1、Credit Risk Management Enhancing Your Bottom Line,Ebrahim Shabudin Managing Director Deloitte & Touche LLP,The AFP 23rd Annual Conference New Orleans November 3-6, 2002,Credit Background,Thorough identification and accurate measurement of credit risk, supported by strong risk management can help imp
2、rove 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,Value Proposition,Credit plays a critical role in “selling” products a
3、nd services Expands revenue opportunities with creditworthy, incremental customers Utilizes innovative structures to support business relationshipsEffective credit risk management limits credit losses and provides stable cash flows and earnings Marketplace rewards companies exhibiting earnings and c
4、ash flow stability with higher P/E multiples Marketplace penalizes credit induced volatility and “surprises” Raises questions about quality of management,Corporate Credit Risk,Companies are exposed to significant levels of credit risk emanating from different sources Accounts Receivables Other Notes
5、 Receivables Buyer and Franchise Financing With Recourse Financing Project Finance Structured Transactions Leases with Recourse Derivatives Exposures FX, Interest Rate Risk, Commodities etc. Collateral Risk Parent or Third Party Guarantees Commercial and Standby Letters of Credit Note also that Crit
6、ical Suppliers to the company may pose specific credit risk,DSO Impact an example,Credit as a Facilitator,Credit risk management is important Credit is a facilitator of business growth and performance High business margins tend to attract lower quality clients and therefore higher risk profile to ma
7、nage Clients (buyers) may be concentrated in selected industries and provide limited portfolio diversification opportunity Poor credit risk management resulting in negative impact to bottom-line is heavily penalized by markets,Credit Strategy & Risk Tolerance,Specific Quantifiable ObjectivesManageme
8、nt Review Methodology,Credit Strategy Statement and Risk ToleranceCoordination with Business Plan,The business strategies and objectives drive the establishment of credit policies and procedures. Measurement and reporting as well as the use of current technologies enhance credit decision-making and
9、improve risk management. The entire process is continually re-evaluated and improved.,Credit Risk Areas to Consider,Credit Policy Credit Approval Authority Limit Setting Pricing Terms and Conditions Documentation: Contracts and Covenants Collateral and Security Collections, Delinquencies and Workout
10、s,Exposure Management Aggregation Control Periodic Account Reviews Payments/Aging Credit Condition Compliance with Covenants, Terms Technology/Reports Transactions/ Bookings Risk-adjusted Return,Sales Channels Risk Strategy Underwriting Standards Credit Application Analysis Business/ Industry Financ
11、ial Credit Credit Scoring and Ratings,Origination/ Assessment,Administration,Monitoring/ Control,Risk Management,Portfolio Management Concentration DiversificationAllowance for Bad Debts Risk Mitigation Objectives Type of Exposure Instruments or Methods,Value Creation,Business Performance Measures,O
12、rganizations need a rigorous set of measures to support continuous improvement,Performance-based management utilizes metrics that measure actual performance against predetermined thresholds. The thresholds are established taking into account the organizations strategy, operating environment and proc
13、ess controls.,The measures drive value creation and should support problem identification and correction.,Business Strategy Systems Operations Finance,Performance Management,Sales channels,Contracts & Documentation,Credit analysis,Credit limit,Pricing & terms,Credit Analysis,Credit Decisions,Collect
14、ions,CREDIT POLICY,Collateral acceptance,Portfolio management,Financial analysis,Disposal / Risk mitigation,Collateral management,Customer management,Exposure measurement,Management reporting,Exposure aggregation,Recoveries,Credit scoring,Risk rating,RISK MANAGEMENT,Credit Risk Managements Inter-rel
15、ated Activities,Compliance,Origination,Reporting,Transactions,Credit Policies & Procedures,Analysis & Risk Management,Governance, Control and Implementation,Measurement Methodologies,Technology & Data Integrity,Credit Strategy & Risk Tolerance,A complete and coherent risk management framework contai
16、ns the following elements,Credit Risk Management,A New Paradigm,A new business paradigm had evolved: causing a lack of reliance on good fundamental analysis The idea that stock market values would continue to go up indefinitely Increasingly competitive, complex and volatile market place Higher than
