TO INDUSTRY SPECIFIC FACTORS SOUTH AFRICA Presenter: Credit Risk I - - PowerPoint PPT Presentation

Presenter: Credit Risk I Strategy and Risk Management I Division: Asset and Liability Management | 11 June 2014

ADAPTING A STANDARDIZED CREDIT RATING METHODOLOGY TO INDUSTRY SPECIFIC FACTORS – SOUTH AFRICA

TABLE OF CONTENTS

• The Role and Structure of Credit Risk
• National Treasury’s Credit Risk
• Contingent Liabilities (Categories)
• Underlying Principles
• Risk Based Analysis (Methodology)
• Risk Rating Indicators and Benchmarks
• Risk Rating Table and Classifications
• Conclusion

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THE ROLE OF CREDIT RISK

• The Credit Risk division is responsible for implementing the credit

risk strategy within the Asset and Liability Management (ALM).

• This mainly includes:
• The development of credit risk policy and its annual review;
• The development of a credit risk manual and its annual review;

and

• Review credit granting processes on an on-going basis.

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ORGANISATIONAL SET-UP/STRUCTURE

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Director Senior Credit Risk Analyst Senior Credit Risk Analyst Credit Risk Analyst Trainee Analyst

NATIONAL TREASURY’S CREDIT RISK

• The National Treasury’s credit risk emanates from:
• Deposit-making activities (Counterparty risk). The national Treasury deposits

surplus cash with the big four South African Banks. The analysis is conducted to gauge the banks’ ability to make funds available when needed.

• Settlement Risk from government bonds auctions with the aim of quantifying the

banks ability to settle their bond obligations after three days. Contingent liabilities

• Arise from the granting of guarantees
• Emanating from Public Private Partnerships (PPPs) in a case of terminations and

defaults.

• Implicit contingent liabilities arising from actuarial deficits and government related

insurance companies.

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CONTINGENT LIABILITIES

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CONTINGENT LIABILITIES Implicit Portfolio

• The analysis is conducted annually on the SOCs’ financial statements and

qualitative information.

• Assess the SOCs’ ability to make good of the insured benefits and to settle

future claims without negatively affecting their solvency. Public Private Partnerships (PPPs)

• The analysis is conducted to gauge the projects construction and operational

stages against terminations, disruptions and defaults.

Implicit Contingent Liabilities

• Unemployment Insurance Fund (UIF)
• Road Accident Fund (RAF)
• Compensation Fund
• South African Special Risks Insurance Association (SASRIA)
• Export Credit Insurance Company (ECIC)

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CONTINGENT LIABILITIES

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Explicit Guarantee Portfolio

• The analysis is conducted annually by way of financial analysis conducted on the

SOCs’ financial statements

• Assess the guarantee portfolio on an annual basis and highlight any possible and

future challenges that pose risks to the quality of the overall guarantee portfolio.

• Give advice to the fiscal liabilities committee on a quarterly basis on the state of

the contingent liabilities and alert the forum on any improvement or deterioration

• n the overall guarantee portfolio.
• Monitor the sustainability measure of net debt, provisions and contingent liabilities

as a percentage of GDP against a limit of 60 per cent.

CONTINGENT LIABILITIES

Energy

• Eskom

Infrastructure

• South African National Roads Agency Limited (Sanral)
• Trans-Caledonian Tunnel Authority (TCTA)

Development Finance Institutions (DFI)

• Development Bank of Southern Africa (DBSA)
• Land Bank
• Industrial Development Corporation (IDC)

Transport

• Transnet
• South African Airways (SAA) and South African Express (SAX)
• Passenger Rail Agency of South Africa (PRASA)

Defence

• Denel

Telecommunications

• Telkom
• South African Broadcasting Corporation (SABC)

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CONTINGENT LIABILITIES

UNDERLYING PRINCIPLES

• NT to operate within an appropriate Credit Risk environment;
• Credit risk inherent in all new activities must be subject to adequate

controls (procedures);

• NT must operate under a sound credit granting process;
• An appropriate credit administration, measurement and monitoring

process must be maintained;

• NT established independent Fiscal Liabilities Committee (FLC).
• The FLC Mandate is the optimum management of contingent

liabilities

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RISK BASED ANALYSIS (METHODOLOGY)

• The Credit Risk Directorate derives its mandate from the Credit Risk policy.
• The analysis is conducted in terms of standardised methodology
• The methodology is in terms of the credit risk policy.
• The methodology also outlines the criteria (indicators) and how the analysis

should be conducted to determine each State Owned Companies (SOC’s) ability to service guaranteed debt.

