, TermsTec
11、hnology/ReportsTransactions/ BookingsRisk-adjusted Return,Sales ChannelsRisk StrategyUnderwriting StandardsCredit ApplicationAnalysisBusiness/ IndustryFinancialCreditCredit Scoring and Ratings,Origination/Assessment,Administration,Monitoring/Control,RiskManagement,Portfolio ManagementConcentrationDi
12、versificationAllowance for Bad DebtsRisk MitigationObjectivesType of ExposureInstruments or Methods,Credit Risk Areas to ConsiderC,Value Creation,Business Performance Measures,Organizations need a rigorous set of measures to support continuous improvement,Performance-based management utilizes metric
13、s that measure actual performance against predetermined thresholds. The thresholds are established taking into account the organizations strategy, operatingenvironment and process controls.,The measures drive value creation and should support problem identification and correction.,Business StrategyS
14、ystemsOperationsFinance,Performance Management,Value CreationBusiness Perform,Sales channels,Contracts & Documentation,Credit analysis,Credit limit,Pricing & terms,Credit Analysis,Credit Decisions,Collections,CREDIT POLICY,Collateral acceptance,Portfolio management,Financial analysis,Disposal / Risk
15、 mitigation,Collateral management,Customer management,Exposure measurement,Management reporting,Exposure aggregation,Recoveries,Credit scoring,Risk rating,RISK MANAGEMENT,Credit Risk Managements Inter-related Activities,Compliance,Origination,Reporting,Transactions,Sales channelsContracts & Docu,Cre
16、dit Policies & Procedures,Analysis & RiskManagement,Governance, Controland Implementation,MeasurementMethodologies,Technology & Data Integrity,Credit Strategy & Risk Tolerance,A complete and coherent risk management framework contains the following elements,Credit Risk Management,Credit Policies & P
17、rocedures,A New Paradigm,A new business paradigm had evolved: causing a lack of reliance on good fundamental analysisThe idea that stock market values would continue to go up indefinitelyIncreasingly competitive, complex and volatile market placeHigher than expected actual debt burdensExtensive reli
18、ance on unrealistic future cash flowsFailures in corporate governanceQuestionable personal and corporate ethics,A New ParadigmA new business p,Implications for Corporate Governance,Current organization structures to be revisitedClarity around roles and responsibilitiesNeed for honesty, integrity and
19、 independence (self-regulation)Technical expertise of people and strong management processesImproved disclosure requirementsImportance and implementation of sanctionsIncreased legislation and compliance requirements,Implications for Corporate Gov,Foundation: Credit Rating and Underwriting StandardsR
20、isk Identification, Origination, Credit Administration, etc.,Short Term: Managing Expected LossRisk Identification, Transaction Structuring, Approval & Pricing Decisions, Reserving, etc.,Near Term: Managing Economic Capital / Credit VaRPortfolio Risk Concentration, Risk Based Limits, etc.,Vision: Ma
21、naging Risk/ReturnPricing decisions,Performance measurement, business and customer segmentation, compensation, etc.,A business model view of Credit Risk Infrastructure components,Credit Risk Management Strategic Vision,Foundation: Credit Rating and,Development Stages,Foundation Stage includes applic
22、ation of risk identification methodologies, risk scoring or rating systems and strong underwriting standards Basic Stage tends to include managing on a transactional basis by evaluating specific attributes such as structuring, collateral and pricing Advanced Stage represents managing on a portfolio
23、basis including aspects such as concentrations, correlations and diversification The Sophisticated Stage includes application of highly developed measurement techniques for transactions and portfolios, supported by decision-making relating to segments or businesses against established hurdle rates.,
24、Development StagesFoundation S,Credit Risk Clarified,Credit risk is defined as the risk of loss or potential loss resulting from: Default in contractual obligations by a customerMigration in condition and ratingDeterioration in performance Credit risk includes both an expected (predictable) and unex
25、pected (volatile) loss component.,Credit Risk ClarifiedCredit r,Businesses have to contend with Expected and Unexpected Losses,Expected LossesAnticipatedCost of doing businessCharged to provisionsCaptured in pricingRelatively easier to measureAssessing expected loss includes determining exposure, de
26、fault probability and severity,Unexpected LossesUnanticipated but inevitableMust be planned forCovered by reservesAllocated to businessesDifficult to measureAssessing unexpected loss requires making qualitative judgments around potential volatility of average losses,Businesses have to contend wit,Cr
27、edit Risk Management Explained,Although credit risk may be difficult to measure it is important to estimate and manage What does Credit Risk Management mean?It represents an institutions ability to properly identify and evaluate the potential risk of default in payment of obligations of customersIt
28、incorporates the firms ability to effectively manage and control this exposure in a way that is consistent with the institutions business strategy, risk appetite and credit culture,Credit Risk Management Explain,Important Building Blocks,Effective Credit Risk Management requiresClear origination and
29、 underwriting standards A strong corporate and credit cultureHighly developed risk measurement techniques Ability to recognize and cover expected and unexpected lossesPricing commensurate with risks undertakenMethodologies to assess net profit contributions by customers and appropriate business segm
30、entsProper allocation of capital and management resourcesIn order to:Improve overall corporate performance, measured by a higher EPS or P/E ratio (or market value),Important Building BlocksEffec,Credit Policy and Process,Credit Policy should be clear and conciseCredit Underwriting Standards must be
