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Credit Risk Management and Measurement Processes

Credit Risk Management (CRM). Credit Risk Management and Measurement Processes. Credit Risk Management Overview. Credit Risk Management Organisation. Chief Credit Officer. CRM MD Avg. Experience= 26yrs. Credit Risk Management Private Banking. Credit Control Officer. Global Recovery

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Credit Risk Management and Measurement Processes

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  1. Credit Risk Management (CRM) Credit Risk Management and Measurement Processes

  2. Credit Risk Management Overview

  3. Credit Risk Management Organisation Chief Credit Officer CRM MD Avg. Experience= 26yrs. Credit Risk Management Private Banking Credit Control Officer Global Recovery Management Quality Management Credit Portfolio Management Chief Administration Officer Recovery Management Business Support & Development Underwriting Capital Commitment America Underwriting Capital Commitment EMEA Regional Credit Americas Regional Credit EMEA Regional Credit Asia Structured Finance Swiss Corp. Traders Ship & Aircraft Finance SME & Income Producing Real Estate Mortgage Centre Private Clients Lombard Centre Private Clients

  4. Credit Risk Management Responsibilities CRM approves all counterparty limits as set forth in the Organizational Guidelines & Regulations and ensures appropriate monitoring of credit risks which includes the following tasks: • Ensures consistent assessment of all credit/counterparty risks and assigns proper ratings • Provides independent and objective views/judgments with regard to risk, risk mitigants and risk tolerance • Monitors and reviews the credit risk portfolio • Identifies and manages impaired assets and establishes provisions and write-offs • Establishes and updates credit policies • In partnership with SRM, set limits and controls for asset classes (e.g. real estate), trading positions (e.g. high yield) and country limits.

  5. Credit Risk Management Philosophy • Risk Measured on Global Integrated Perspective (Geography & Product) • “Hands on” – ongoing review • Senior Credit Staff • Independent Review Function (Credit Control, Policy & Procedures) • Focus on High Risk Counterparties • Regional Administration & Coordination

  6. Based on OGR – Highest Level Document – BOD approved Global Credit Policy Framework Overview on credit risk regulation framework:

  7. Policy Approval Matrix

  8. Credit Authority Levels Credit Authority Levels-Non Corporate < 1 Year 1000 Cr. Unit Head Level 1 750 Level 2 Level 3 Level 4 500 Approval Authority $MM 250 0 AAA AA A BBB BB B CCC Approval levels integrated into risk management & approval system - Insight

  9. New request from business unit Limit increases to existing credit lines Regular review cycle Large rating change by external agency (Moodys or S&P) Material counterparty event (negative or positive) Significant movement in counterparty’s debt or equity prices Ratings Process Triggers

  10. Loans Derivatives EMG Business Counterparty Type Core Rating Process Core Increasing complexity Product Rating Process Real Estate Asset Finance Product specific CS Has A Core Ratings Process • Ratings Process fully documented. • Globally consistent guidelines form part of Credit Policy.

  11. Equity Mkt. Data • Earnings • Adequate Capital • Asset Quality • Liquidity and Funding Quantitative Inputs CRS rating calculated • Control Environment • Competition • Rating Agency Views • Explicit Support • Internal Experience • Market Perception • Management Experience Qualitative Inputs Analyst forms rating opinion Rating documented in CA Credit Authorization Approved by Credit Officer Proactive Monitoring for Rating Changes The CS Corporate Ratings Process

  12. Quantitative Factors – Examples • Profitability (ROA of x%) • Cash flow • Gearing/Leverage • Interest costs as % of gross margin • Dividends and cover ratios • Intrinsic value of fixed assets • Hidden reserves/unrealized gains • Total Assets • EBITDA/Total Interest Bearing Debt • Long Term Debt/Long Term Debt+Equity • EBIT/Total Assets • Loss in past 3 years (EDITDA)

