Credit Risk ManagementCredit Risk Management Enhancing Your Bottom LineEnhancing Your Bottom Line EbrahimEbrahim ShabudinShabudin Managing Director Managing Director Deloitte & Touche LLPDeloitte & Touche LLP The AFP 23rdAnnual Conference New Orleans November 3-6, 2002 Credit BackgroundCredit Background Thorough identification and accurate Thorough identification and accurate measurement of credit risk, supported by strong measurement of credit risk, supported by strong risk management can help improve the bottom risk management can help improve the bottom lineline .An uncertain and volatile economic .An uncertain and volatile economic environment significantly impacts this abilityenvironment significantly impacts this ability .The desire to grow and turn in outstanding .The desire to grow and turn in outstanding results has a tendency to put pressure on the results has a tendency to put pressure on the checks and balances within businesseschecks and balances within businesses Value PropositionValue Proposition Credit plays a critical role in Credit plays a critical role in “ “sellingselling” ” products and servicesproducts and services Expands revenue opportunities with creditworthy, incremental Expands revenue opportunities with creditworthy, incremental customerscustomers Utilizes innovative structures to support business relationshipsUtilizes innovative structures to support business relationships Effective credit risk management limits credit losses and providEffective credit risk management limits credit losses and provides es stable cash flows and earningsstable cash flows and earnings Marketplace rewards companies exhibiting earnings and cash flow Marketplace rewards companies exhibiting earnings and cash flow stability with higher P/E multiplesstability with higher P/E multiples Marketplace penalizes credit induced volatility and Marketplace penalizes credit induced volatility and “ “surprisessurprises” ” Raises questions about quality of managementRaises questions about quality of management Corporate Credit RiskCorporate Credit Risk Companies are exposed to significant levels Companies are exposed to significant levels of credit risk emanating from different sourcesof credit risk emanating from different sources Accounts Receivables Accounts Receivables Other Notes ReceivablesOther Notes Receivables Buyer and Franchise FinancingBuyer and Franchise Financing With Recourse FinancingWith Recourse Financing Project FinanceProject Finance Structured TransactionsStructured Transactions Leases with RecourseLeases with Recourse Derivatives Exposures Derivatives Exposures FX, Interest Rate Risk, Commodities etc.FX, Interest Rate Risk, Commodities etc. Collateral RiskCollateral Risk Parent or Third Party Guarantees Parent or Third Party Guarantees Commercial and Standby Letters of CreditCommercial and Standby Letters of Credit Note also that Critical Suppliers to the company Note also that Critical Suppliers to the company may pose specific credit riskmay pose specific credit risk DSO Impact DSO Impact an examplean example CashCashHypotheticalHypothetical 51.351.3DSOsDSOs $261,201,000$261,201,000Q3 SalesQ3 Sales +$173,393,770+$173,393,770$122,002,230$122,002,230 Q3 A/R =Q3 A/R = * * Equals 295.4M/261.2M x 90(or number of days in sales period)Equals 295.4M/261.2M x 90(or number of days in sales period) 51.351.3124*124* DSOs =DSOs = $261,201,000$261,201,000Q3 SalesQ3 Sales $295,396,000$295,396,000Q3 A/RQ3 A/R Peer AveragePeer AverageCompany ACompany AActualActual Credit as a FacilitatorCredit as a Facilitator Credit risk management is importantCredit risk management is important Credit is a facilitator of business growth and Credit is a facilitator of business growth and performanceperformance High business margins tend to attract lower quality High business margins tend to attract lower quality clients and therefore higher risk profile to manageclients and therefore higher risk profile to manage Clients (buyers) may be concentrated in selected Clients (buyers) may be concentrated in selected industries and provide limited portfolio diversification industries and provide limited portfolio diversification opportunityopportunity Poor credit risk management resulting in negative Poor credit risk management resulting in negative impact to bottomimpact to bottom- -line is heavily penalized by marketsline is heavily penalized by markets Credit Strategy & Risk ToleranceCredit Strategy & Risk Tolerance Specific Quantifiable Objectives Management Review Methodology Credit Objectives and Risk Tolerances Credit Policies Credit Risk Management Processes Improve Profitability Reporting Credit Strategy/ Plan Common Performance Metrics Credit Strategy Statement and Risk Tolerance Coordination with Business Plan The business strategies and objectives drive the establishment of credit policies and procedures. Measurement and reporting as well as the use of current technologies enhan