Transcript The Costs of Producing Crops Around the World 2003
Sector Risk Ratings
A Unique Tool for Active Sector-Based Risk Management
Copyright © 2005 Global Insight
Introduction to Global Insight’s World Industry Service (WIS) Sector Risk Ratings (SRR)
Why Focus on Sector-Level Risk?
Quantifies the sector impact on credit quality relative to that from country or geography Accommodates the greater role of global supply chains and trade in business operations Sector benchmarks link macroeconomic events to impacts on companies and portfolios New Basle II regulations —new requirements for internal risk measures and controls Current phase of business cycle portends changes in credit quality & bankruptcies
What are WIS Sector Risk Ratings?
SRR are derived from WIS’ globally consistent sector benchmarks and forecasts
SRR indicate changes in sector-level credit quality across countries and industries Validation of SRR with bond defaults and corporate bankruptcies, country and globally
How to Use WIS Sector Risk Ratings?
Monitor changes in risk ratings across sectors and within a set of countries/geographies Use framework and navigation facilitates to “drill down” for more granular information on “flagged” sectors or countries
Perform stress testing and correlations for active portfolio risk management Quantitative drivers for forecasting loss reserve requirements, bankruptcies, and defaults
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What Are WIS Sector Risk Ratings (SRR)?
SRR Measure and Rank Sector-Based Credit and Operating Risks Unique SRR methodology provides globally consistent, forward-looking benchmarks of credit quality for each sector and country A composite rating from lowest (1) to highest (10) is created for each sector, built up from 40 separate risk factors
Comparative metrics for each sector and country, history and forecast
Globally consistent sector benchmarks of credit and operating risks
Ratings are created from structural and cyclical indicators that conform with standard credit risk frameworks
User-friendly tool for risk management and stress testing
Scientific, transparent construct, and long track record
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Composite Risk Ratings Are Built Up from 40 Individual Risk Factors that Reflect and Predict Changes in Credit Quality
Sector risk factors are derived from the standard credit risk framework used in corporate lending and fixed income portfolios
Growth Risk
Growth in real revenue
Growth in sales
Volatility, turning points
Profitability Risk
Pricing strength
Operating profitability
Free cash flow and variability Return on invested capital Fixed asset turnover Degree of operating leverage
Supply Risk
Capital intensity
Capacity overhang
Depreciation cost of sales Sector risk factors show the influence of industry structure, stage in lifecycle, and sovereign/ macroeconomic environment on industry risk profiles
Market Structure Risk
Industry structure
Dependence on suppliers and customers
Dependence on energy and labor Barriers to entry and exit Technology and substitution
Economic & Country Risk
Sector cyclicality
Sector interest rate sensitivity
Country-level sovereign risks (From Global Insight’s Global Risk Service):
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Exchange rate
–
Equity markets
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Regulation policy
–
Tax policy
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SRRs Provide a “Top-Down” Complement to Standard “Bottom-Up” Credit Risk Frameworks for Corporates
The Top-Down Consistency and Credit Framework of WIS SRR Provide Sector Benchmarks that Complement Traditional Bottom-Up Analysis
Credit Risk Framework
A) Internal Liquidity & Solvency B) Business & Operational Risk Growth Risk Operational Characteristics Oversupply Risk C) Industry Risk Industry Structure Risk Sector's Political & Economic Risk D) Financial Risk Capital Structure Rating & Equity Risk E) External & Market Liquidity F) Country & FX Risk Top Down Macro & Sector Poor Excellent Excellent Excellent Good Excellent Excellent Excellent Average Average Good Excellent Excellent Bottom Up Company Financials Good Average Average Good Average Average Good Average Good Excellent Good Average -- • • • •
Risk ratings and underlying data are credit benchmarks for companies, “peer groups,” and portfolios Risk metrics include income statement and cash flow items, metrics of industry structure, and commercial environment Transmit “high-level” macro economic events down to sector-level risks and credit benchmarks Link macro and industry views directly to portfolio exposures for simulation, stress testing, and active risk management
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8 4 3 7 6 5
Global Insight’s Sector Risk Ratings Show the Level and Direction of Change in Sector Risks Over Time and Across Countries Example of Composite Risk Rating for One Sector Shown Over Time and Across Several Geographies (Sector Ratings between 1 and 10 — Least to Most Risk)
Communication Equipment U.S.
