1. Managing Credit Risk across a
Diverse Corporate Portfolio
Tarun Dara, Mubadala GE Capital
Confidential

2. “It is not the strongest or the most intelligent who
will survive but those who can best manage
change”
- Charles Darwin
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3. Traditional View: Individual Transaction
5 C’s of Credit
Character
Capacity
Capital
Collateral
Conditions
Profitability
Yield is greater than threshold set
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4. Credit Risk Quantified : Individual Transaction
Exposure Probability Loss Expected
At Default X of Default X Given =
Losses
Default
• Expected Size of • Probability of • Economic Losses • “Cost Of Doing
Exposure at Default Within 1 Post Default Business”
Default year
• Includes All • Given
• Need to model • Default = Costs, Timing of Predictable, not
for Revolvers & Bankruptcy, Recoveries “Risk” per se
for other 90 Days Past Due, • Function Of • Typically
unfunded Restructuring to Collateral, reflected in
commitments Avoid Default Seniority Pricing
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5. Credit Risk Measures for a Diverse Portfolio
PD Distribution LGD Distribution
700 635 1200 1060
600 1000
EAD ($mm)
EAD ($mm)
500 705
800
400 350 320 600
300 245 225
175 400
200
160
100 50 200 75
0 0
0.59% 0.89% 1.34% 2.01% 3.03% 4.55% 6.84% 0%-15% 15%-30% 30%-45% 45%-65%
PD % LGD %
EL Distribution
400 380
350
300 265
EAD ($mm)
250 225
200 175
150 145
150
100 100
100 75 75 60 60 70 60 60
50
0
0.23% 0.27% 0.30% 0.31% 0.34% 0.36% 0.45% 0.47% 0.50% 0.54% 0.60% 0.68% 0.90% 0.91% 1.03%
EL % 5
Confidential

6. At deal level we understand the “risk characteristics”
What should be the portfolio composition ?
How do we maximize portfolio return ?
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7. Expected Loss Vs. Unexpected Loss
Economic Capital is Provided to Cover Extreme or “Tail Risk” Events
EL
Probability of a “Tail Risk” Event is a function of
Unexpected Loss (Volatility) 7
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8. Portfolio Risk Measures
1 Average Loss (Expected Loss or “EL” )
1
2 Volatility (Unexpected Loss or “UL”)
High EL 3 Extreme Loss or “Tail Risk”
2
Confidence level scaled to
Probability of Loss
UL
target rating level
3
“Tail Risk” loss event
99.9% Confidence Level
Low
Very Small Size of Loss Very Large
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9. Economic Capital
 Ecap (Economic Capital) is the amount of capital a
business or product require, for a given amount of risk,
to achieve a specified level of confidence that an
extreme loss will not exceed the capital
 Measured as the potential loss in excess of EL over one
year time period at a specified confidence level or
criterion
 Represents comprehensive risk measurement which can
be thought of as “unit of risk”
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10. Comprehensive Ecap Framework
Overall EC
Inter-risk
correlations
Credit Operational Structural Equity
Business risk
risk risk ALM risk
- Change in - Losses - Change in - Change in - Losses
value of credit resulting from Economic value of Equity resulting from
positions due inadequate or Value of investments volume and
to default and failed internal Equity under under market margin decline
credit processes, interest rate scenarios
migrations people and and FX
- Most systems or scenarios
substantial risk from external
type events
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11. Credit Risk Ecap: Measurement
Two approaches to measure Credit Risk Ecap
In-house formula based model
Moody’s Risk Frontier
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12. Model Formula
Loss History
Critical (Recoveries, Collateral
Ratings S&P, KMV, Outstanding's at
Assumptions: FICO etc.
etc.)
default
• 1 Year Time Horizon
Probability of Default x Loss Given x Exposure at Default = Expected Loss
PD Default LGD EAD EL
• Cycle-Neutral
• Benchmark
Correlation / Desired Credit Rating
Diversification Unexpected Loss ( UL)
Assumption (Standard deviation
in Expected Loss)
• Benchmark Capital Credit Rating
Default Correlations
Multiplier Diversification Credit Capital Multiplier
Historical Correlation
of the Portfolio Credit Risk Economic
Capital
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13. Moody’s Risk Frontier
• A simulation approach to calculate the capital required to maintain
a certain level of risk in a credit portfolio
• Allocates capital to individual exposures in the portfolio
• Uses multiple factors based on the global economy, region, sector,
industry and country
• Correlation between any two firms’ returns can be explained by
the firms’ relationship to a set of common factors
• The greater the link of two individual firms to common economic
factors, the greater the likelihood that their fortunes will rise and
fall together Confidential 13

