1、Credit Risk ManagementEnhancing Your Bottom LineEbrahim ShabudinManaging Director Deloitte & Touche LLPThe AFP 23rd Annual Conference New OrleansNovember 3-6, 2002.Credit BackgroundThorough identification and accurate measurement of credit risk, supported by strong risk management can help improve t

2、he 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 PropositionCredit plays a critical role in “selling products and servi

3、cesExpands revenue opportunities with creditworthy, incremental customersUtilizes innovative structures to support business relationshipsEffective credit risk management limits credit losses and provides stable cash flows and earningsMarketplace rewards companies exhibiting earnings and cash flow st

4、ability with higher P/E multiplesMarketplace penalizes credit induced volatility and “surprisesRaises questions about quality of management.Corporate Credit RiskCompanies are exposed to significant levels of credit risk emanating from different sourcesAccounts Receivables Other Notes ReceivablesBuye

5、r and Franchise FinancingWith Recourse FinancingProject FinanceStructured TransactionsLeases with RecourseDerivatives Exposures FX, Interest Rate Risk, Commodities etc.Collateral RiskParent or Third Party Guarantees Commercial and Standby Letters of CreditNote also that Critical Suppliers to the com

6、pany may pose specific credit risk.DSO Impact an exampleActualCompany APeer AverageQ3 A/R$295,396,000Q3 Sales$261,201,000 DSOs =124*51.3HypotheticalD CashDSOs51.3Q3 Sales$261,201,000 Q3 A/R =$122,002,230+$173,393,770 * Equals 295.4M/261.2M x 90(or number of days in sales period).Credit as a Facilita

7、torCredit risk management is important Credit is a facilitator of business growth 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 diversific

8、ation opportunityPoor credit risk management resulting in negative impact to bottom-line is heavily penalized by markets.Credit Strategy & Risk ToleranceSpecific Quantifiable ObjectivesManagement Review MethodologyCredit Strategy Statement and Risk ToleranceCoordination with Business PlanThe busines

9、s strategies and objectives drive the establishment 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 Risk Areas to Cons

10、iderCredit PolicyCredit Approval AuthorityLimit SettingPricing Terms and ConditionsDocumentation: Contracts and CovenantsCollateral and SecurityCollections, Delinquencies and WorkoutsExposure ManagementAggregationControlPeriodic Account ReviewsPayments/AgingCredit ConditionCompliance with Covenants,

11、 TermsTechnology/ReportsTransactions/ BookingsRisk-adjusted ReturnSales ChannelsRisk StrategyUnderwriting StandardsCredit ApplicationAnalysisBusiness/ IndustryFinancialCreditCredit Scoring and RatingsOrigination/AssessmentAdministrationMonitoring/ControlRiskManagementPortfolio ManagementConcentratio

12、nDiversificationAllowance for Bad DebtsRisk MitigationObjectivesType of ExposureInstruments or Methods.Value CreationBusiness Performance MeasuresOrganizations need a rigorous set of measures to support continuous improvementPerformance-based management utilizes metrics that measure actual performan

13、ce 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 StrategySystemsOperationsFinancePerformanc

14、e Management.Sales channelsContracts & DocumentationCredit analysisCredit limitPricing & termsCredit AnalysisCredit DecisionsCollectionsCREDIT POLICYCollateral acceptancePortfolio managementFinancial analysisDisposal / Risk mitigationCollateral managementCustomer managementExposure measurementManage

15、ment reportingExposure aggregationRecoveriesCredit scoringRisk ratingRISK MANAGEMENTCredit Risk Managements Inter-related ActivitiesComplianceOriginationReportingTransactions.Credit Policies & Procedures Analysis & RiskManagementGovernance, Controland ImplementationMeasurementMethodologiesTechnology

16、 & Data IntegrityCredit Strategy & Risk ToleranceA complete and coherent risk management framework contains the following elementsCredit Risk Management.A New ParadigmA new business paradigm had evolved: causing a lack of reliance on good fundamental analysisThe idea that stock market values would c

17、ontinue to go up indefinitelyIncreasingly competitive, complex and volatile market placeHigher than expected actual debt burdensExtensive reliance on unrealistic future cash flowsFailures in corporate governanceQuestionable personal and corporate ethics.Implications for Corporate GovernanceCurrent o

18、rganization structures to be revisitedClarity around roles and responsibilitiesNeed for honesty, integrity and independence (self-regulation)Technical expertise of people and strong management processesImproved disclosure requirementsImportance and implementation of sanctionsIncreased legislation an

19、d compliance requirements.Foundation: Credit Rating and Underwriting StandardsRisk Identification, Origination, Credit Administration, etc.Short Term: Managing Expected LossRisk Identification, Transaction Structuring, Approval & Pricing Decisions, Reserving, etc.Near Term: Managing Economic Capital