EMU U.K.
• • •
Composite SRR shows the level and direction of operating and credit risks.
Which geographies lead into or lag behind global sector risk changes?
•
What is the outlook for future sector risk migrations?
How does the outlook compare with historical performances?
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WIS Sector Risk Ratings Facilitate Active Management of Sector-Based Credit Risks
Which Sectors Have High Risk Profiles?
Which Sectors Are Improving or Deteriorating?
Change in Risk Measures Sector Risk Levels: Falling Risk Low Risk Moderate Risk High Risk Potential Recovery? Static Risk Rising Risk Yellow Flag Red Flag
• • •
Monitor Sector Risk Profiles through changes in the composite risk ratings Flag strategic sectors or ones with changing risk profiles for deeper investigation “Drill down” to the 40 individual sub-factors and underlying sector data to see the drivers for changing risk profiles
•
Compare sector risk factors on a global and country basis, compare risks across sectors
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Color-Coded Monitor of Changes in Sector Risk Rankings:
Example of Within One Country Over Time
US Example of WIS Sector Risk Ratings with Rankings Across Industries
ISIC Sector Description ISIC Code Basic Industrial Chemicals Computing Machinery Energy Mining Watches & Clocks 3511 3825 2a 3853 (Mill US $) 119912 Composite Risk Rating 5.4
2005 Rank* of Composite Risk Rating 46 Change in Change in Rating**: 2006 – 2004 2006*** Composite Risk Rating 0.9
-0.4
73015 258486 724 5.6
6.6
6.6
49 70 68 -1 2.3
-0.3
-0.8
-0.1
0.5
High Risk Sectors (6.1 — 10.0) expected to Improve High Risk Sectors (6.1 — 10.0) expected to Degenerate Moderate Risk Sectors (4.6 — 6.0) expected to Degenerate * Represents the rank for a given sector across all 71 industries ** Represents the change in Composite Risk over the specified time periods *** Represents the change in Composite Risk from the previous forecast 8
Use Navigator to “Drill Sown” to 40 Individual Risk Factors to Investigate Changes in Sector Risk Profiles
WIS SRR Navigator Allows Easy “Point-and-Click” Web Access to all of the Sector Risk Rating Factors and Benchmarks For All Countries, All Sectors
Global Insight offers a variety of methods for access to the WIS and the Sector Risk Ratings. One of them is the WIS Sector Risk Ratings (SRR) Navigator
The WIS SRR Navigator provides easy point-and-click access to the Risk Ratings, both history and forecast
Data retrieval results are displayed in Microsoft® Excel, and queries can be saved for easy update and alteration
WIS SRR Navigator supplies instant, Web-based updates
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WIS Sector Risk Ratings Correlate with Standard Measures of Credit Quality
Composite Risk Ratings Have Current and Leading Indicator Relationships with Corporate Bankruptcies (Correlation Coefficient over 1990-2003) 0.90
0.80
0.70
0.60
0.50
0.40
0.30
0.20
0.10
0.00
Japan Germany UK Contemporary Correlation between Composite Risk Rating & Corporate Bunkruptcy Year Ahead Correlation between Composite Risk Rating & Corporate Bankruptcy All of the data shown are available in Global Insight data bases Source:
World Industry Service Sector Risk Rationgs; UK National Statistics, Financial Statistics Freestanding Table Number: fsfreFSF, Total Company Insolvencies; Japan - Release by Teikoku Data Bank, Business Failures, Total Number of Cases; Germany - Statistisches Bundesamt Business Failures, Total Company Insolvencies; 10
Several of the WIS Ratings Components Correlate Well with Bankruptcies
(Example of Revenue Growth Risk Factor)
Correlation Coefficient Between the Number of Corporate Bankruptcies and the Sub-factor for
Real Revenue Risk Ratings ,
the “All Corporate” Sector (1993-2004) 0.90
0.80
0.70
0.60
0.50
0.40
•
“Real revenue” growth is consistently correlated with corporate bankruptcies across a variety of countries
•
This is despite each country having its own unique definition of bankruptcies