  13. Qualitative Factors - Examples • Technologically advanced product range? • High margin products? • Organizational structure – individual profitability/heavy losses • Adequate funding sources – committed vs. uncommitted • Environmental issues • Management – Quality and depth • Regulatory environment • Market Share • Customer Diversification • Earnings Diversity • Tight Financial Controls – on top of A/R • Transaction Overview • Committed Facilities • Maturity Profile

  14. Global Credit policy dictates that credits are reviewed: Credit Review Cycle AAA to A- Annual rating affirmation and bi-annual detailed review BBB+ to BB- Annual detailed review with monthly surveillance Impaired Assets Reviewed quarterly Watchlist Assets Summary monthly review under watchlist procedures

  15. Rating Horizons Counterparty credit rating assessments include consideration of potential longer term events which may have effects on the counterparty • Sector views (e.g. negative auto industry view) • Business cycles • Cash flow projections • Potential business sales/restructurings • Future regulatory changes (e.g. utilities)

  16. Gathering Information • Financial information • External rating agency reports • External news search • Web search • Market information including 6 months of debt and equity prices • Search alternative information sources • Internal/external equity analysis • Client calls

  17. Jurisdictional/Industry analysis Regulatory regime Regulations and restrictions Relevant precedents of regulatory intervention Accounting requirements Legal framework Analysis gives CRM key information in a concise fashion Updates occur periodically if/when static information changes Jurisdictional Analysis

  18. 12 month forward-looking scenario Domestic economy Fiscal & monetary policy External balance and FX Banking system Political developments Risks and critical success factors Rating rationale Prepared by CS economists/analysts Analysis gives CRM key information in a concise fashion Updates occur periodically if/when static information changes Country Analysis

  19. CS Rating Structure and IRB Requirements • CS rating system provides a “meaningful differentiation of risk” • Meaningful assessment of borrower risk on the basis of rating criteria. • CS and CSG Credit policy dictates relationship between borrower creditworthiness and risk grade including PD estimates per grade. • CS ratings show no excessive concentrations across grades. Differentiation of Risk

  20. PD • PD dimension is well understood and used • CS systems capture ratings and rating history (internal/external) • CRM Credit policy requires PD ratings for each counterparty • Different areas of CSG organization consistent in approach to PD • PD reflects a forward-looking, conservative view of risk

  21. High Degree of PD Grade Definition Moody’s CS Policy Definition S&P Details Substantially Risk Free Extremely low risk, very high stability, still solvent under extreme conditions Aaa AAA AAA Very low risk, long term stability, repayment sources sufficient under lasting adverse conditions, extremely high medium term stability AA+ - AA- AA+ - AA- Minimal Risk Aa1 - Aa3 A+ - A- Minimal Risk A+ - A- A1 - A3 Low risk, short and mid term stability, small adverse developments can be absorbed long-term, short and mid-term solvency preserved in the event of serious difficulties BBB+ - BBB- Average Risk BBB+ -BBB- Baa1 - Baa3 Medium to low risk, high short term stability, adequate substance for medium-term survival, very stable short term BB+ - BB- Acceptable Risk BB+ -BB- Ba1 - Ba3 Medium risk, only short term stability, only capable of absorbing minor adverse developments in the medium term, stable in the short term, no increased credit risks expected within the year B+ - B- High Risk B+ -B- B1 - B3 Increasing risk, limited capability to absorb further unexpected negative developments CCC+ - CCC- Caa1 - Caa3 CCC+ - CCC- Very High Risk High risk, very limited capability to absorb further unexpected negative developments Substantial credit risk has materialized, i.e. counterparty is distressed and/or non-performing. Adequate specific provisions must be made as further adverse developments will result directly in credit losses. C - D C C, D1, D2 Imminent/Actual Loss

  22. Rating Dimension and Coverage • CS Rating process differentiates borrower and transaction risks • PD - CS has more than minimum number of grade levels required • LGD – Policy guidelines and systems in place to capture LGD in relation to transaction structure codes • Ratings Coverage • Policy requires all counterparties/borrowers to be rated • Some exceptions due to risk materiality vs effort considerations (e.g. cash trading)

