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CREDIT RATING IN EMERGING MARKETS Learn the best strategies and techniques for effective credit rating processes, including the latest critical regulatory developments

MYRA Training


COURSE HIGHLIGHTS

• Understand basics of credit risk: Definition, calculation methods, hazard rates, loss given default, recovery assumption. Methods to quantify credit risk and migration statistics. • The purpose of Credit Rating models: What do they try to establish? • Modelling Credit Ratings: System Development, implementation and backtesting • Credit Rating Agencies – The relationship between internal and external ratings – Methodologies of major rating houses, how they calculate credit risk and translate the findings into Rating Score ∗ Moody’s KMV Model ∗ CreditRisk+ ∗ CreditMetrics ∗ Standard and Poor’s ∗ Fitch – Rating Process • How rating agencies obtain Default Probabilities, Recovery Rates, Loss Given Default and default frequencies • Credit scores in time: Downgrades and risk of credit score change. • Assesment and Comparison of models and Rating Agencies

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– Inconsisties and inaccuracies in Credit Rating Agencies – Developing and using financial, qualitative and market indicators to benchmark emerging market ratings performance – Use qualitative frameworks (sector, business model, management) combined with quantitative tools (ratios, cash flows, forecasts) to distinguish strong and weak performers and identify early warning signals of credit deterioration and translate the findings into credit rating – Recognize early warning signals of credit deterioration in full and limited disclosure situations and compare the results to rating agency performance ∗ Insight into the causes and early warning signals of credit deterioration and failure in financial institutions ∗ Use market indicators, where available (e.g. commodity prices, macro indicators, ratings, equity and debt prices) to understand refinancing risk and the market view on a credit • Real-life case studies and hands-on exercises for practical credit risk assessment of corporate and the financial institutions and comparing the results with rating agencies • 2008 Financial crisis and Rating Agencies: Fallacies and drawdowns. What did they do wrong?

Istanbul, Turkey

2009

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MODULE Stochastic Calculus ONE • Probability theory refreshment: Random Variables, Distributions, Ex-

• Credit risk of portfolios compared with single positions

pectations, Conditional Expectations and Martingales

• Loss distributions and relationship to expected loss, worst credit loss, economic and regulatory capital

• Monte Carlo Simulation Methods as used by Moody’s

♣ Case Study 1 Estimation of market factor volatility, market factor correlations

– Standard Monte Carlo

♣ Case Study 2 Implementation of Monte Carlo simulation methods

– Variance Reduction Techniques ∗ Anthitetic variance reduction techniques ∗ Quasi random sequences

Rating Agency Methodology

• Monte Carlo methods used by Moody’s vs Static Analysis used by S&P and Fitch, which to choose?

• Overview of debt ratings, types of ratings and the criteria applied by rating agengies • Key drivers of Emerging Market sovereign risk • Key challenges in EM Credit Rating World

Credit Risk and Rating Agencies

• A rating process: • Historical default experience

– Qualitative Analysis, Ownership structure, Governance – Industry and tier risk, Country risk – Quantitative analysis: Liquidity, Profability, Operational efficiency, Growth

• Historical recovery experience • Historical experience on correlated defaults • Major rating agencies explored: Structure, definitions and rating assessment process – Rating scales and components of different agencies – Different agency ratings and converting one rating scale to another

• Credit risk of a corporate as default probability, recovery rates and exposure • Relating credit risk to balance sheet, cashflow statements, debt and equity prices of a corporate • Probability of default, loss given default and correlation of default

Istanbul, Turkey

Internal Ratings • Similarities between internal and external rating models • Scoring models and rating assesment

• Credit risk, default, failure to pay and other events

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♣ Case Study 3 Spreadsheet implementation of portfolio credit models

2009

• Comparing internal models with external models • Basel II requirements • Problems and difficulties of internal rating especially in EM World ♣ Case Study 4 Spreadsheet implementation of internal credit rating model page 3 of 7


MODULE Regulatory Capital and Basel Applications in Emerging Markets TWO • Key challanges in Emerging Corporate Credit

– Differing vulnerabilities by sector: liquidity and reputation risks in broker dealers and asset managers; cash flow and reserve adequacy for insurance companies; asset quality concerns for banks and finance companies

• Economic and regulatory capital

– Challenge of regulated industries: changes in regulation, ring fencing of regulated entities

• Regulatory capital under Basel I and II • Differing approaches - banks, rating agencies, regulators, equity and bond investors – Credit pricing - evaluating the corporate risk the transaction

return profile of

– Cost of credit - probability of default and loss given default

• Identify the likely triggers or events which would change the credit standing of a corporate in the future. – Diversity and stability of funding sources: refinancing risk: quantifying liquidity and financial flexibility – Asset and liability management concerns: foreign exchange, interest rate and maturity mismatches

– Credit charges - expected loss of a corporate at different rating levels.