17、expected actual debt burdens Extensive reliance on unrealistic future cash flows Failures in corporate governance Questionable personal and corporate ethics,Implications for Corporate Governance,Current organization structures to be revisited Clarity around roles and responsibilities Need for honest
18、y, integrity and independence (self-regulation) Technical expertise of people and strong management processes Improved disclosure requirements Importance and implementation of sanctions Increased legislation and compliance requirements,Foundation: Credit Rating and Underwriting Standards Risk Identi
19、fication, Origination, Credit Administration, etc.,Short Term: Managing Expected Loss Risk Identification, Transaction Structuring, Approval & Pricing Decisions, Reserving, etc.,Near Term: Managing Economic Capital / Credit VaR Portfolio Risk Concentration, Risk Based Limits, etc.,Vision: Managing R
20、isk/Return Pricing decisions,Performance measurement, business and customer segmentation, compensation, etc.,A business model view of Credit Risk Infrastructure components,Credit Risk Management Strategic Vision,Development Stages,Foundation Stage includes application of risk identification methodol
21、ogies, risk scoring or rating systems and strong underwriting standardsBasic Stage tends to include managing on a transactional basis by evaluating specific attributes such as structuring, collateral and pricingAdvanced Stage represents managing on a portfolio basis including aspects such as concent
22、rations, correlations and diversificationThe 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.,Credit Risk Clarified,Credit risk is def
23、ined 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 unexpected (volatile) loss component.,Businesses have to contend with Expec
24、ted and Unexpected Losses,Expected Losses Anticipated Cost of doing business Charged to provisions Captured in pricing Relatively easier to measureAssessing expected loss includes determining exposure, default probability and severity,Unexpected Losses Unanticipated but inevitable Must be planned fo
25、r Covered by reserves Allocated to businesses Difficult to measureAssessing unexpected loss requires making qualitative judgments around potential volatility of average losses,Credit Risk Management Explained,Although credit risk may be difficult to measure it is important to estimate and manageWhat
26、 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 incorporates the firms ability to effectively manage and control this exposure in a way that is consistent with the instit
27、utions business strategy, risk appetite and credit culture,Important Building Blocks,Effective Credit Risk Management requires Clear origination and underwriting standards A strong corporate and credit culture Highly developed risk measurement techniques Ability to recognize and cover expected and u
28、nexpected losses Pricing commensurate with risks undertaken Methodologies to assess net profit contributions by customers and appropriate business segments Proper allocation of capital and management resources In order to: Improve overall corporate performance, measured by a higher EPS or P/E ratio
29、(or market value),Credit Policy and Process,Credit Policy should be clear and concise Credit Underwriting Standards must be developed and included in policy Credit Processes should be reasonable and allow quick response to clients Healthy balance between sales and credit approval should exist and be
30、 respected,Risk Monitoring,Exposure must be complete and current Regular reporting and updating of clients payment performance Minimum annual reviews of clients should be performed Financial conditions should be regularly assessed Required action must be initiated and follow up must take place,Contr
31、act Terms and Documentation,Contract negotiations must take place at the right level in the organization Appropriate approvals must be obtained Internal or external legal departments must document completely Terms and conditions should be understood and compliance mechanism put in place Exceptions m
32、ust be reported and managed urgently to resolution,Risk Rating System Effectiveness,Credit Scoring is generally used to “risk rate” homogeneous portfoliosHighest applicability is in consumer and retail portfolios Some advanced scoring systems are being migrated for use in rating “middle market” clie
33、nts Such models are only as good as the underlying assumptions Internal credit rating systems are difficult to assess and are often not independently validatedClient relationship may interfere with objective assessment of risks Rating criteria usually a matter of practice rather than written policy