  23. Transaction Structure and Recovery Rate Codes Fully Secured = 100% average recovery - Complete risk coverage by cash/G-10 Govt Sec Senior Secured = 70% average recovery - Complete collateral coverage based on collateral that may deteriorate in credit crisis or less liquid (PP&E) Senior Unsecured = 50% average recovery - All senior unsecured transactions and derivative transactions as they are expected to rank pari-passu with SU Subordinate = 25% average recovery - All subordinated obligations Equity = 0% average recovery - Deeply subordinated or where we directly finance a portion of company’s equity or material legal risk of occurrence

  24. Transaction Structure’s Effect On The Portfolio Transaction Codes FS = 100% avg recovery SS = 70%avg recovery SU = 50% avg recovery Sub = 25%avg recovery Eq = 0% avg recovery

  25. Exposures to counterparties rated and assigned Credit Ratings C, D1 and D2 are impaired. These risk classes comprise all distressed and non performing counterparties (i.e. with at least one distressed and/or non performing transaction). If a counterparty is classified impaired then all business with that counterparty is affected and a conservative estimate of the expected credit loss is established. Credit risk provisions are then put in place to fully reflect any expected or actual credit loss. Default flagging

  26. Transactions of impaired counterparties are allocated one of the following classes. CPotential problem loans – Interest payments have been received according to schedule however doubt remains over the repayment of the principle D1Non-Performing assets – Non-performing status means interest continues to accrue for collection purposes even though interest payments have been suspended. D2Non-Interest earning loans – Interest accrual has been stopped in the system. This may occur for a number of reasons including legal proceedings which stipulate that interest may no longer be charged to the customer Defaultflagging

  27. A report is submitted for each existing impaired asset on a quarterly basis to Global Recovery Management For each new impaired asset and for a material deterioration of an existing impaired asset a report is sent to GRM immediately Upon receipt of the Impaired Asset Reports GRM review and present to the CCO for sign off. GRM also ensure relevant senior management is informed. Default flagging - Reporting

  28. Loan ratings from Shared National Credit uploaded into Insight on periodic basis at the facility level. CS participate in programme however do not use the information to drive their ratings process. Use of SEC/FED Classifications

  29. Concentration Risk Single Name Concentration Group Level Aggregation • Counterparties are linked in hierarchies in the credit system to reflect legal ownership. • Exposures are calculated at the business area, counterparty legal entity and group level. • This enables management to review exposures at various levels and identify any concentrations. Counterparty limits • Overall risk appetite (ceiling) can be set at both the legal entity and group levels, and allocated out to different business areas. • All lending facilities are individually approved. • Exposures monitored daily by credit control and any limit excesses are investigated. • Unauthorized trades reported to desk head and COO, and included on weekly and monthly reporting to senior business and credit management. • Target final hold amounts are established for non investment grade counterparties ($100m for BBB, $50m for BB, and $25 for B). • Quarterly MIS highlights facilities above these levels to senior credit management.

  30. Concentration Risk Global Credit Risk Report • Monthly report detailing credit exposures on a portfolio level. Includes exposure by product, rating and industry. • Top 20 schedules of exposures to investment grade (IG) and non investment grade (NIG) counterparties, including and excluding lending exposure; and inventory exposures to IG & NIG groups. • Reviewed by senior risk and business management. (example attached in Appendix 1) Legal Entity Reports • Monthly reports of exposures in key CS European legal entities (policy and example in Appendix 1). • Details top exposures in various categories and compares these exposures to the capital allocated to that entity. • Trigger and target values exist for different categories (IG, NIG etc.) • Breaches of trigger notified to the finance committee and target notified to the executive committee. • This report is also provided to the FSA on a quarterly basis and discussed in the regular “close and continuous” meetings.

