Global Best Practices in Credit Analysis and Training

transcript

Global Best Practices in Credit Analysis and Training “A Focus on Cash Flow, Projections and Fraud Awareness”

September 3, 2014

Risk Management Workshop

Agenda

1 Moody’s Analytics and Indonesia 2 Global Best Practices in Credit Risk Analysis

Moody’s framework and tools for credit analysis: a. Corporates

• Overview: cash flow, projections, fraud - Corporates • Moody’s Financial Metrics for Corporates

b. Banks • Credit analysis overview and scorecard - Banks • Moody’s Financial Metrics for Banks • Other analytical factors and context - Banks

3 Global Best Practices in Credit Risk Training

Moody’s Analytics and Indonesia 1

Independent provider of credit rating opinions and related information for over 100 years.

Leading provider of data, software, research related professional services for financial risk management.

Moody’s Analytics helps our global clients measure, understand, and mitigate risk – beyond ratings

Integrating Risk Practices Across the Enterprise

Moody’s Analytics is recognized as a leader in risk and regulatory solutions.

Voted #1 in Economic Capital Calculation Management – third consecutive year

» #2 in Regulatory Capital Calculation and Management

» Top Vendor in Liquidity Risk Management

» Best Regulatory Reporting Software

» Best Data Management Service Provider

Pricing, Valuation & Risk Management Award 2012

» Moody’s Analytics #1 in customer service by Structured Credit Investor

Recognized for Risk Management Technology

» Risk Magazine predicts Moody’s Analytics will be one of the most influential Technology Vendors over the next five years

Ranked 40th Overall

» Moody’s Analytics has been voted as a Preferred Vendor

Voted #8 Top Vendor Overall – up significantly

» #1 in Economic & Regulatory Capital Calculation Solutions

» Top Vendor in Regulatory Compliance and Reporting and Credit Risk Management

Ranked in Top Five for Two Risk Management Areas

» #3 Regulatory/Economic Capital Calculation

» #5 Credit

Voted #5 in Overall Rankings – up from #7 (out of 100)

» #1 in Organizational Strength for second consecutive year

Moody’s Analytics in Indonesia

• Credit Ratings and Research • Credit Risk Analytics: Market Implied Ratings, Financial

Metrics

Credit Risk Analysis

• Credit Risk Management System - Spreading and Scoring • Limits Management and Workflow • Asset and Liability Management System (under discussion) • Basel III Program for IRB Implementation (under discussion)

Risk Management Systems

• Middle Market and SME Scorecards Development • FI Scorecard Development • Corporate Scorecard Validation • Basel III Program for IRB Implementation (under discussion)

Advisory

• Credit Skills Assessment • E-Learning: Commercial & Retail Lending, Problem Loans • Bank Credit Risk Analysis Training • Insurance Risk Analysis Training • Basel III Program for IRB Implementation (under discussion)

Training & Certification

Global Best Practices in Credit Analysis

“Cash Flow, Projections & Fraud Awareness” 2

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What is a Moody’s Rating?

Credit Risk = Expected

Loss = Default Probability x Loss Given

Default

Credit Risk = Business

Risk + Financial Risk + Structure

Definition of Credit Risk

» An Independent Opinion ...on the future ability of an issuer to make timely payments on its financial commitments

» A measure of Relative Credit Risk ...based on fundamental credit assessment

» A statement of Expected Loss A forward-looking through-the-cycle opinion/ prediction about relative creditworthiness

Corporates 2a

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Credit Risk Analytical Framework and Process

»Before looking at the financials • 4 Cs and 3 Ms • Porter 5 Forces • Identify and analyze relevant parties

»Financial Statement Analysis • Focus on cash flow and debt • Identify credit need • Assess repayment sources • Structured approach using credit risk grid • Link business risk to financial risk analysis • Assess quality of financial data and accounting policies

»Scorecard • Analyst/Committee Override

»Credit mitigants and notching • Issue specific • Monitor of trends and ratios

Analytical Process

Credit Risk Analysis Framework

Who? What?