•
Norway: # of bankruptcies proceedings commenced; Finland: # of bankruptcy proceedings instituted; Germany: # of bankruptcies resolved Source:
World Industry Service; Teikoku Data Bank, Statistisches Bundesamt, INSEE, Statistics Norway, Statistica Centralbyran, Statistics Finland 11
WIS Sector Risk Ratings Correlate with Sector-Level Bankruptcies in Japan
Correlation Coefficient Between the Number of Bankruptcies in a Sector and WIS Composite Risk Rating in the Same Sector in Japan (1990-2004) 0.80
0.70
0.60
0.50
0.40
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Source:
World Industry Service; Teikoku Data Bank
WIS Sector Risk Ratings’ Correlation with Bankruptcies in Germany Is Stronger in Recent Years
Sector Risk Ratings Anticipate Changes in Germany’s Corporate Insolvencies “Current year” and “year ahead” correlation coefficient between the total number of insolvencies in Germany and the WIS Composite Risk Rating for the total corporate sector 0.90
0.80
0.70
0.60
0.50
0.40
0.30
0.20
0.10
0.00
1993-1998 1993-2000 1993-2004 Contemporary Correlation between Composite Risk Rating & Corporate Bunkruptcy Year Ahead Correlation between Composite Risk Rating & Corporate Bankruptcy Source:
World Industry Service; Statistisches Bundesamt Business Failures, Total Company Number Insolvencies 13
WIS Sector Risk Ratings Correlate Well with Bond Default Rates in North America
4.2
3.8
3.4
3 Global Insight’s Composite Risk Ratings and Bond Default Rates in North America 5 4.6
5 4 1 0 3 2 Global Insight's Composite Risk Rating for North America Corporate Sector (LHS) Moody's North America All-Corp. Bond Issuer Default Rate (RHS) Correlation Coefficient Between WIS Composite Risk Rating for North America’s Corporate Sector and Moody’s Bond Default Rate In North America 0.90
0.80
0.70
0.60
0.50
0.40
0.30
0.20
0.10
0.00
1990 2004 1995 2004 2000 2004 Source:
World Industry Service, Moody‘s Investors Service Global Credit Research 14
WIS Sector Risk Ratings Correlate Well with Bond Default Rates in Europe and the CIS
4.8
4.6
4.4
4.2
4 3.8
3.6
5 Global Insight’s Composite Risk Ratings and Bond Default Rates in Europe & CIS 3.5
3 2.5
2 1.5
1 0.5
0 1-year Ahead WIS Composite Risk Rating for All European (incl. CIS) Private Non-Ag Sectors (LHS) Moody's European All-Corp. Bond Issuer Default Rate (RHS) Correlation Coefficient Between WIS Composite Risk Rating for European Corporate Sector and Moody's Corporate Bond Issuer Default Rate in Europe & CIS 0.90
0.80
0.70
0.60
0.50
0.40
0.30
0.20
0.10
0.00
1994-2004 1999-2004 2001-2004 Source:
World Industry Service, Moody‘s Investors Service Global Credit Research 15
WIS Sector Risk Rating Factors Correlate Well with Bond Default Counts Globally
7 6.5
6 5.5
5 4.5
4 3.5
3 WIS Composite Sector Risk Ratings and Global Corporate Bond Issuer Default Counts Globally 200 175 150 125 100 75 50 25 0 Correlation Coefficient Between WIS Profitability/Pricing Risk and Bond Issuer Default Counts Globally 0.90
0.80
0.70
0.60
0.50
0.40
0.30
0.20
0.10
0.00
1992-2004 1999-2004 2001-2004 WIS SRR Profitability & Pricing Risk Factor (LHS) Bond Issuer Default Counts (RHS) Current Year Correlation Year Ahead Correlation Source:
World Industry Service; Moody‘s Investors Service Global Credit Research 16
Sector Risk Ratings Help Evaluate and Anticipate Changes in Credit Profiles of Companies and Portfolios
Quantify the Risk Profile of Key Sectors in a Loan or Bond Portfolio
Is portfolio risk high or low? Is it improving or deteriorating?
Identify groups of correlated industries that improve/deteriorate together Use rigorous framework for evaluating diversification and strategy
Monitor and Anticipate Changes in Sector Credit Quality
Monitor composite ratings, flag sectors to “drill down” for deeper investigation
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Which risk factors are driving the change?
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What is the geographical composition of the sector change?