  31. Concentration Risk Large Exposure Limits • Imposed by regulatory requirements and monitored daily by financial control (procedures attached in Appendix 1). • Reporting triggers set below the hard limits to prevent accidental breaches. • Exceeding a trigger will freeze trading with the counterparty or require specific approval. Stress testing • Monthly reports that highlight the top 25 IG and NIG exposures by region based on a defined set of scenarios (example report including scenario definitions included in Appendix 1). • In addition detailed reporting of stress testing is also produced for the hedge fund portfolio.  Credit Derivatives • Monthly report (example included in Appendix 1) highlighting exposure to key counterparties in relation to credit derivatives purchased. • Includes amount of protection purchased from key providers by rating of reference credit, and largest single underlying counterparty exposure to each provider for top 20

  32. Concentration Risk • Credit derivatives purchased as part of trading activities are reflected against the inventory positions of the underlying reference entity. Risk Mitigation • CS actively manages risk through the use of netting, collateral agreements, credit derivatives, selling down of loan exposures, purchasing credit insurance or securitizations. Sector Concentration Country Exposure • Exposure to EMG countries is reported on a weekly basis and reviewed at a senior management level. The level of risk to an individual country is controlled via several levels of limits. (Policy and example report included in Appendix 1) Industry Concentrations • The global credit risk report referred to above includes a schedule highlighting the top 20 industry exposures. These are compared to capital and wherever trigger levels are exceeded these need to be discussed with the Chief Credit Officer. (Policy attached in Appendix 1)

  33. Concentration Risk Other • CARMC, or senior management may periodically request reports to be prepared highlighting exposures to particular areas that are currently considered high risk – e.g. special reports may be prepared detailing exposures to particular industries and the individual counterparties within them. • The firm also has several policies (attached in Appendix 1) designed to capture and control the additional risk incurred through correlated/wrong way transactions.

  34. Credit control department maintain excess monitoring process. Completed on daily basis to identify all open and unassigned excesses within Insight. Reviewed by Credit Control for accuracy and validity then forwarded to appropriate risk manager for follow up. Excess monitoring process

  35. Risk manager must then determine if exposure permitted to remain on books. If acceptable then exposure must be approved within Insight. If unacceptable Risk Manager to work with business unit to unwind position, obtain collateral, purchase credit protection etc. Credit control review all excess actioned by risk managers daily to ensure satisfy credit policy for closure of excess. Excess monitoring process

  36. Generates an agency like issuer credit rating and does not include any assessment of structure or likely recovery in default. Driven by the most recent financial statements and if available, equity prices and volatility. The models are built by capturing the statistical relationships between a company’s financial fundamentals and it’s external rating using a large sample. The model rating is purely derived from the quantitative non-subjective financial statement and equity price derived inputs. It does not incorporate any subjective analyst input. Model Performance validated annually by FITCH What is FACT CRS

  37. Quantitative Risk reporting Risk Appetite Approved Limits, Facilities, Ctpy Info, Rating Limit management Inputs CRS PD Rating CA Sys. Insight Exposure management Recommended PD Rating Qualitative PD Ratings’ Flow Through Risk Mgmt. Systems

  38. CRS has four rating modules Corporate Private Model Corporate Public Model (Listed companies) Utility Model Bank Models: 7 types North America Developed markets – mainly Western Europe Asia Middle East/Africa South America Japan Eastern Europe The models are based on Ordered Logic Regression How FACT CRS Works

  39. Sample set consists of 1924 publicly rated corporate counterparties domiciled in developed countries Dataset uses 7 years (1999-2005) of financial and rating history for each company. The final sample includes a total of 10270 data points. The initial master set of all rated corporates was screened to eliminate companies whose financial and business fundamentals do not drive their ratings – (Example: Government owned or guaranteed companies) Model Creation – Corporate Sample Set

  40. Rating used for each annual snapshot is a composite of the published Fitch, Moody’s and/or Standard & Poor’s ratings for corporates and FITCH Individual Ratings for banks Where an explicit issuer rating is not given the senior unsecured rating has been used The individual agency ratings are mapped using a simple linear scale to a score between 0 and 100. Each rating notch has an equal numeric spacing as follows: AAA = 97.5, AA+ = 92.5, AA = 87.5 etc through to CCC- = 7.5,CC = 2.5, C = 0 Ratings and Finance

