ADAPTING A STANDARDIZED CREDIT RATING METHODOLOGY TO INDUSTRY SPECIFIC FACTORS – SOUTH AFRICA Presenter: Credit Risk I Strategy and Risk Management I Division: Asset and Liability Management | 11 June 2014
TABLE OF CONTENTS • The Role and Structure of Credit Risk • National Treasury’s Credit Risk • Contingent Liabilities (Categories) • Underlying Principles • Risk Based Analysis (Methodology) • Risk Rating Indicators and Benchmarks • Risk Rating Table and Classifications • Conclusion 2
THE ROLE OF CREDIT RISK • The Credit Risk division is responsible for implementing the credit risk strategy within the Asset and Liability Management (ALM). • This mainly includes: o The development of credit risk policy and its annual review; o The development of a credit risk manual and its annual review; and o Review credit granting processes on an on-going basis. 3
ORGANISATIONAL SET-UP/STRUCTURE Director Senior Senior Credit Credit Risk Risk Credit Analyst Analyst Risk Analyst Trainee Analyst 4
NATIONAL TREASURY’S CREDIT RISK • The National Treasury’s credit risk emanates from: • Deposit-making activities (Counterparty risk). The national Treasury deposits surplus cash with the big four South African Banks. The analysis is conducted to gauge the banks’ ability to make funds available when needed. • Settlement Risk from government bonds auctions with the aim of quantifying the banks ability to settle their bond obligations after three days. Contingent liabilities Arise from the granting of guarantees • Emanating from Public Private Partnerships (PPPs) in a case of terminations and • defaults. • Implicit contingent liabilities arising from actuarial deficits and government related insurance companies. 5
CONTINGENT LIABILITIES CONTINGENT LIABILITIES Implicit Portfolio • The analysis is conducted annually on the SOCs’ financial statements and qualitative information. • Assess the SOCs’ ability to make good of the insured benefits and to settle future claims without negatively affecting their solvency. Public Private Partnerships (PPPs) • The analysis is conducted to gauge the projects construction and operational stages against terminations, disruptions and defaults. 6
CONTINGENT LIABILITIES Implicit Contingent Liabilities • Unemployment Insurance Fund (UIF) • Road Accident Fund (RAF) • Compensation Fund • South African Special Risks Insurance Association (SASRIA) • Export Credit Insurance Company (ECIC) 7
CONTINGENT LIABILITIES Explicit Guarantee Portfolio • The analysis is conducted annually by way of financial analysis conducted on the SOCs’ financial statements • Assess the guarantee portfolio on an annual basis and highlight any possible and future challenges that pose risks to the quality of the overall guarantee portfolio. • Give advice to the fiscal liabilities committee on a quarterly basis on the state of the contingent liabilities and alert the forum on any improvement or deterioration on the overall guarantee portfolio. • Monitor the sustainability measure of net debt, provisions and contingent liabilities as a percentage of GDP against a limit of 60 per cent. 8
CONTINGENT LIABILITIES Energy • Eskom Infrastructure • South African National Roads Agency Limited (Sanral) • Trans-Caledonian Tunnel Authority (TCTA) Development Finance Institutions (DFI) • Development Bank of Southern Africa (DBSA) • Land Bank • Industrial Development Corporation (IDC) Transport • Transnet • South African Airways (SAA) and South African Express (SAX) • Passenger Rail Agency of South Africa (PRASA) Defence • Denel Telecommunications • Telkom • South African Broadcasting Corporation (SABC) 9
UNDERLYING PRINCIPLES • NT to operate within an appropriate Credit Risk environment; • Credit risk inherent in all new activities must be subject to adequate controls (procedures); • NT must operate under a sound credit granting process; • An appropriate credit administration, measurement and monitoring process must be maintained; • NT established independent Fiscal Liabilities Committee (FLC). • The FLC Mandate is the optimum management of contingent liabilities 10 10
