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Risk Management Workshop 
Global Best Practices 
in Credit Analysis and Training 
“A Focus on Cash Flow, Projections and 
...
Agenda 
2 
1 Moody’s Analytics and Indonesia 
2 Global Best Practices in Credit Risk Analysis 
Moody’s framework and tools...
Moody’s Analytics 1 and Indonesia
4 
4 
Moody’s Analytics helps our global clients measure, 
understand, and mitigate risk – beyond ratings 
Independent pro...
Integrating Risk Practices Across the Enterprise 
6 
6
Moody’s Analytics is recognized as a leader in risk and 
regulatory solutions. 
7 
Voted #1 in Economic Capital 
Calculati...
Moody’s Analytics in Indonesia 
• Credit Ratings and Research 
• Credit Risk Analytics: Market Implied Ratings, Financial ...
Global Best Practices in Credit Analysis 
“Cash Flow, Projections & Fraud Awareness” 
2
11 
What is a Moody’s Rating? 
» An Independent Opinion 
...on the future ability of an issuer to make timely payments on ...
Corporates 2a 
Global Best Practices in Credit Analysis
13 
Credit Risk Analytical Framework and Process 
Analytical Process 
»Before looking at the financials 
• 4 Cs and 3 Ms 
...
Credit Risk Analysis Framework 
1 
Who? 
What? 
Where from? 
2 
Credit 
Risk 
Grid 
3 
Decision, 
Monitoring 
Who: Legal 
...
Credit Risk Analysis Framework 
Structure 
Risks 
Financial 
Risks 
Transaction 
Structure Risks 
Debt Service & Liquidity...
16 
Credit Risk Tools and Analysis 
»Solvency and Liquidity focus of financial analysis 
Is there a business there? Can it...
Cash Flow is Key, as EBITDA (and Net Income)… 
» is an earnings concept, and not an ideal proxy for cash flow 
» is not de...
Operating Cash Flow 
Retained Cash Flow 
Free Cash Flow 
1. 
2. 
3. 
Three Levels of Cash Flow 
Less Dividends = 
Less CAP...
“PACED” The Five Cash Flow Drivers 
»The volume of sales 
»Price Elasticity 
»Stability of Operating Margins 
»Tax and oth...
Projections: PAWS a Structured Approach 
» Relate to past performance 
» Where are we now? 
» Gaps between final historic ...
Fraud 
What can we spot in financial statements? 
» Revenue overstatement – fictitious sales 
» Understating/overstating e...
Fraud 
Non financial clues: 
»Corporate Governance model – do we understand it 
»Lack of Understanding of the Business Mod...
23 
Rating Methodologies and Scorecards - Non-financial corporations 
» Aerospace and Defense » EMS & IT Distribution » Po...
Context and Tools 
» For an analyst, one number - even a ratio - signifies little 
» One needs another number for comparis...
25 
Moody’s Key Financial Ratio Medians
Financial Analytic Tool Used by Moody’s Analysts 
26
Moody’s Financial Metrics Platform 
27
Banks 2b 
Global Best Practices in Credit Analysis
Indonesian Banks 
29
Indonesian Banks have improved… 
30
31
Despite that… 
32
NPLs remain low, but are expected to rise… 
33
Stress Test NPLs—similar to 2005 experience 
34
Indonesian Banks rated by Moody’s 
35
To Perform Financial Analysis on These Banks… 
36
The Bank Financial and Analytics Platform 
37
38 
Moody’s Bank Rating Methodology
Moody’s Bank Rating Methodology 
INPUTS OUTPUTS 
FINANCIAL 
FUNDAMENTALS 
FRANCHISE 
VALUE 
RISK 
POSITIONING 
OPERATING 
...
40
Bank Rating Methodology 
41 
The 5 Key Rating Factors are: 
1. Franchise Value 
2. Risk Positioning 
3. Regulatory Environ...
Bank Credit Risk Analysis 
Operating and Regulatory 
Environment 
Risk Positioning and 
Franchise Value 
Profitability, Ef...
Outlook for Indonesian Banks 
43
44
45
46 
Banks Rating Methodologies and Scorecards: 2 significant factors
47 
Where you sit determines where you stand 
Differing interests dictate different perspectives and focus: 
• Bankers 
• ...