20、 / Credit VaRPortfolio Risk Concentration, Risk Based Limits, etc. Vision: Managing Risk/ReturnPricing decisions,Performance measurement, business and customer segmentation, compensation, etc.A business model view of Credit Risk Infrastructure componentsCredit Risk Management Strategic Vision.Develo

21、pment StagesFoundation Stage includes application 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 Advanc

22、ed Stage represents managing on a portfolio 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 b

23、usinesses against established hurdle rates.Credit Risk ClarifiedCredit 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 (predictabl

24、e) and unexpected (volatile) loss component. .Businesses have to contend with Expected and Unexpected LossesExpected LossesAnticipatedCost of doing businessCharged to provisionsCaptured in pricingRelatively easier to measureAssessing expected loss includes determining exposure, default probability a

25、nd severityUnexpected LossesUnanticipated but inevitableMust be planned forCovered by reservesAllocated to businessesDifficult to measureAssessing unexpected loss requires making qualitative judgments around potential volatility of average losses.Credit Risk Management ExplainedAlthough credit risk

26、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 incorporates the firms ability to effectively manage

27、 and control this exposure in a way that is consistent with the institutions business strategy, risk appetite and credit culture.Important Building BlocksEffective Credit Risk Management requiresClear origination and underwriting standards A strong corporate and credit cultureHighly developed risk m

28、easurement techniques Ability to recognize and cover expected and unexpected lossesPricing commensurate with risks undertakenMethodologies to assess net profit contributions by customers and appropriate business segmentsProper allocation of capital and management resourcesIn order to:Improve overall

29、 corporate performance, measured by a higher EPS or P/E ratio (or market value).Credit Policy and ProcessCredit Policy should be clear and conciseCredit Underwriting Standards must be developed and included in policyCredit Processes should be reasonable and allow quick response to clientsHealthy bal

30、ance between sales and credit approval should exist and be respected.Risk MonitoringExposure must be complete and currentRegular reporting and updating of clients payment performance Minimum annual reviews of clients should be performedFinancial conditions should be regularly assessedRequired action

31、 must be initiated and follow up must take place.Contract Terms and DocumentationContract negotiations must take place at the right level in the organizationAppropriate approvals must be obtainedInternal or external legal departments must document completelyTerms and conditions should be understood

32、and compliance mechanism put in placeExceptions must be reported and managed urgently to resolution.Risk Rating System EffectivenessCredit Scoring is generally used to “risk rate homogeneous portfoliosHighest applicability is in consumer and retail portfoliosSome advanced scoring systems are being m

33、igrated for use in rating “middle market clientsSuch models are only as good as the underlying 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 matt

34、er of practice rather than written policyRatings are not consistent over timeQualitative credit assessments often lag current market informationInstitutions often assume a mapping with external ratings in order to quantify credit risk.Effective Risk Rating SystemsSufficient granularity of risk ratin

35、g categoriesAccurate and timely assignment 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) .Cre

36、dit Evaluation: Financial FactorsGet 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

37、whole story!.Credit Evaluation: Qualitative FactorsEvaluation 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, competition etc. al

38、l influence results and must be properly assessedAnalysis-paralysis may lead to wrong decisions.Art and Science of JudgmentGetting access to the best clients and all the relevant information is a challengeEnsuring proper analysis is done requires a strong corporate cultureUtilizing qualified resourc

39、es both internally and externally enhances the resultsOften the lack of the will to act is what causes high losses.Concluding CommentsCompanies that measure and manage credit risk in a pro-active manner will benefit from a favorable risk profile resulting in Higher revenueLower lossesImproved effici

40、enciesHigher EPS, P/E ratios and market values.Concluding CommentsRisk Assessment and Limit ManagementCredit Infrastructure and Portfolio ManagementCredit Analytics SupportCredit Technology EnablementCredit QualityCredit UnderwritingRisk Rating System EffectivenessCounterparty and Portfolio LimitsOr

41、ganizational Structure Policies and ProceduresTechnology Selection and ImplementationProblem Asset ManagementRisk Rating CalibrationTransaction Pricing, Structure and SupportDefault Probability and Recovery CalibrationCredit Reserve MethodologyRisk Based Pricing ModelsRisk Adjusted Return AnalysisPo

42、rtfolio Value MeasurementCredit Risk MeasurementCredit Performance Scorecards Internal Software External Vendor Software.Appendix: Business Proposal ChecklistBusiness Proposal SummaryCustomer, Rating, Legal Status, Line of BusinessGuarantor, if anysameCollateral, if anytrue value explainedOther Supp

43、ort, if any. Legal or moral onlyThe Transactionrisks and mitigationAmount, purpose, terms and conditionsSources of repayment clearly identifiedClient payment history and relationship.Appendix: Business Proposal ChecklistRationale and AnalysisCustomer, Guarantor, Collateral, SupportFacility Descripti

44、onAmount, purpose, tenor, pricing, terms, conditions, covenants, restrictions etc.Consider affect on above e.g. new leverageFacility 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 Checkli