RISK BASED ANALYSIS (METHODOLOGY) • The Credit Risk Directorate derives its mandate from the Credit Risk policy. • The analysis is conducted in terms of standardised methodology • The methodology is in terms of the credit risk policy. • The methodology also outlines the criteria (indicators) and how the analysis should be conducted to determine each State Owned Companies (SOC’s) ability to service guaranteed debt. • The business risk indicators focus on the qualitative information while the financial risk indicators focus on the quantitative information. • The guidelines, depending on specific indicators, take into account a combination of the industry norms, rating agencies benchmarks and peer analysis. 11 11
RISK INDICATORS FOR SOC’S (EXCLUDING DFIS) Business Risks Financial Risks Industry Prospects Profitability - Operating Environment - Cost to income ratio (DFIs) - Regulatory Framework - Net profit margin - EBITDA margin Corporate Governance Capital structure - Adherence to PFMA - Debt to assets - Management Quality - Debt to equity Market Position Cash flow adequacy - Diversification - Funds from operations/Debt - Size - Interest cover Liquidity ratios - Cash ratio - Quick ratio - Current ratio Source: National Treasury 12 12
RISK INDICATORS FOR DFIS Financial Risk Indicators Business Risk Indicators Financial performance Industry risks Total Assets (R'm) Segmental Business Units Total Equity (R'm) Growth Potential Profit for the period (R'm) Size and Barriers to entry Net Interest Revenue (R'm) Operating Environment Leverage Challenges Debt Ratio (%) Successes Debt to Equity (%) Future/Current Developments Profitability ROA (%) Management Quality Risk Indicators ROE (%) Competence Cost to income (%) Risk appetite Net Int. Margin (%) Management stability Non-Interest Income/Total Income (%) Intergrity EBITDA margin (%) Interest cover (times) Liquidity Non-performing loans/Gross loans (%) Current ratio (%) Funds from operations/Total debt (%) Credit Rating Expected Default Frequency (%) Source: National Treasury 13 13
RISK RATING METHODOLOGY – BENCHMARKS Scale Risk Ratings 10 9 8 7 6 5 4 3 2 1 Financial Risk Classifications Extremely Very High Moderate Moderate Moderate Moderate Low Very Extremely High High High Low Low Low Risk Descriptions Known Loss Doubtful Substandard Special Attention Marginal Acceptable Fair Good Strong Excellent 1-10 Net profit margin (%) <6 6-9 10-12 13-15 16-18 19-21 22-24 25-27 28-30 >30 1-10 Operating profit margin (%) <10 11-15 16-20 21-25 26-30 31-35 36-40 41-45 46-50 >50 1-10 EBITDA margin (%) <10 10-14 15-19 20-24 25-29 30-34 35-39 40-44 45-50 >50 1-10 Debt to Equity (times) >16 15.9-15 14.9-14 13.9-13 12.9-11 11.9-11 10.9-10.25 10.24-9.5 9.4-8.75 8.76< 1-10 Debt to Assets (%) >100 99-98 97-96 95-94 93-92 91-90 89-82.5 82.4-75 74-67.5 67.6< 1-10 Return on Equty (%) >1.2 1.1-2.8 2.7-4.6 4.5-6.4 6.3-8.2 8.1-10 9.9-13.75 13.74-17.5 17.4-21.25 25< 1-10 Return on Assets (%) >0.5 0.6 0.7 0.8 0.9 1-1.24 1.25-1.49 1.50-1.74 1.75-1.9 2< 1-10 Cost to Income (%) >80 79-74 73-68 67-62 61-56 55-50 49-47.5 47.4-45 44-42.5 42.6< 1-10 Funds from operations/Total debt (%) <10 10-14 15-19 20-24 25-29 30-34 35-39 40-44 45-50 >50 1-10 Interest cover (times) <1 1.1-1.9 1.2-1.29 1.3-1.39 1.4-1.49 1.5-1.59 1.6-1.69 1.7-1.79 1.8-1.89 >2 1-10 Net-interest Margin (%) >1 1.1 1.2 1.3 1.4 1.5-2.24 2.25-2.9 3-3.74 3.75-4.4 4.5< 1-10 Non-interest Income/income (%) >30 33-34 35-38 37-42 41-46 47-50 51-53.75 53.76-57.5 57.4-61.25 61.26< 1-10 Current ratio (%) <0.5 0.5-0.8 0.9-1.1 1.2-1.4 1.5-1.7 1.8-2 2.1-2.3 2.4-2.7 2.8-3 >3 1-10 Credit loss (%) >5 4.9-4.2 4.1-3.4 3.3-2.6 2.5-1.8 1.7-1 0.99-0.88 0.75-0.64 0.63-0.6 0.5< 1-10 Non-performing Loans (%) >7 6.9-5.8 5.7-4.6 4.5-3.4 3.3-2.2 1.1-1 0.99-0.88 0.75-0.64 0.63-0.6 0.5< 1-10 Credit Ratings D C CC CCC B BB BBB A AA AAA Source: National Treasury 14 14
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