Basel III: When is it changing 
48
Indonesia Basel III Implementation 
49
Global Basel III Implementation 
50
Regional Basel III Implementation: Total Capital Required 
51
Global Basel III Implementation 
52
Fraud regulation in Indonesia 
53 
Introduced in 2011 
(SE BI No.13/28/DPNP dated 9 December 2011 concerning Application o...
Global Best Practices in 3 Credit Risk Training
55 
Best Practices in Credit Risk Training 
Goal 
»The One-handed Analyst 
• Elevator analysis inadequate 
• Decision must...
56 
Best Practices in Credit Risk Training 
Content: 
»Structured approach 
ƒ Moody’s Training 
ƒ Moody’s Investors Servic...
57 
If you think education is expensive… 
Then try ignorance. 
Derek Bok, former President of Harvard College 
Too many fi...
58 
Best Practices in Credit Training… 
Moody’s Analytics 
• Offers a structured approach, 
• Using active learning, 
• Em...
Thank you! 
59
60 
Moody’s Analytics Indonesia Country Team: 
Client Relationship Ritika Kak 
Relationship Manager 
Office +65.6511.4463 ...
ABOUT US 
Moody’s Analytics helps capital markets and risk management professionals worldwide respond to an evolving 
mark...
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Global Best Practices in Credit Analysis and Training

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With an emphasis on Indonesia, this presentation discusses Global Best Practices in Credit Analysis and Training: A Focus on Cash Flow, Projections and Fraud Awareness.

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Global Best Practices in Credit Analysis and Training

  1. 1. Risk Management Workshop Global Best Practices in Credit Analysis and Training “A Focus on Cash Flow, Projections and Fraud Awareness” September 3, 2014
  2. 2. Agenda 2 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
  3. 3. Moody’s Analytics 1 and Indonesia
  4. 4. 4 4 Moody’s Analytics helps our global clients measure, understand, and mitigate risk – beyond ratings 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.
  5. 5. Integrating Risk Practices Across the Enterprise 6 6
  6. 6. Moody’s Analytics is recognized as a leader in risk and regulatory solutions. 7 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
  7. 7. 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 9
  8. 8. Global Best Practices in Credit Analysis “Cash Flow, Projections & Fraud Awareness” 2
  9. 9. 11 What is a Moody’s Rating? » 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 Definition of Credit Risk Credit Risk = Expected Loss = Default Probability x Loss Given Default Credit Risk = Business Risk + Financial Risk + Structure Risk
  10. 10. Corporates 2a Global Best Practices in Credit Analysis
  11. 11. 13 Credit Risk Analytical Framework and Process Analytical 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 »Credit mitigants and notching • Issue specific • Monitor of trends and ratios »Scorecard • Analyst/Committee Override
  12. 12. Credit Risk Analysis Framework 1 Who? What? Where from? 2 Credit Risk Grid 3 Decision, Monitoring Who: Legal Counterparty & Credit Base What: Credit Need Where from: Repayment Sources Simple or Comprehensive Assessment Internal Triggers Data Quality Setting of Triggers Monitoring Plan Non-financial EWS Client Risk Conclusion Group Structure Risks Parent/Group Support Finance Risk Structure Risk 4Cs and 3Ms Structure Mitigants Revenue & Profitability Asset Management Debt Capacity & Leverage Debt Service & Liquidity Business Risk 14
  13. 13. Credit Risk Analysis Framework Structure Risks Financial Risks Transaction Structure Risks Debt Service & Liquidity Debt Capacity & Leverage Asset Management Revenues & Profitability Business Risks Management Company Position Market (Industry) Macro economy Country 15
  14. 14. 16 Credit Risk Tools and Analysis »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
  15. 15. 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 17
  16. 16. Operating Cash Flow Retained Cash Flow Free Cash Flow 1. 2. 3. 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” “CFO” Standard Definition Standard Definition Moody’s Cash Flow Concepts * Working capital and other items not directly related to ongoing operations (e.g. pension and OPEB contributions) 18
  17. 17. “PACED” The Five Cash Flow Drivers »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 new capital »Cost of Capital »Access to debt markets »Cost of Debt »Debt Maturity profile »Contingent Liabilities Profit ACC Capex Equity Debt
  18. 18. Projections: PAWS a Structured Approach » 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 20
  19. 19. 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. 21
