Credit Risk Management Enhancing Your Bottom LineEbrahim Shabudin Managing Director Deloitte & Touche LLPThe AFP 23rd Annual Conference New Orleans November 3-6, 2002Credit BackgroundlThorough identification and accurate measurement of credit risk, supported by strong risk management can help improve the bottom linelAn uncertain and volatile economic environment significantly impacts this abilitylThe desire to grow and turn in outstanding results has a tendency to put pressure on the checks and balances within businessesValue PropositionlCredit plays a critical role in “selling” products and services Expands revenue opportunities with creditworthy, incremental customers Utilizes innovative structures to support business relationshipslEffective credit risk management limits credit losses and provides stable cash flows and earnings Marketplace rewards companies exhibiting earnings and cash flow stability with higher P/E multiples Marketplace penalizes credit induced volatility and “surprises”lRaises questions about quality of managementCorporate Credit RisklCompanies are exposed to significant levels of credit risk emanating from different sourceslAccounts Receivables lOther Notes Receivables lBuyer and Franchise Financing lWith Recourse Financing Project Finance Structured Transactions Leases with Recourse lDerivatives Exposures FX, Interest Rate Risk, Commodities etc. lCollateral Risk Parent or Third Party Guarantees Commercial and Standby Letters of Credit Note also that Critical Suppliers to the company may pose specific credit riskDSO Impact an exampleActualCompany APeer Average Q3 A/R$295,396,000 Q3 Sales$261,201,000 DSOs =124*51.3HypotheticalD Cash DSOs51.3 Q3 Sales$261,201,000 Q3 A/R =$122,002,230+$173,393,770* Equals 295.4M/261.2M x 90(or number of days in sales period)Credit as a FacilitatorlCredit risk management is important Credit is a facilitator of business growth and performance High business margins tend to attract lower quality clients and therefore higher risk profile to manage Clients (buyers) may be concentrated in selected industries and provide limited portfolio diversification opportunity Poor credit risk management resulting in negative impact to bottom-line is heavily penalized by marketsCredit Strategy & Risk ToleranceuSpecific Quantifiable ObjectivesuManagement Review MethodologyuCredit Strategy Statement and Risk ToleranceuCoordination with Business PlanThe business strategies and objectives drive the establishment of credit policies and procedures. Measurement and reporting as well as the use of current technologies enhance credit decision-making and improve risk management. The entire process is continually re-evaluated and improved.Credit Risk Areas to ConsiderlCredit PolicylCredit Approval AuthoritylLimit SettinglPricing Terms and ConditionslDocumentation : Contracts and CovenantslCollateral and SecuritylCollections, Delinquencies and WorkoutslExposure Management Aggregation ControllPeriodic Account Reviews Payments/Aging Credit ConditionlCompliance with Covenants, Terms lTechnology/Reports Transactions/ Bookings Risk-adjusted Returnn nSales Sales ChannelsChannelsn nRisk StrategyRisk Strategyn nUnderwriting Underwriting StandardsStandardsn nCredit Credit ApplicationApplicationn nAnalysisAnalysisuuBusiness/ Business/ IndustryIndustryuuFinancialFinancialuuCreditCreditn nCredit Scoring Credit Scoring and Ratingsand RatingsOrigination/ AssessmentAdministrationMonitoring/ ControlRisk Managementn nPortfolio Portfolio ManagementManagementn nConcentrationConcentrationn nDiversificationDiversificationn nAllowance for Allowance for Bad DebtsBad Debtsn nRisk Risk MitigationMitigationn nObjectivesObjectivesn nType of Type of ExposureExposuren nInstruments or Instruments or MethodsMethodsValue CreationBusiness Performance MeasuresOrganizations need a rigorous set of measures to support continuous improvementPerformance-based management utilizes metrics that measure actual performance against predetermined thresholds. The thresholds are established taking into account the organizations strategy, operating environment and process controls.The measures drive value creation and should support problem identification and correction.nBusiness StrategySystemsOperationsFinancePerformance ManagementSales channelsContracts & DocumentationCredit analysisCredit limitPricing & termsCredit AnalysisCredit DecisionsCollectionsCREDIT POLICYCollateral acceptancePortfolio managementFinancial analysisDisposal / Risk mitigationCollateral managementCustomer managementExposure measurementManagement reportingExposure aggregationRecoveriesCredit scoringRisk ratingRISK MANAGEMENTCredit Risk Managements Inter-related ActivitiesComplianceOriginationReportingTransactionsCredit Policies & Procedures Analysis & Risk ManagementGovernance, Control and ImplementationMeasurement MethodologiesTec