34、Ratings are not consistent over time Qualitative credit assessments often lag current market information Institutions often assume a mapping with external ratings in order to quantify credit risk,Effective Risk Rating Systems,Sufficient granularity of risk rating categoriesAccurate and timely assign
35、ment of ratings 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),Credit Evaluation: Financial Factors,Get t
36、he information you need to make a full analysis Some information will need to be cross-checked and obtained on a regular and timely basis Be constructively cynical: new business models are difficult to pull off Be cognizant of delaying tactics Numbers dont tell the whole story!,Credit Evaluation: Qu
37、alitative Factors,Evaluation of subjective factors is often times more important than the numerical analysis People make a business: visions, values and strategies are only words unless people implement them Management, industry, product, geography, competition etc. all influence results and must be
38、 properly assessed Analysis-paralysis may lead to wrong decisions,Art and Science of Judgment,Getting access to the best clients and all the relevant information is a challenge Ensuring proper analysis is done requires a strong corporate culture Utilizing qualified resources both internally and exte
39、rnally enhances the results Often the lack of the will to act is what causes high losses,Concluding Comments,Companies that measure and manage credit risk in a pro-active manner will benefit from a favorable risk profile resulting in Higher revenueLower lossesImproved efficienciesHigher EPS, P/E rat
40、ios and market values,Concluding Comments,Risk Assessment and Limit Management,Credit Infrastructure and Portfolio Management,Credit Analytics Support,Credit Technology Enablement,Credit Quality Credit Underwriting Risk Rating System Effectiveness Counterparty and Portfolio Limits,Organizational Str
41、ucture Policies and Procedures Technology Selection and Implementation Problem Asset Management,Risk Rating Calibration Transaction Pricing, Structure and Support Default Probability and Recovery Calibration,Credit Reserve Methodology Risk Based Pricing Models Risk Adjusted Return Analysis Portfolio
42、 Value Measurement,Credit Risk Measurement Credit Performance Scorecards,Internal Software,External Vendor Software,Appendix: Business Proposal Checklist,Business Proposal Summary Customer, Rating, Legal Status, Line of Business Guarantor, if anysame Collateral, if anytrue value explained Other Supp
43、ort, if any. Legal or moral only The Transactionrisks and mitigation Amount, purpose, terms and conditions Sources of repayment clearly identified Client payment history and relationship,Appendix: Business Proposal Checklist,Rationale and Analysis Customer, Guarantor, Collateral, Support Facility De
44、scription Amount, purpose, tenor, pricing, terms, conditions, covenants, restrictions etc. Consider affect on above e.g. new leverage Facility Rating? Repayment Capacity Future cash flow, conversion of assets etc. Consistency with Credit Strategy and Policy Confirm, and identify any exceptions to po
45、licy, underwriting standards, or process Risk adjusted return acceptability,Appendix: Business Proposal Checklist,Client Relationship Business strategy: increase, maintain or decrease exposure or exit relationship Consider relation to rating, latest risk profile and payment performance Customer prof
46、itability: risk adjusted return, revenue, fees, direct and allocated costs etc. Any conflicts of interest or special concerns,Appendix: Business Proposal Checklist,Macro Analysis Business Environment Review Customers competitive market position and future industry prospects: size, cycle, volatility,
47、 new entrants Strength of customers business and financial strategies Management Evaluation: competency, experience and effectiveness,Appendix: Business Proposal Checklist,Customer Analysis Company history, background, objectives and performance Relevance and strength of future business plans Consid
48、er seasonality and scenario analysis Primary and secondary sources of repayment Historical financial capacity and analysis of future performance: sales, profitability, working capital, liquidity, cash flow, leverage, tangible net worth etc. Quality of earnings Absolute and ratio analysis Peer compar
49、isons,Appendix: Business Proposal Checklist,Strengths, Weaknesses and Recommendation Key factors that could jeopardize collection: environment or company specific Any mitigating factors Consider probability and impact Consider all sources of repayment: primary, secondary and tertiary, including access to capital markets, refinancing etc. Summarize strengths and weaknesses and conclude with a recommendation,