  41. The bank models in CRS are designed to generate an agency like rating for regulated commercial banks whose primary business is retail savings and loans and /or corporate lending. FACT CRS Bank Rating Models Model produces a FITCH Individual Rating which mapped to LT currency rating Support ratings are also incorporated to assess the likeliness and ability of a sovereign or institutional bank owner to support a bank Bank models vary by region for main two reasons: • Variations in the regulatory and economic environment mean the criteria used by agencies to rate banks vary • Differences in accounting standards mean there are different levels of financial detail available.

  42. Potential Exposure (PE) and Derivative Loan exposure (DLE) • What is PE? • The 95th percentile loss as a result of the inability of a counterparty to fulfill its financial obligations to Credit Suisse. • PE depends on the trade, not the credit quality of the counterparty or our assessment of how much risk we are willing to take. E.g. the PE for a swap is the same for a CCC rated counterparty as it is for a AAA rated counterparty. • PE is as objective as possible, it depends on the statistical properties of the underlying risk factors and the methodology is consistent across all trades. • In order to provide a more realistic measure of the firms derivative exposure it is moving towards a Derivative Loan Exposure (DLE) methodology.

  43. DLE is calculated using the formula DLE = (3*EPE + PE) 4 EPE represents the expected positive exposure. This is the probability weighted average of the positive half of the distribution of future MtM. Potential Exposure (PE) and Derivative Loan exposure (DLE)

  44. Global Risk Review

  45. GRR’s primary functions are to evaluate the quality and transparency of credit analysis and the effectiveness of credit appetite monitoring of the firm’s credit units worldwide. Specificially: Global Risk Review • evaluate the accuracy and consistency of the assigned ratings. • verify the transparency of rating justifications. • validate the effectiveness of monitoring and control of credit appetite. • review the firms’ credit units worldwide for their adherence to CS’s policies and best practices. • recommend improvements based on CS and industry best practices. • GRR has an independent reporting line to the Chief Risk Officer.

  46. Reviews are performed on a 12-18 month cycle. Each analysis will be evaluated based on a GRR checklist of required/recommended elements and assessed within the relevant credit policy. GRR evaluates the analyses and assigned ratings for consistency both within a portfolio and across credit units globally. reporting and control matters are reviewed to assure adequate risk monitoring of the portfolio. Risk Review Analysis

  47. GRR Portfolio Sampling Methodology GRR targets 15% of the counterparties (Ultimate Parents), which owing to portfolio concentration, typically represents around 30-50% of limits and exposures GRR calculates the distribution of ratings within the portfolio to have a general idea of its overall composition (e.g. % IG vs. % Non-Invest Grade). This typically represents % split Country/Industry - Calculate the distribution of industry or country (when applicable) and ensure a diverse sample Additional names are chosen at GRR’s discretion to include in the sample, should there be any outstanding issue from our current discussions with management (fieldwork) or from past GRR reviews (as follow-up/verification). Credit Portfolio of CRM Unit Being Reviewed Portfolio Concentrations Largest Exposures Industry Coverage Analyst Coverage Risk Issues GRR Credit Review Sample

  48. Validation Process Ratings Validation Process Status Global Risk Review Ratings, Validation Control Function Annual Default Study Credit Control Function

  49. Based on continuous credit review and monitoring processes. Serves to identify counterparties whose ratings are in danger of deterioration. Deteriorating situation characterised by awareness of potentially negative circumstance which indicate material worsening of counterparties risk profile eg ratings downgrade, news announcement, weakening of collateral value, significant market movement. The CCO and GRM determine if any watchlist names should be transferred to GRM for their direct management. Watch list

  50. CREDIT PROVISIONING PROCESS CREDIT SUISSE INVESTMENT BANK

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