• The business risk indicators focus on the qualitative information while the

financial risk indicators focus on the quantitative information.

• The guidelines, depending on specific indicators, take into account a combination
• f the industry norms, rating agencies benchmarks and peer analysis.

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Business Risks Financial Risks Industry Prospects Profitability

• Operating Environment - Cost to income ratio (DFIs)
• Regulatory Framework
• Net profit margin
• EBITDA margin

Corporate Governance Capital structure

• Adherence to PFMA
• Debt to assets
• Management Quality
• Debt to equity

Market Position Cash flow adequacy

• Diversification
• Funds from operations/Debt
• Size
• Interest cover

Liquidity ratios

• Cash ratio
• Quick ratio
• Current ratio

RISK INDICATORS FOR SOC’S (EXCLUDING DFIS)

Source: National Treasury

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RISK INDICATORS FOR DFIS

Source: National Treasury

Financial Risk Indicators Business Risk Indicators Financial performance Industry risks Total Assets (R'm) Segmental Business Units Total Equity (R'm) Growth Potential Profit for the period (R'm) Size and Barriers to entry Net Interest Revenue (R'm) Operating Environment Leverage Challenges Debt Ratio (%) Successes Debt to Equity (%) Future/Current Developments Profitability ROA (%) Management Quality Risk Indicators ROE (%) Competence Cost to income (%) Risk appetite Net Int. Margin (%) Management stability Non-Interest Income/Total Income (%) Intergrity EBITDA margin (%) Interest cover (times) Liquidity Non-performing loans/Gross loans (%) Current ratio (%) Funds from operations/Total debt (%) Credit Rating Expected Default Frequency (%)

RISK RATING METHODOLOGY – BENCHMARKS

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Source: National Treasury

Scale Risk Ratings 10 9 8 7 6 5 4 3 2 1 Financial Risk Classifications Extremely High Very High High Moderate High Moderate Moderate Moderate Low Low Very Low Extremely Low Risk Descriptions Known Loss Doubtful Substandard Special Attention Marginal Acceptable Fair Good Strong Excellent 1-10 Net profit margin (%) <6 6-9 10-12 13-15 16-18 19-21 22-24 25-27 28-30 >30 1-10 Operating profit margin (%) <10 11-15 16-20 21-25 26-30 31-35 36-40 41-45 46-50 >50 1-10 EBITDA margin (%) <10 10-14 15-19 20-24 25-29 30-34 35-39 40-44 45-50 >50 1-10 Debt to Equity (times) >16 15.9-15 14.9-14 13.9-13 12.9-11 11.9-11 10.9-10.25 10.24-9.5 9.4-8.75 8.76< 1-10 Debt to Assets (%) >100 99-98 97-96 95-94 93-92 91-90 89-82.5 82.4-75 74-67.5 67.6< 1-10 Return on Equty (%) >1.2 1.1-2.8 2.7-4.6 4.5-6.4 6.3-8.2 8.1-10 9.9-13.75 13.74-17.5 17.4-21.25 25< 1-10 Return on Assets (%) >0.5 0.6 0.7 0.8 0.9 1-1.24 1.25-1.49 1.50-1.74 1.75-1.9 2< 1-10 Cost to Income (%) >80 79-74 73-68 67-62 61-56 55-50 49-47.5 47.4-45 44-42.5 42.6< 1-10 Funds from operations/Total debt (%) <10 10-14 15-19 20-24 25-29 30-34 35-39 40-44 45-50 >50 1-10 Interest cover (times) <1 1.1-1.9 1.2-1.29 1.3-1.39 1.4-1.49 1.5-1.59 1.6-1.69 1.7-1.79 1.8-1.89 >2 1-10 Net-interest Margin (%) >1 1.1 1.2 1.3 1.4 1.5-2.24 2.25-2.9 3-3.74 3.75-4.4 4.5< 1-10 Non-interest Income/income (%) >30 33-34 35-38 37-42 41-46 47-50 51-53.75 53.76-57.5 57.4-61.25 61.26< 1-10 Current ratio (%) <0.5 0.5-0.8 0.9-1.1 1.2-1.4 1.5-1.7 1.8-2 2.1-2.3 2.4-2.7 2.8-3 >3 1-10 Credit loss (%) >5 4.9-4.2 4.1-3.4 3.3-2.6 2.5-1.8 1.7-1 0.99-0.88 0.75-0.64 0.63-0.6 0.5< 1-10 Non-performing Loans (%) >7 6.9-5.8 5.7-4.6 4.5-3.4 3.3-2.2 1.1-1 0.99-0.88 0.75-0.64 0.63-0.6 0.5< 1-10 Credit Ratings D C CC CCC B BB BBB A AA AAA