Where from?

Credit Risk Grid

Decision, Monitoring

Who: Legal Counterparty & Credit Base

What: Credit Need

Where from: Repayment Sources

Simple or Comprehensive

Assessment

Internal Triggers

Setting of Triggers

Monitoring Plan

Non-financial EWS

Client Risk

Conclusion

Group Structure Risks

Data Quality

Parent/Group Support

Finance Risk

Structure Risk

4Cs and 3Ms

Structure Mitigants

Revenue & Profitability

Asset Management

Debt Capacity & Leverage

Debt Service & Liquidity

Business Risk

Credit Risk Analysis Framework

Structure Risks

Financial Risks

Revenues & Profitability

Asset Management

Debt Capacity & Leverage

Debt Service & Liquidity

Structure Risks

Transaction

Business Risks

Country

Macro economy

Market (Industry)

Company Position

Management

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»Solvency and Liquidity focus of financial analysis Is there a business there? Can it pay its bills?

»Context is key: History, common size, peers »Cash flow metrics: FFO, CFO, RCF, FCF »Various ratios used for each area: Scorecards select and weight ratios »Static vs. Dynamic ratios

Useful distinctions for covenants »Adjustments Not so common in Asia, typically operating leases »Projections

Shorter for non-investment grade

Credit Risk Tools and Analysis

Cash Flow is Key, as EBITDA (and Net Income)… » is an earnings concept, and not an ideal proxy for cash flow

» is not defined by any GAAP or IFRS

» is subject to influence by accounting decisions

» makes benchmarking/peer comparison difficult, in particular across borders

» ignores changes in working capital

» does not consider the CAPEX required by the firm

» does not always supersede dividends and taxes

» is not a good indicator of a firm’s (near-term) liquidity

Operating Cash Flow

Retained Cash Flow

Free Cash Flow

Three Levels of Cash Flow

Less Dividends =

Less CAPEX =

before Ʃ w/c*

after Ʃ w/c*

before Ʃ w/c*

after Ʃ w/c*

before Ʃ w/c*

after Ʃ w/c*

“FFO”

Standard Definition

“CFO”

Standard Definition

Moody’s Cash Flow Concepts

* Working capital and other items not directly related to ongoing operations (e.g. pension and OPEB contributions)

»Access to new capital »Cost of Capital

»The volume of sales »Price Elasticity »Stability of Operating Margins »Tax and other Fixed Charge coverage

»Volume of Sales »Time »Bargaining power of customers and suppliers

»Mandatory vs. Discretionary Capex »Time lag to productivity »Impact on volume / margins

»Access to debt markets »Cost of Debt »Debt Maturity profile »Contingent Liabilities

Profit

Equity

“PACED” The Five Cash Flow Drivers

» Relate to past performance » Where are we now? » Gaps between final historic figures & 1st year of the

projection? » Relate to credit need existing bank facilities and

proposed repayments

Present Position

» Who made the projections? » Do you agree with business scenarios driving future

cash flow? » Take a 'cash drivers' approach » Don't forget financing costs » Compare with the past performance

Assumptions

» Base the sensitivity analysis on the major business factors identified during the business risk analysis

» Use common sense. Are the projections reasonable?

What if?

Almost certainly the projections will be wrong. If the company fails to meet its projections what is our monitoring strategy to ensure remedial action is taken by the client and the bank?

Strategy

Projections: PAWS a Structured Approach 20

Fraud What can we spot in financial statements? » Revenue overstatement – fictitious sales » Understating/overstating expenses/assets/liabilities

Due to the difficulty is detecting fraud, comparison and context are keys. Public information about litigation and share buybacks could be in the notes to the financial statements, but may only be found in news sources, or remain unpublished.

Non financial clues: »Corporate Governance model – do we understand it »Lack of Understanding of the Business Model – us or them? »Frequent Debt Raising »Balance Sheet Massaging Through M&A Activity »Resignations of Auditors/Board »Site visits!