  20. 20. Fraud 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? 22
  21. 21. 23 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
  22. 22. 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 24
  23. 23. 25 Moody’s Key Financial Ratio Medians
  24. 24. Financial Analytic Tool Used by Moody’s Analysts 26
  25. 25. Moody’s Financial Metrics Platform 27
  26. 26. Banks 2b Global Best Practices in Credit Analysis
  27. 27. Indonesian Banks 29
  28. 28. Indonesian Banks have improved… 30
  29. 29. 31
  30. 30. Despite that… 32
  31. 31. NPLs remain low, but are expected to rise… 33
  32. 32. Stress Test NPLs—similar to 2005 experience 34
  33. 33. Indonesian Banks rated by Moody’s 35
  34. 34. To Perform Financial Analysis on These Banks… 36
  35. 35. The Bank Financial and Analytics Platform 37
  36. 36. 38 Moody’s Bank Rating Methodology
  37. 37. Moody’s Bank Rating Methodology INPUTS OUTPUTS FINANCIAL FUNDAMENTALS FRANCHISE VALUE RISK POSITIONING OPERATING ENVIRONMENT LOCAL CURRENCY DEPOSIT CEILING 1/ (Aaa-C) LOCAL CURRENCY DEPOSIT/DEBT RATINGS (Aaa-C) FOREIGN CURRENCY DEPOSIT/DEBT CEILINGS 2/ (Aaa-C) FOREIGN CURRENCY DEPOSIT/DEBT RATINGS (Aaa-C) EXTERNAL SUPPORT FACTORS PROBABILITY OF AVOIDING FOREIGN CURRENCY MORATORIUM BANK FINANCIAL STRENGTH RATING (A-E) REGULATORY ENVIRONMENT INTRINSIC FACTORS EXTERNAL 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. 39
  38. 38. 40
  39. 39. 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
  40. 40. 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 » Corporate Governance, Financial Reporting, Risk Management and Internal Controls, Concentration Risk, Liquidity, Market Risk » Franchise Value » Critical earnings analysis » Efficiency » Liquidity ratios » Key Quantitative Factors 42
  41. 41. Outlook for Indonesian Banks 43
  42. 42. 44
  43. 43. 45
  44. 44. 46 Banks Rating Methodologies and Scorecards: 2 significant factors
  45. 45. 47 Where you sit determines where you stand Differing interests dictate different perspectives and focus: • Bankers • Bond market • Equity investors • Regulators Regulatory approaches CAMELS » Capital adequacy » Asset quality » Management » Earnings » Liquidity » Sensitivity to market risk Basel III Themes » More and better quality capital » Two new CCBs » SIFIs » Leverage ratio » Liquidity ratios » Increased interaction with regulators
  46. 46. Basel III: When is it changing 48
  47. 47. Indonesia Basel III Implementation 49
  48. 48. Global Basel III Implementation 50
  49. 49. Regional Basel III Implementation: Total Capital Required 51
  50. 50. Global Basel III Implementation 52
  51. 51. 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
  52. 52. Global Best Practices in 3 Credit Risk Training
  53. 53. 55 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
  54. 54. 56 Best Practices in Credit Risk Training Content: »Structured approach ƒ Moody’s Training ƒ Moody’s Investors Service methodologies Retention: »Style of learning influence ƒ Emphasizes active learning ƒ Reinforced by practical application
  55. 55. 57 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.
  56. 56. 58 Best Practices in Credit Training… Moody’s Analytics • Offers a structured approach, • Using active learning, • Emphasizing practical applications, that Contribute to Best Practices in Credit Analysis and Management • Provide banks with tools to better analyze credit, improve policies and procedures.
  57. 57. Thank you! 59
  58. 58. 60 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
  59. 59. ABOUT US Moody’s Analytics helps capital markets and risk management professionals worldwide respond to an evolving marketplace with confidence. The company offers unique tools and best practices for measuring and managing risk through expertise and experience in credit analysis, economic research and financial risk management. By providing leading-edge software, advisory services, and research, including the proprietary analysis of Moody’s Investors Service, Moody’s Analytics integrates and customizes its offerings to address specific business challenges. © 2014 Moody’s Analytics, Inc. and/or its licensors and affiliates (collectively, “MOODY’S”). All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY’S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY’S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided “AS IS” without warranty of any kind. Under no circumstances shall MOODY’S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY’S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY’S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY’S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding, or selling.

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