RISK RATING METHODOLOGY (Cont.)

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Application of Risk Rating Methodology Business Risk Profile Corporate governance i) Management quality 60 0.048154093 1 0.03383 5 4 3 Financial Risk Profile Leaverage Debt ratio (Debt/Assets) 60 0.048154093 3 0.1015 4 3 5 Debt to equity (gearing) 60 0.048154093 1 0.03383 4 3 5 Profitability indicators

Return on Assets

60 0.048154093 3 0.18045 4 3 5

Return on Equity

60 0.048154093 7 0.42105 4 3 5

Net-interest Margin (%)

60 0.048154093 5 0.22556 4 3 5

Non-interest Income/income (%)

60 0.048154093 10 0.45113 4 3 5 Efficiency indicators Cost to income ratio 45 0.03611557 8 0.27068 3 3 5 Liquidity Indicators Liquit assets/ Deposits and money market fun 125 0.100321027 3 0.22556 5 5 5

Loan to Deposits

125 0.100321027 5 0.37594 5 5 5 Asseta Quality

Credit loss

125 0.100321027 5 0.46992 5 5 5

Non-performing Loans/ Gross loans

125 0.100321027 5 0.46992 5 5 5 Credit rating 60 0.048154093 4 0.191731576 3 4 5 Total with credit rating 1246 Total without credit rating 1061 Weighted risk rating 0.599161174 7.993409227 Exposure figures in millions 125 000 103.523 Proportional exposure 59.81 0.06 Weighted risk rating in proportion to exposure 0.00 0.46 Priority Methodology Indicators Weight Weight with credit rating Bank A (2011/12) rating R X W Bank A (2012/13) rating R X W Strategic Importance Risk Priority Ease of Measurement

Source: National Treasury

RISK RATING METHODOLOGY (Cont.)

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Application of Risk Rating Methodology for SOE Qualitative Analysis Industry prospects 1.927 3 1.942 3 Regulatory framework 2.801 5 2.725 5 Corporate governance i) Adherence to the PFMA 3.774 7 3.693 8 ii) Management quality 2.685 4 2.678 4 Market Position i) Diversification (in core business) 1.641 2 1.414 2 ii) Size (relative to the market) 1.450 1 1.290 1 Financial Risk Profile Profitability ratio (profit margin) 4.352 11 4.811 11 Operating income as % of business (sales) 4.706 10 4.875 12 Cost to income 4.547 12 4.180 10 EBITDA 3.406 6 3.379 6 Capital structure Debt ratio 5.093 14 5.429 14 Debt to equity (gearing) 5.696 16 6.707 16 Cash flow adequacy ratios Funds from operations/total debt 6.737 17 7.159 17 Debt service coverage ratio (interest cover) 4.913 13 5.400 13 Liquidity Indicators Cash ratio 5.368 9 4.173 9 Quick ratio 3.833 8 3.574 7 Current ratio 5.362 15 5.524 15 Credit rating 1.036 1.372 Total with credit rating Total without credit rating Weighted risk rating 69.327 70.326 % in proportion to whole portfolio (ideal) Exposure (2012/13 figures) in millions (Actual) 153706 180239 Ideal exposure in proportion to risk Weighted exposure Weighted risk rating in proportion to exposure 6.1 7.1 Source: Natioanal Treasury-ALM TOTAL Ranking Drivers TOTAL Ranking Drivers Criteria 2011/12 2012/13