Financial: »If you see high debtors/high cash and high debt – check why »Investigate who buyers and suppliers are. Are they connected?

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Rating Methodologies and Scorecards - Non-financial corporations » Aerospace and Defense » EMS & IT Distribution » Power Generation Projects» Agricultural Cooperatives » Equipment & Automobile Rental » Postal and Express Delivery» Airlines, Passenger » Gaming » Publishing» Airports, Unregulated Rate Setting » Heavy Manufacturing » Railroads, Freight» Airports, Outside of the USA » Healthcare Service Providers » Railroads, Passenger» Alcoholic Beverage » Homebuilding » Railroad Networks, Govt Owned» Apparel » Hospital, For-Profit » Restaurants» Automobile Manufacturing » Investment Holding Companies » Retail» Automotive Retailer » Lodging & Cruise » REITs» Automotive Supplier » Manufacturing » Shipping» Broadcast & Advertising Related » Medical Products & Devices » Soft Beverage» Building Materials » Mining » Software Industry» Business & Consumer Services » Natural Gas Pipelines » Solid Waste Management» Cable Television » Natural Product Processors » Sport-Related Enterprises» Chemicals » Oil & Gas, Independent E&P » Steel» Construction Industry » Oil & Gas, Integrated » Technology Hardware» Consumer Durables » Oil & Gas, Midstream Energy » Telecom Equipment» Consumer Electronics, Asian » Oil & Gas, Refining & Marketing » Telecom Infrastructure» CMDTY MERCH & Processing Cos » Oilfield Services » Telecommunications» Diversified Media » Packaged Goods » Tobacco» Electric G&T Cooperatives, US » Packaging Manufacturers » Toll Roads, Operational» Electric and Gas Networks, Regulated » Paper & Forest Products » UK Independent Gas Distribution» Electric and Gas Utilities, Regulated » Pharmaceuticals » Water Utilities, Regulated

Context and Tools

» For an analyst, one number - even a ratio - signifies little

» One needs another number for comparison

» Peer comparison is a useful tool

» Especially comparison with global standards

» Information sources are key

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Moody’s Key Financial Ratio Medians

Financial Analytic Tool Used by Moody’s Analysts

Moody’s Financial Metrics Platform

Banks 2b

Indonesian Banks

Indonesian Banks have improved…

Despite that… 32

NPLs remain low, but are expected to rise…

Stress Test NPLs—similar to 2005 experience

Indonesian Banks rated by Moody’s

To Perform Financial Analysis on These Banks…

The Bank Financial and Analytics Platform

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Moody’s Bank Rating Methodology

INPUTS OUTPUTS

FINANCIAL FUNDAMENTALS

RISK POSITIONING

OPERATING ENVIRONMENT

LOCAL CURRENCY DEPOSIT/DEBT

RATINGS (Aaa-C)

LOCAL CURRENCY DEPOSIT CEILING 1/

(Aaa-C)

FOREIGN CURRENCY DEPOSIT/DEBT

RATINGS (Aaa-C)

FOREIGN CURRENCY

DEPOSIT/DEBT CEILINGS 2/

(Aaa-C)

EXTERNAL SUPPORT FACTORS

1/ Measures ability of a government to support troubled banks and the risk of a local currency deposit freeze. 2/ Measures the risk of a foreign currency deposit or foreign currency debt moratorium.