– Cash capital management: managing transaction and funding stability

– Standardized approach

– Credit link to EM Corporate Bonds:

• Recognise key themes that recur in challenged Emerging Market corporate credits

– Double leverage: challenges of a leveraged corporate ∗ Identify and quantify credit drivers which may impact fixed income securities ∗ Investigate reasons why bonds may trade outside thier rating

– Common themes: excessive growth, over-concentration, volatile earnings sources, asset and liability mismatches, dependence on ♣ Case Study 5 Spreadsheet implementation of regulatory capital requirements unstable funding – Signs of distress: financial, non-financial and market indicators – Structured analytic approach: our 4 step approach to focus on key issues: purpose, payback, risks and structure • Highlight the key vulnerabilities of the different types of financial institution: banks, broker dealers, insurance companies, finance companies and funds

MYRA Training

• Use qualitative, quantitative and market indicators, to identify vulnerable exposures – Systemic risks within a financial system: macro variables, competitive pressures, quality of regulation and supervision

Istanbul, Turkey

2009

Credit Grades and CreditRisk + • Basic Assumptions • Model Design • Backtesting Model • Drawbacks of the Model • Performance in 2008 Crisis • Excel Implementation

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MODULE Modelling Credit Exposure of Loans and Bonds THREE • Loans and derivatives – Loan quality - portfolio analysis, problem loans and reserve adequacy – Trading, investment and derivatives risk - VAR and other models • Transaction based models

• Simulation approach to economic capital • Risk rating model, Rating migration matrix, Loss given default

Managing Credit Risk: Securitisation, Risk Transformation and Credit Derivatives

• Foreign exchange transactions

• Concepts of regulatory capital for credit risk and return on assets

• Interest rate swap transactions

• Techniques for moving risk off balance sheet

• Market factor based models

• Pros and cons of securitisation for origination firms and investors

• Counterparty exposure simulation models

• What are credit derivatives and why are they used?

• Handling credit exposure limits

• Credit default swap, Total return swap, First-to-default basket note

– Funding risk - stability and variety of funding sources, contingency funding

• Regulatory capital impacts of credit derivatives

– Gap and liquidity management

♣ Case Study 6 Securitization

– Capital adequacy - size, quality and adequacy of capital base

♣ Case Study 7 Spreadsheet implementation of single name credit derivatives

• Integration of netting • Integration of margin / collateral

Fitch

• Stress testing

• Basic Assumptions

– incremental transactions

• Model Design

– market discontinuities

MYRA TrainingEvaluating

• Backtesting Model • Drawbacks of the Model

the Credit Risk of Derivatives

• Performance in 2008 Crisis

• Credit loss profile

• Excel Implementation

• Expected and unexpected credit loss Istanbul, Turkey

• Default only versus economic loss

2009

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MODULE Securitization: Credit Rating Perspective FOUR • Why securitization? Originator motivations

• High inflation and/or frequent currency devaluation environment • Distinguishing between markets in different stages of transition

• Parties to the transaction and their role

• Using business risk to gauge the appropriate level of financial risk

• SPV: understanding the asset configuration and funding structure of the issuer

• Understanding corporate treasury objectives - tenor matching, funding and liquidity needs

• Use a structured approach to understand the ABS product (using credit card ABS as the illustration asset class): basic transaction structures, roles of the parties, and originator motivations

• Analyzing target capital structures - the effect of leverage on shareholder returns

• Recognize the main risks pertaining to the collateral, originator and servicer • Appreciate how the key variables and target ratings impact credit enhancement levels • Identify key risks and understand how they are allocated within ABS structures.

Funding stability and capital adequacy • Sources of funding - classification of banking and insurance liabilities • Securitization - de-recognition (off balance sheet treatment) requirements for special purpose entities; on balance sheet treatment of securitization vehicles

• Capital adequacy - economic capital - the need for adequate capital to meet unexpected losses;

• Capital adequacy - impact of fair value and impairment adjustments on tier one and tier two capital; classification of hybrid debt instruments; rating agency definitions of core capital

• Basel II - measuring regulatory capital for credit risk under standardized and advanced measurement approaches

• Basel II capital adequacy calculations - link between accounting and regulatory treatment

• Off balance sheet obligations - pensions and other commitments

Standard & Poor’s

• Credit derivatives adopted to Emerging Markets

• Basic Assumptions

• Securization in Emerging Markets: Future products

• Model Design • Backtesting Model

The operating environment

• Drawbacks of the Model

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Istanbul, Turkey

• Understanding key drivers of sovereign risk

• Performance in 2008 Crisis

• Key macro vulnerabilities of emerging markets - FX, regulatory framework, systemic risk: impact of key variables on differing sectors

• Excel Implementation

2009

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MODULE International Rating Agencies and Methodology in Depth FIVE

Model Building • Internal rating models: Outsource or inhouse development?

• Inconsisties and inaccuracies in Credit Rating Agencies

• External Rating models: Outsource or inhouse development?

• 2008 Financial crisis and Rating Agencies: Fallacies and drawdowns. What did they do wrong?

• Calculating credit risk and translating into rating score • Backtesting models

• Standardization in Credit Rating and Rating the agencies • Model calibration according to backtest

• Credit Rating in Emerging Markets – Credit rating in Turkey: A feasible idea or a dream?

Assessing Rating Agency Capabilities

– Database building problems due to opaqueness of the system: Do we need a change in reporting standards? • Major Rating houses performances in other Emerging Markets

• Minimum requirements for Rating agencies • Choice of testing model for Rating Agencies • Comparison of test results with international data

Rating Agency Recovery Rate Estimation methods

• Setting an ongoing monitoring system to oversee rating agencies

Concluding Remarks

• How rating agencies calculate recovery rates?

• Course Summary and closing

• Recovery models • Facts: Recovery models

MYRA Training

Istanbul, Turkey

Moody’s KMV

• Relation to bank internal rating systems

• Basic Assumptions

• Basel II requirements

• Model Design

• Implementing methodologies of developed markets to Turkey.

• Backtesting Model

– Realigning the models built for developed markets according to realities of Turkey

• Drawbacks of the Model

– Backtesting the model

• Performance in 2008 Crisis

– Legal issues and documentation

• Excel Implementation

2009

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