Day 1
Part One - analysis relevant to The Good Book
This session describes developments in credit analysis that fosters credit culture by helping banks to better manage their portfolios, assist with acquisitions to ensure that they are accomplished smoothly, and establish a common approach to profitable delivery of credit to the marketplace. Lenders who survive and prosper today will most likely be those who get assistance from sophisticated credit tools designed to help price loans and manage risk effectively.
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The time tested PRISM credit model
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Management and administration
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Business operations & bank relationship
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Loan purpose and repayment
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Protecting the loan, setting up a matrix system
- Perspective
Case study: Crochet Candy Corp.
(Note: This case will be distributed to delegates as pre-course reading and preparation in outline form as the basis for discussion)
The bank has been approached by Crochet Candy Corporation to provide a $500,000 increase to $2,000,000 in the existing unsecured line of credit. In light of attractive compensation balances and a relationship dating from 1968, the company has requested that pricing on the line be maintained at the prime rate. Delegates have the fiscal audited statements for review and must make a credit decision reinforcing the PRISM credit model.
Small to mid-sized bank relationship challenge - know the client’s business
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Keys to make the bank-client relationship work
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Reconciliation of conflicting demands, bank and customer
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Understanding the mission of your customer’s business
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Internal scrutiny at the business level
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Assessment of the business' strengths and weakness' against each of the most relevant competitors
Advances in financial and risk analysis - credit analysis application
Participants review regulators’ sentiments about evolving credit analytics particularly, from the consultative paper issued by the Basel Committee on Banking Supervision, September 2000.
The discussion includes:
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The differences between deterministic and stochastic methods
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Sensitivity forecasting methods versus simulations
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Deterministic and stochastic optimisation
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Time series and regression modelling
Loan pricing
By combining precise credit analysis with risk-adjusted pricing, a bank can reasonably anticipate a targeted return on all classes of loans.
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Class discussion: how do local banks price loans?
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The past, present and future of Indian loan pricing
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Determining loan loss reserve
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Determining additional loan loss reserve when the loan is downgraded
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Loan pricing sensitivities (how changes in the following affect change in ROA)
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Increased funding costs
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The ‘fee-in-lieu-of-balances’ calculation
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Loan servicing and activity costs
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Using potential loss to allocate capital
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Determining capital to be set aside for potential losses
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Evaluating computerised pricing model
The role of non-financial analysis in risk management - risk parameters
Though financial institutions comprise the single large share of the market, it is worth stressing that analysis risks described in this lecture are applicable to all corporate participants – financial as well as non-financial.
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Credit risk
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Market risk
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Liquidity risk
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Legal risk
- Operational risk
Day 2
Part Two - analysis relevant to the troubled book
Debt management skills (problem loans)
Can bankers detect signs early enough so that they can initiate a proper course of action before things get out of hand? Diagnostics serve the disease well so long as bankers take seriously the notion that to serve well is to learn well.
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Common causes of bad loans and how to avoid lending loss
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A checklist of storm signals
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Financial distress models
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Problems in financial reporting
Problem loan management
The goals of workout are twofold, to explain why the credit is not performing as agreed and to develop an analytical foundation for thinking about solutions to the problem. Generally two choices are open to workout, loan restructuring or liquidation. We shall examine these alternatives more fully in the next section. For now, we assume a ‘goahead’ mode aimed at loan restructuring so the concepts might be more succinctly developed.
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Responsibilities of a well run problem loan department
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Nature of loan workouts
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Loan classifications
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Follow-up procedures and documentation
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Legal aspects of problem loans
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Liquidation
Jen Krist case - analysis of a problem loan and debt recovery alternatives
‘What went wrong?’ Identify the storm signals in this middle market loan. Class discussion, could problems have been avoided? Delegates identify risks and evaluate the following alternatives:
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We should liquidate our position i.e. the borrower is no longer viable; (2)
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We should see the company through a structuring i.e. the opportunity cost of liquidation is too high or (3)
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Accept the status quo. Jen Krist Inc. is a mid sized clothing manufacturer and distributor. Founded in 1970 as children’s wear manufacturer, the firm expanded into designer apparel
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Due to this unit’s poor sales performance and the severity of inventory write-downs, consolidated liquidity has been significantly eroded.
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Suppliers are steadily decreasing trade support, threatening to put purchases on a cash only basis. The firm now finds itself in a highly precarious financial situation.
Emerging distress management techniques debt recoveries and valuation (value engineering in turnarounds)
The module provides delegates with the financial tools and methodology to determine the value of a company when attempting a debt recovery and / or turnaround. Valuation is used to validate projections provided in a troubled borrower’s strategic plans. Comparing valuation methods: book value, last transaction approach (transaction sale), valuation multiples, liquidation valuation approach and cash flow approach
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Survival plans / turnaround strategies
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Identifying the key value drivers
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The McKinsey valuation model
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Developing the cash flow valuation worksheet
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Using simulation to lock in more precise cost of capital and free cash flow results
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Techniques of organising and writing up a borrower’s valuation appraisal
Day 3
Part three - analysis relevant to both the good and troubled book.
Non-traditional credit products e.g. Structured finance, asset based finance and investment banking
Financial analysis for bankers
Case analysis: Gem Furniture Corporation, Atlanta Georgia.