14. Modeling Co-relation
Blue Chip MNC (PD : 0.0003) Best Pizza LLC (PD : 0.1029)
Systematic
Idiosyncratic
Systematic High R2 Idiosyncratic
Low R2
Blue Chip MNC has very low stand-alone risk, but Best Pizza, LLC is very risky, but its risk is mainly
that risk is mainly associated to factors that affect due to factors that are specific to that company
the entire economic system and, therefore, all (e.g. neighborhood, health of owner/manager,
other obligors in a portfolio (i.e. it cannot be competition on the street, local economy) and,
diversified away). therefore, not correlated with other obligors in a
portfolio.
Industry, Country and Sales Size determine how much risk is
systematic (undiversifiable) vs. idiosyncratic (diversifiable) 14
Confidential

15. Capital Sensitivity to LGD
Higher levels of LGDs are associated with increasing capital charges,
even though the PDs decrease enough to keep the EL at the same level
Given the same EL, it’s always better to have lower LGD
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Confidential

16. Diverse Corporate Portfolio
UK , $190mm
Germany, $ 120mm
Turkey, $120mm
Egypt, $310 mm Japan, $50mm
USA $440mm UAE, $160 mm
KSA, $390mm
Australia, $220mm
Country, EAD (This is sample data set created for this discussion)
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17. Ecap Requirements: Country Level
21.0%
KSA has same
19.0% level of EL as UK
but significantly
Egypt
17.0% higher Ecap
KSA
15.0% UAE & Turkey
Ecap(%)
UAE attract more
Turkey Avg. 13.0%
13.0% capital than
UK
Australia despite
11.0% similar EL levels
Avg. 0.52%
USA
9.0%
Australia Germany, Japan
Germany
7.0% look very
attractive
Japan
5.0%
0.25% 0.35% 0.45% 0.55% 0.65% 0.75% 0.85% 0.95%
EL(%)
Distinguish attractiveness of countries at same level of EL
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Bubble Size is based on the EAD of Sample Country Confidential

18. Ecap Requirements: Product Level
17.0% Working Capital
16.0%
has higher EL
than Corp Loans
15.0%
Corporate Loan but lower Ecap
Real Estate Working Capital
14.0%
13.0% Avg. 13.0%
Ecap(%)
12.0%
Project Finance
Asset Finance Asset Finance EL
11.0%
level is close to
10.0% Avg. 0.52% highest but has
9.0% the lowest Ecap
8.0%
7.0%
0.20% 0.30% 0.40% 0.50% 0.60% 0.70% 0.80%
EL(%)
Attractiveness at product level…. 18
Bubble Size is based on the EAD of Sample Product Confidential

19. Ecap Requirements: Deal Level
24.0%
M
22.0%
20.0% N
I
18.0%
16.0% K
Ecap(%)
14.0% L Avg. 13.0%
12.0%
10.0% Avg. 0.52%
8.0%
6.0%
4.0%
0.2% 0.3% 0.4% 0.5% 0.6% 0.7% 0.8% 0.9% 1.0% 1.1%
EL(%)
Deals in bottom right have lower capital requirements and in top left
Bubble Size is based on the Sample Deal EAD
have higher capital requirements
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20. Ecap vis-à-vis Yields
9.0%
D
8.0%
R Z G
V
Q
7.0%
Yield
6.0% Avg. 6.45%
T W
O
I M
5.0%
Avg. 13%
P
4.0% K
3.0%
3.0% 8.0% 13.0% 18.0% 23.0% 28.0%
Ecap(%)
Deals in top left are most profitable and the mix has changed
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Bubble Size is based on the Sample Deal EAD

21. Ecap vis-à-vis Risk Adjusted Returns
28.0%
24.0%
Hurdle 20%
20.0%
RAROC
16.0%
B
12.0%
Limit 20%
8.0%
4.0%
4.0% 8.0% 12.0% 16.0% 20.0% 24.0% 28.0%
Ecap(%)
Deals in top left quadrant meet the hurdle rate and Ecap % limit
21
Bubble Size is based on the Sample Deal EAD
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22. Concluding Remarks
 This framework is meant to supplement the underwriting of each
credit. Continue to maintain high standards of underwriting
 A Deal looking attractive on its own may not enhance portfolio
returns if it is carrying similar “risk characteristics”
 Diversification of portfolio is key for return maximization
 Mechanism to proactively manage the portfolio
 Extend this to perform stress testing which has taken a very
important role from regulatory standpoint
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23. Thank You
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24. Mubadala GE Capital
Mubadala GE Capital PJSC is a specialized commercial finance company providing
structured financing solutions to businesses across MENAT. Headquartered in
Abu Dhabi and owned by Mubadala Development Company & GE Capital.
Tarun Dara
Tarun is currently leading credit risk and portfolio analytics at Mubadala GE
Capital. Over last 13 years he has worked in area of underwriting, corporate
finance, portfolio analytics and financial risk consulting spread across India, Asia
Pacific and Middle East region. His current focus is on building a robust portfolio
and capital management framework, governance of risk models in use across
diverse asset classes and portfolio quality reviews. Tarun holds an MBA in finance
and strategy from IIT, Delhi ; MS (Hons) Economics from BITS, Pilani in India and
has graduated from a financial management program with GE.
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