Modeling Structural Default Risk

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  • 1. Modeling structural default risk for allocating deposits to money market counterparties Basis: Agusto Ratings, Fitch Weights, Edward Altman’s “Z-score” modelparameters for financial institutions, Merton/ Moody’s KMV Model(time) All ratings 2009 for 2010 placements
  • 2. Demonstration of methodology• each plot covers the period of prior to intervention announcements by the CBN:• assigned z-scores were trended for the period to reflect firm and market changes• these bear a simple rating system:• Z < 1.8 = “default”,• 1.8< Z <3.0 “troubled credit”• ….> 3.0 “Okay”
  • 3. Basis of allocation to counterparties… After data entry on the internal spread; All inputs are entered from each firm’s financials and transformed into comprehensive weights before assigning a score to allocate permissible weights. Qualitative factor’s may change the final output G.Rev/Factor WC/TA RE/TA EBIT/TA MVE/TL T.Assets Z-Score % Allocation Year EndMultiple 1.20 1.40 3.30 0.60 1.00 ACCESS 0.93 0.05 0.05 106.21 0.03 6.51 4.20% 31-Mar-08 AFRIBANK 0.45 0.02 0.04 64.68 0.04 3.96 2.55% 29-Feb-08 PLATINUM 1.06 0.08 0.07 24.64 0.05 1.65 1.06% 29-Feb-08 DIAMONDBNK 0.73 0.07 0.05 267.34 0.05 16.16 10.43% 31-Dec-08 FIDELITYBK 1.09 0.07 0.07 192.75 0.05 11.73 7.57% 31-Dec-08 FIRSTINLND 0.68 0.08 0.10 45.92 0.08 2.89 1.86% 29-Feb-08 FIRSTBANK 0.61 0.09 0.12 209.18 0.07 12.68 8.19% 02-Jun-08
  • 4. Jan 2008-July 2010: the black lines represent computed z-scores, the coloured lines reflect forecast levels Z<1.8 = “default”, 1.8<Z<3.0 “troubled credit”….>3.0 “Okay”
  • 5. Jan 2008-July 2010: the black lines represent computed z-scores, the coloured lines reflect forecast levels Z<1.8 = “default”, 1.8<Z<3.0 “troubled credit”….>3.0 “Okay”
  • 6. Jan 2008-July 2010: the black lines represent computed z-scores, the coloured lines reflect forecast levels Z<1.8 = “default”, 1.8<Z<3.0 “troubled credit”….>3.0 “Okay” Below required score …future looked manageable
  • 7. Jan 2008-July 2010: the black lines represent computed z-scores, the coloured lines reflect forecast levels Z<1.8 = “default”, 1.8<Z<3.0 “troubled credit”….>3.0 “Okay” Clear sign of default
  • 8. The industry average Z-scored over the period
  • 9. Allocation limits are based on these screens to mitigate counterparty risk and form basis for negotiation with deposit placement lines
  • 10. Resulting deposit placement limits… and tenures