Delegates complete the construction of a comprehensive cash flow and determine if a new $2 million facility should be approved by YOUR BANK. Gem Furniture Corporation runs a furniture-making empire, ranking as one of the top US makers of residential furniture. The loan request represents a new relationship, and if you approve this loan, the firm will transfer $35 million worth of business to YOUR BANK. We will review the financial statements in class to insure all delegates understand the fundamentals of cash flow construction.
Understanding best practices in global risk management - Basel II
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Overview of the proposed Basel capital accord
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Basel committee’s concerns: management of credit risk
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Bank wide risks falling under protective capital
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Consultative paper issued by the Basel committee
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Risk management process and controls
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First pillar: minimum capital requirements
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Second pillar - supervisory review of capital adequacy
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Third pillar: public disclosure
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New products: introduction to structured financing, project finance, asset based lending, investment banking and credit derivatives project financing
Project financing versus direct financing
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Advantages and disadvantages of project financing
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Requirements for project financing
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Appropriateness of project financing
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The advantages of separate incorporation
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Project finance risk rating and analysis
Asset based financing: receivables and inventory
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Accounts receivable audit worksheet
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Determining borrowing base
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Inventory management
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Evaluating marketability of inventory Inventory computer audit worksheets Price stability and physical properties
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Trust receipts
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Warehouse receipts
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Inventory evaluation checklist (Excel) for bankers
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Collateral auditing procedures
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Collateral structuring and control: regulatory requirements
Credit rating grids for borrowers / facilities
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Delegates learn to structure a credit rating grid and, in groups, undertake computer-modelling exercises with real data. Risk assessment and management are the key skills of a successful bank. The credit risk rating system gives a bank a common language and uniform framework for discussing and assessing risk. The system enables bankers to evaluate and track risk on individual transactions on a continuing basis. And most importantly, it enables banks to track and manage risk within the portfolio as a whole.
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The risk grading process
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Risk rating & loan portfolio optimisation
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Ratings & expected default frequencies
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Standards & guidelines
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Borrower and transaction risks
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Evaluating and setting-up obligor financial measure weights
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Evaluation collateral & guarantees
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Transfer and portfolio risk
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The auditing component of credit risk rating systems
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How to develop specific industry risk rating systems
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Loss loan provisions and additional required provision upon credit downgrades
Case study: Local Bank Delegates credit grade this credit in groups.
Each group will have the opportunity to present their conclusions - obligor grade, facility grade, final grade, expected default factor and derived internal bond rating. Most importantly, using the risk rating system, delegates determine the loss loan provision and additional provision to take on a loan if the loan is downgraded.
Day 4
Credit portfolio management
Quantitative methods for portfolio analysis have developed since Markowitz's pioneering work in 1950. These methods have been applied successfully in a variety of areas of finance, notably to equity portfolios. These methods show the amount of risk reduction achievable through diversification. They measure the amount of risk contributed by an asset, or group of assets, to a portfolio. By extension, they also show the amount of diversification provided by a single asset or group of assets. The aim of these methods is to maximise the return to a portfolio while keeping the risk within acceptable bounds. This maximisation requires a balancing of return to risk within the portfolio, asset by asset, group of assets by group of assets.
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Crucial ingredients of portfolio model
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Case study: terminology and statistics of loan portfolio management
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Loan concentrations
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Risk & return
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Beta coefficients - equations and methods
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The behaviour of unsystematic and systematic risk
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Asset pricing model
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Sensitivity analysis and simulation
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Macro-economic factors in
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Optimising a loan portfolio: Moody’s-KMV’s ‘Efficient Frontier’.
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Workable approximation of the complete loss distribution
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Portfolio Management Application and Design
Writing an effective credit review
The primary goal of the loan review function to reduce loan losses. Bank credit review programs evaluate the quality and administration of loans after they are booked, assisting loan officers in strengthening their loans, and informing management of the condition of the loan portfolio on a regular basis by way of oral and written analysis. The most important report is the ‘credit review’
- A Credit Review Outline
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Purpose of the review
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Identification key issues affecting repayment ability
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Identifying loan protection
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How to write a fiscal year analysis
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How to write a projection analysis
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The section on debt capacity and financial strategies
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Analysis of collateral and / or ‘second way out’ protection
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Explanation of material changes
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Strengths and weakness
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Your recommendations
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Weed out unnecessary information. look at what's important
Setting up and implementing a global exposure system
The GES is an exposure management and management information system that facilitates the approval and review of credit related exposure to commercial customers and provides a detailed database which is used for a variety of risk monitoring, reporting and management purposes. Delegates learn the fundamentals of this important portfolio management tool and discuss how it can be applied within their own institution.
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Portfolio exposure management
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How to set up the reporting function within a GES
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Portfolio analysis
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Management reporting
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Exception reports
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Special reports for users
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Credit administration reports
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Communication with senior management
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GES perspectives
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Indirect exposures: third party undertaking
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Corporate risk management
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Divisional exposure management
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Regulatory / external reporting
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GES source of important data
The role of monitoring and control in risk management
Delegates review issues dealing with credit administration, responsibilities of the credit approval process together with the credit review function.
Focus is the Bank’s loan policy.
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The role of credit administration at the bank
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Credit policy committee
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Setting up statements of loan policy
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CAMELS bank rating system
Course summary and close