31、developed and included in policyCredit Processes should be reasonable and allow quick response to clientsHealthy balance between sales and credit approval should exist and be respected,Credit Policy and ProcessCredi,Risk Monitoring,Exposure must be complete and currentRegular reporting and updating
32、of clients payment performance Minimum annual reviews of clients should be performedFinancial conditions should be regularly assessedRequired action must be initiated and follow up must take place,Risk MonitoringExposure must b,Contract Terms and Documentation,Contract negotiations must take place a
33、t the right level in the organizationAppropriate approvals must be obtainedInternal or external legal departments must document completelyTerms and conditions should be understood and compliance mechanism put in placeExceptions must be reported and managed urgently to resolution,Contract Terms and D
34、ocumentati,Risk Rating System Effectiveness,Credit Scoring is generally used to “risk rate” homogeneous portfoliosHighest applicability is in consumer and retail portfoliosSome advanced scoring systems are being migrated for use in rating “middle market” clientsSuch models are only as good as the un
35、derlying assumptionsInternal credit rating systems are difficult to assess and are often not independently validatedClient relationship may interfere with objective assessment of risksRating criteria usually a matter of practice rather than written policyRatings are not consistent over timeQualitati
36、ve credit assessments often lag current market informationInstitutions often assume a mapping with external ratings in order to quantify credit risk,Risk Rating System Effectivene,Effective Risk Rating Systems,Sufficient granularity of risk rating categoriesAccurate and timely assignment of ratings
37、Clear and consistent application of default definitionPeriodic calibration, triangulation and validation of risk ratings Accurate identification of migration of transactions and portfolios (as reflected by upgrades and downgrades in ratings),Effective Risk Rating SystemsS,Credit Evaluation: Financia
38、l Factors,Get the information you need to make a full analysisSome information will need to be cross-checked and obtained on a regular and timely basisBe constructively cynical: new business models are difficult to pull offBe cognizant of delaying tacticsNumbers dont tell the whole story!,Credit Eva
39、luation: Financial F,Credit Evaluation: Qualitative Factors,Evaluation of subjective factors is often times more important than the numerical analysisPeople make a business: visions, values and strategies are only words unless people implement themManagement, industry, product, geography, competitio
40、n etc. all influence results and must be properly assessedAnalysis-paralysis may lead to wrong decisions,Credit Evaluation: Qualitative,Art and Science of Judgment,Getting access to the best clients and all the relevant information is a challengeEnsuring proper analysis is done requires a strong cor
41、porate cultureUtilizing qualified resources both internally and externally enhances the resultsOften the lack of the will to act is what causes high losses,Art and Science of JudgmentGet,Concluding Comments,Companies that measure and manage credit risk in a pro-active manner will benefit from a favo
42、rable risk profile resulting in Higher revenueLower lossesImproved efficienciesHigher EPS, P/E ratios and market values,Concluding CommentsCompanies t,Concluding Comments,Risk Assessment and Limit Management,Credit Infrastructure and Portfolio Management,Credit Analytics Support,Credit Technology En
43、ablement,Credit QualityCredit UnderwritingRisk Rating System EffectivenessCounterparty and Portfolio Limits,Organizational Structure Policies and ProceduresTechnology Selection and ImplementationProblem Asset Management,Risk Rating CalibrationTransaction Pricing, Structure and SupportDefault Probabi
44、lity and Recovery Calibration,Credit Reserve MethodologyRisk Based Pricing ModelsRisk Adjusted Return AnalysisPortfolio Value Measurement,Credit Risk MeasurementCredit Performance Scorecards,Internal Software,External Vendor Software,Concluding CommentsRisk Assess,Appendix: Business Proposal Checkli
45、st,Business Proposal SummaryCustomer, Rating, Legal Status, Line of BusinessGuarantor, if anysameCollateral, if anytrue value explainedOther Support, if any. Legal or moral onlyThe Transactionrisks and mitigationAmount, purpose, terms and conditionsSources of repayment clearly identifiedClient payme
46、nt history and relationship,Appendix: Business Proposal Ch,Appendix: Business Proposal Checklist,Rationale and AnalysisCustomer, Guarantor, Collateral, SupportFacility DescriptionAmount, purpose, tenor, pricing, terms, conditions, covenants, restrictions etc.Consider affect on above e.g. new leverag
47、eFacility Rating?Repayment CapacityFuture cash flow, conversion of assets etc.Consistency with Credit Strategy and PolicyConfirm, and identify any exceptions to policy, underwriting standards, or processRisk adjusted return acceptability,Appendix: Business Proposal Ch,Appendix: Business Proposal Che
48、cklist,Client RelationshipBusiness strategy: increase, maintain or decrease exposure or exit relationshipConsider relation to rating, latest risk profile and payment performanceCustomer profitability: risk adjusted return, revenue, fees, direct and allocated costs etc.Any conflicts of interest or sp
49、ecial concerns,Appendix: Business Proposal Ch,Appendix: Business Proposal Checklist,Macro AnalysisBusiness Environment ReviewCustomers competitive market position and future industry prospects: size, cycle, volatility, new entrantsStrength of customers business and financial strategiesManagement Eva
50、luation: competency, experience and effectiveness,Appendix: Business Proposal Ch,Appendix: Business Proposal Checklist,Customer AnalysisCompany history, background, objectives and performanceRelevance and strength of future business plansConsider seasonality and scenario analysisPrimary and secondar