Stress test the portfolio through simulation and “what if” scenarios
Forecast Changes in Bankruptcies, Defaults, and Loan Loss Requirements
For individual sectors as well as for entire portfolio
Use SRR as Sector Benchmark for Corporate Credit Research
Compare company risk prospects to that of its own sector peer group
Analyze market prospects for key client markets into which it sells product
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WIS SRR Provides a Framework for Stress Testing Credit Portfolios Under Variety of Scenarios and Conditions
Evaluate the Impact of Stress Factors on Portfolio Credit Quality Given Certain Hypothetical Macroeconomic, Government Policy, and Industry-Specific Events
Derive the sector and portfolio impact of internal “house views” Analyze the potential impact on portfolio values of unlikely but plausible events Evaluate expected portfolio losses over a given time horizon, assess the capital adequacy of individual firms and industries Research the migration of the company credit ratings, changes in expected losses, and economic capital on the industry level Address shortcomings of value-at-risk analysis References for Stress Testing of Portfolios:
Lopez, J., 2005 “Stress Tests: Useful Complements to Financial Risk Models”, http://www.frbsf.org/publications/economics/letter/2005/el2005-14.html FRBSF Economic Letter, June 2005, Sorge, M. 2004. "Stress-Testing Financial Systems: An Overview of Current Methodologies." Working paper no. 165, Monetary and Economic Department, Bank for International Settlements. http://www.bis.org/publ/work165.htm
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WIS SRR Uses Two Common Techniques for Stress Testing of Sectors and Custom Portfolios
1) Scenario Tests
Risk managers identify portfolio’s key financial drivers and then formulate scenarios in which these drivers are stressed beyond standard VAR levels Event-driven approach analysis addresses the manner in which plausible but unlikely events might affect the risk factors relevant to a portfolio
2) Sensitivity Tests
Assess the impact of large movements in financial variables on portfolios without specifying the reasons for such movements Examples include a 100-basis-point increase across the yield curve and a sudden, 20% depreciation of currency
Global Insight Can Help:
Develop rationale and design for macro- and industry-level scenarios and simulations for the purpose of assessing impacts on credit quality in portfolio segments Use our tools and economic models to simulate sensitivity tests and macro environments; derive the sector impacts on sales, pricing, profits, and capex; and calculate the changes in Sector Risk Ratings and the credit prospects for sectors and portfolios Quantify likely changes in migration patterns in sector credit quality 19
Typical Process for Stress Testing Portfolios —
Flow Chart of Basic Steps for Stress Testing Identify Stress Factors Simulate Macro Models to Derive Industry Drivers Simulation of Industry Performances Asses Impact On SRR and Portfolio Credit Quality Common Stress Factors include:
• • • • • •
Oil prices GDP growth Inflation Interest rate Currency Policy Use Global Insight’s Economic Models of Macro and Industry to Calculate the Response to a Range of Scenarios
WIS provides the link between macroeconomic scenarios and
performance of portfolio exposures Project movements in default migration
Develop groups of industries that are hurt or helped by scenarios
Simulate changes in sector correlations Use Impacts on Sector Sales, Profits, Capex, Free Cash Flow, and SRR Factors to Derive Changes in Credit Quality for Sectors and Custom Portfolios Calculate impacts on key Financial Ratios Used in Agency Ratings:
•
EBITDA interest coverage
•
Operating margins
•
Free cash flow/total debt
•
Return on invested capital
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Why Use Global Insight for Sector Risk Ratings?
The SRR framework has been designed, tested, and used extensively by a number of banks in the United States and Europe for over 10 years. The original product, and subsequent improvements, were designed in collaboration with our banking clients and the RMA
Quantitative rigor provides a critical component for analysis and risk strategy; it provides a between link sector risk measures and custom portfolio analytics, active risk management
Unique and globally consistent coverage of all sectors in all countries
Global Insight is a global leader in custom analysis and sector stress testing
The product is delivered via Global Insight’s Web site, with easy navigation and monitoring of results across risk dimensions; includes telephone access to sector and country analysts
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More Information?
Please contact us for a personal demonstration!
Mark Killion, CFA
Managing Director, World Industry Service 1-610-490-2547 [email protected]
Natasha Muravytska
Economist, World Industry Service 1-610-490-2558 [email protected]
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