RISK RATING METHODOLOGY (Cont.)

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DEFENCE 1% 0.0% 1% 9.5% TELECOMMUNICATIONS 1% 19.4% 0% 19.4% DFI's 18% 20.6% 15% 21.7% TRANSPORT 3% 32.4% 3% 20.1% INFRASTRUCTURE 26% 18.8% 22% 18.0% Actual Sector Portfolio Ideal Sector Portfolio Actual Sector Portfolio Ideal Sector Portfolio ENERGY 51% 8.9% 58% 11.4% Sector Analysis 2011/12 2012/13

RISK RATING TABLE AND CLASSIFICATIONS

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Risk Rating Description Risk Class 10 Known Loss Extremely High 9 Doubtful Very High 8 Substandard High 7 Special Attention Moderate High 6 Marginal Moderate 5 Acceptable Moderate 4 Fair Moderate Low 3 Good Low 2 Strong Very Low 1 Excellent Extremely Low

MONITORING AND REPORTING

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IDC Eskom PRASA Transnet SAA DBSA Land Bank Telkom TCTA Denel SANRAL SABC Extremely Low Very Low Low Moderate Low Moderate Moderate Moderate High High Very High Extremely High IDC Transnet Eskom DBSA TCTA Land Bank Telkom PRASA Denel SANRAL SABC Extremely Low Very Low Low Moderate Low Moderate Moderate Moderate High High Very High Extremely High 2012/13 2011/12

Guarantee and exposure amounts

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Total Guaranteed Amount (R'million) Total Exposure Amount (R'million) Total Guaranteed Amount (R'million) Total Exposure Amount (R'million) SANRAL 38,687 19,482 38,687 23,491 TCTA 25,259 19,886 25,530 20,404 Eskom 350,000 103,523 350,000 125,125 DBSA 29,589 25,621 29,590 25,747 IDC 2,145 575 2,146 504 LandBank 1,900 893 4,600 1,097 Denel 1,850 1,850 1,850 1,850 PRASA 1,400 133 1,400 133 SAA 7,906 2,238 7,906 5,010 SA Express 539 539 Transnet 3,500 3,757 3,500 3,757 SABC 1,000 167 1,000 Telkom 285 90 285 111 Other Entities (Non-Analysed) 3,953 2,024 3,681 1,354 Total Guarantee Amount 467,474 180,239 470,713 209,122 2013/14 2012/13 State Owned Entities

Net loans, provisions and contingent liabilities

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Component 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 Net Debt 27.44 29.84 33.19 36.95 39.70 41.93 43.48 44.34 Provisions 3.30 2.68 3.31 3.64 3.58 3.87 3.45 3.02 Contingent Liabilities 10.96 10.72 11.25 11.57 11.56 11.10 10.17 9.32 Total 41.71 43.24 47.75 52.15 54.84 56.90 57.10 56.68

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20 30 40 50 60 10 20 30 40 50 60 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 Percentage Perecentage Net Debt as % GDP Provisions as % GDP Contingent Liabilities as % GDP

CONCLUSION

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• Individual ratings consolidated to determine the quality of government’s portfolio of

contingent liabilities

• Risk ratings are applied to the different indicators for each SOC
• The ratings are aggregated to determine a risk rating for each of the SOCs
• The ratings of the different SOCs are consolidated to determine a consolidated

rating for the portfolio.

• Methodology determines portfolio’s default probability

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THANK YOU