PROBABILITY OF AVOIDING FOREIGN

CURRENCY MORATORIUM

REGULATORY ENVIRONMENT

INTRINSIC FACTORS

FRANCHISE VALUE

BANK FINANCIAL STRENGTH

RATING (A-E)

EXTERNAL FACTORS

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Bank Rating Methodology 41

The 5 Key Rating Factors are:

1. Franchise Value

2. Risk Positioning

3. Regulatory Environment

4. Operating Environment

5. Financial Fundamentals

Bank Credit Risk Analysis

Operating and Regulatory Environment

Risk Positioning and Franchise Value

Profitability, Efficiency and Liquidity

Capital Adequacy and Asset Quality

» Economic and Political Environment » Social Forces » Banking Market Dynamics

» Key Quantitative Factors

» Critical earnings analysis » Efficiency » Liquidity ratios

» Corporate Governance, Financial Reporting, Risk Management and Internal Controls, Concentration Risk, Liquidity, Market Risk

» Franchise Value

Outlook for Indonesian Banks

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Banks Rating Methodologies and Scorecards: 2 significant factors

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» Capital adequacy

» Asset quality

» Management

» Earnings

» Liquidity

» Sensitivity to market risk

CAMELS

Where you sit determines where you stand Differing interests dictate different perspectives and focus: • Bankers • Bond market • Equity investors • Regulators

Regulatory approaches Basel III Themes

» More and better quality capital

» Two new CCBs

» SIFIs

» Leverage ratio

» Liquidity ratios

» Increased interaction with regulators

Basel III: When is it changing

Indonesia Basel III Implementation

Global Basel III Implementation

Regional Basel III Implementation: Total Capital Required

Global Basel III Implementation

Fraud regulation in Indonesia 53

Introduced in 2011 (SE BI No.13/28/DPNP dated 9 December 2011 concerning Application of Anti Fraud Strategy for Commercial Banks.)

“Banks must own and apply strategy of anti Fraud adjusted to the internal and external environment, complexity of business activities, potentials, types, and Fraud risks and supported by adequate resources.” Four pillars:

»Prevention »Detection »Investigation, Reporting, and Sanction »Monitoring, Evaluation, and Follow up

Indonesian Banking Booklet 2014, OJK, Indonesian Financial Services Authority

Global Best Practices in Credit Risk Training 3

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Best Practices in Credit Risk Training Goal »The One-handed Analyst

• Elevator analysis inadequate • Decision must be made

» Able to show and justify the path to a decision

• Key factors and ratio analysis • Evaluate their relative importance

Challenge

»Learning styles »Retaining knowledge

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Best Practices in Credit Risk Training

Content: »Structured approach � Moody’s Training � Moody’s Investors Service methodologies

Retention: »Style of learning influence � Emphasizes active learning � Reinforced by practical application

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If you think education is expensive… Then try ignorance.

Derek Bok, former President of Harvard College

Too many financial institutions and investors simply outsourced their risk management.

Lloyd Blankfein, Speech to Council of Institutional Investors, 2009

Credit risk management is not: »credit risk avoidance »BPU (business prevention unit) »just a cost center, or a tick in a box.

Credit risk management is

»a core competence of a bank or firm.

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Moody’s Analytics • Offers a structured approach, • Using active learning, • Emphasizing practical applications, that

Best Practices in Credit Training…

• Provide banks with tools to better analyze credit, improve policies and procedures.

Contribute to Best Practices in Credit Analysis and Management

Thank you!

Moody’s Analytics Indonesia Country Team:

Client Relationship Ritika Kak Relationship Manager Office +65.6511.4463 Mobile +65.9126.0034 ritika.kak@moodys.com

Enterprise Risk Management Solutions

Sagar Rajput Enterprise Risk Management Specialist Office +65.6511.4494 Mobile +65.9125.5818 sagar.rajput@moodys.com

Credit & Macro-economics: Research & Analytics

Hong Huat Tan Credit Products Specialist Office +65.6511.4613 Mobile +65.9649.9190 honghuat.tan@moodys.com

Irene Chau Senior Associate Products Specialist Office +852.3551.3092 Mobile +852.9728.2790 irene.chau@moodys.com

Training and Certification Alan Blair

Director Office +65.6511.4668 Mobile +65.9723.7726 alan.blair@moodys.com

Client Services Support Phone +852.3551.3077 clientservices.asia@moodys.com

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