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05.2 credit quality monitoring
1.
Copyright © 2018
CapitaLogic Limited This presentation file is prepared in accordance with Chapter 5 of the text book “Managing Credit Risk Under The Basel III Framework, 3rd ed” Website : https://sites.google.com/site/crmbasel E-mail : crmbasel@gmail.com Chapter 5 Credit Quality Monitoring
2.
Copyright © 2018
CapitaLogic Limited 2 Declaration Copyright © 2018 CapitaLogic Limited. All rights reserved. No part of this presentation file may be reproduced, in any form or by any means, without written permission from CapitaLogic Limited. Authored by Dr. LAM Yat-fai (林日辉), Director, CapitaLogic Limited, Adjunct Professor of Finance, City University of Hong Kong, Doctor of Business Administration, CFA, CAIA, CAMS, FRM, PRM.
3.
Copyright © 2018
CapitaLogic Limited 3 Outline Individual borrowers monitoring Financial markets monitoring Large borrowers monitoring CapLogic SiFi credit index
4.
Risk tolerance level
Single debt The maximum EL which a lender can accept Determine through an experiment Debt portfolio The maximum XCL which a lender can accept Proxy by the maximum portfolio default loss in one year Every lender has his own subjective risk tolerance level Copyright © 2018 CapitaLogic Limited 4 Example 5.1
5.
Copyright © 2018
CapitaLogic Limited 5 Credit assessment techniques Credit assessment External (by independent expert) Corporate credit rating Internal (by lender) RetailCorporate Retail FICO score Merton’s corporate default model Altman’s Z-score Credit scoring Credit scoring
6.
Copyright © 2018
CapitaLogic Limited 6 External credit monitoring Corporate credit rating (> BBB) Moody’s, S&P, Fitch Retail FICO score (> 680) Individual persons TranUnion, Equifax, Experian SMEs Dun and Bradstreet
7.
Copyright © 2018
CapitaLogic Limited 7 Internal credit monitoring Listed companies Merton’s corporate default model Altman’s Z-score Credit scoring Private firms Altman’s Z-score Credit scoring Individual persons and SMEs Credit scoring
8.
Copyright © 2018
CapitaLogic Limited 8 Regular interest payments Before lending Up-to-date borrower information After lending Outdated borrower information Regular interest payments as a monitoring tool Monthly interest payments for retail lending Monthly, quarterly, semi-annual or annual interest payments for corporate debts
9.
Copyright © 2018
CapitaLogic Limited 9 Payroll accounts Borrower Open a savings account at the lending bank Register the savings account with employer for monthly payroll collection Monthly salary deposited by employer to payroll account on specific day monthly
10.
Copyright © 2018
CapitaLogic Limited 10 Operating accounts Borrower Open an operating account at the lending bank Managing payrolls, payments, credit cards, mortgages, foreign currencies, equities, funds All banking and investment transactions go through this integrated account Monthly cash inflows and outflows recorded in detail by the lender Excessive cash outflows over inflows triggers alerts to the lender
11.
Copyright © 2018
CapitaLogic Limited 11 External vs internal monitoring External Advantages Leverage on external expertise of credit assessments Lower cost Disadvantages Only for borrowers with credit ratings or FICO scores Usually updated on annual basis or when there is a major credit event Internal Advantages Applicable to all borrowers Frequency controlled by lender Tailored for different types of borrowers Disadvantages Not a profit making activity Time consuming Expensive
12.
Copyright © 2018
CapitaLogic Limited 12 Outline Individual borrowers monitoring Financial markets monitoring Large borrowers monitoring CapLogic SiFi credit index
13.
Copyright © 2018
CapitaLogic Limited 13 Market based monitoring To monitor a manageable number of systematic market monitoring factors (30 to 100) in a lender’s lending universe To take mitigation actions if systematic market risk factors exhibit a confirmed trend of deterioration
14.
Copyright © 2018
CapitaLogic Limited 14 Systematic market monitoring factors (1) Major currency rates USD, EUR, GBP, JPY, CNY Major interest rates Zero treasury rates Short term 1-year, medium term 5-year, longer term 10-year
15.
Copyright © 2018
CapitaLogic Limited 15 Systematic market monitoring factors (2) Major equity market indices S&P500, DAX, CAC 40, FTSE, Nikkie 225, China SSE Major volatility indices S&P500, DAX, CAC 40, FTSE, Nikkie 225 Major commodity prices Gold, oil Major credit indices CapLogic SiFi credit indices
16.
Copyright © 2018
CapitaLogic Limited 16 Weekly percentage change Weekly percentage change Market value of monitoring factor current week = - 1 100% Market value of monitoring factor previous week
17.
Copyright © 2018
CapitaLogic Limited 17 Weekly percentage change Early detection with change instead of levels What is this week’s percentage change relative to the most recent business cycle (260 weeks) ? Emergency – extremities (+1%) Warning – wing regions (+1% to +5%) Attention – side regions (+5% to +10%) Normal – middle region (-10% to 10%) Snapshot analysis Trend analysis
18.
Copyright © 2018
CapitaLogic Limited 18 Weekly percentage changes 80% = 4 year
19.
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CapitaLogic Limited 19 Snapshot analysis Example 5.2
20.
Copyright © 2018
CapitaLogic Limited 20 Snapshot summary
21.
Copyright © 2018
CapitaLogic Limited 21 Trend analysis
22.
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CapitaLogic Limited 22 Outline Individual borrowers monitoring Financial markets monitoring Large borrowers monitoring CapLogic SiFi credit index
23.
Copyright © 2018
CapitaLogic Limited 23 Large borrowers By EL Ten bank borrowers with the largest EL Ten non-bank borrowers with the largest EL By outstanding debt amount Ten bank borrowers with the largest outstanding debt amount Ten non-bank borrowers with the largest outstanding debt amount
24.
Copyright © 2018
CapitaLogic Limited 24 Monitoring Weekly records of Credit rating FICO score CDS spread Trend analysis Financial news
25.
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CapitaLogic Limited 25 Practical monitoring Systematic credit quality Specific credit quality of large borrowers
26.
Copyright © 2018
CapitaLogic Limited 26 Outline Individual borrowers monitoring Financial markets monitoring Large borrowers monitoring CapLogic SiFi credit index
27.
Copyright © 2018
CapitaLogic Limited 27 Systematically important financial institution (SiFi) A financial institution whose distress or disorderly failure, because of its size, complexity and systemic inter-connectedness, would cause significant disruption to the wider financial system and economic activity 30 designated by Basel Committee and Financial Stability Board To be reviewed annually in November
28.
Copyright © 2018
CapitaLogic Limited 28 Systematically important financial institutions (1) North America Bank of America Bank of New York Mellon Citigroup Goldman Sachs JP Morgan Chase Morgan Stanley State Street Wells Fargo Asia Mitsubishi UFJ FG Mizuho FG Sumitomo Mitsui FG Bank of China ICBC Agricultural Bank of China China Construction Bank
29.
Copyright © 2018
CapitaLogic Limited 29 Systematically important financial institutions (2) UK and France Barclays HSBC Standard Chartered Bank Royal Bank of Scotland BNP Paribas Groupe Credit Agricole Groupe BPCE Société Générale Rest of Europe Credit Suisse UBS Deutsche Bank ING Bank Nordea Santander Unicredit
30.
Copyright © 2018
CapitaLogic Limited 30 CapLogic SiFi credit index CapLogic SiFi credit index Average of SiFis’ five-year CDS spreads Specifically designed for financial markets monitoring No default effect, discontinuity or selection bias Very consistent and very little adjustment