CreditMark Corporate Loan Transparency: Transitioning From Accrual Accounting To Mark-To-Market Valuation February 2004
The Traditional Approach To Bank Lending Accrual accounting Loans valued at par until significantly impaired Buy and hold investment behavior Little to no measurement of credit portfolio performance Loans belong to the loan officer, not to a portfolio manager COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 2
The New Corporate Lending Environment Investors and regulators are demanding greater transparency about the value of the loan book The head of credit wants to know what the plunge in the Credit Default Swap (CDS) market means for the value of the loans A relationship manager in the energy sector is frustrated that credit risk management keeps turning down his credit proposals because this is affecting his ability to do other business with his clients A bank calls and wants to sell some of its loan What is the loan worth? COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 3
Banks Need To Ask Themselves What is the credit portfolio worth today? How confident are we of that value? Are we originating loans at par? If not, are our relationships profitable enough to cover the losses? COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 4
Moody s KMV Provides A New Methodology For Loan Valuation Better understanding of how credit markets interrelate How information provided by one market can be used to value risks in another market Better valuation methodology for revolving credits, a major component of the corporate lending market An infrastructure that makes it feasible to process diverse data and value large loan portfolios COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 5
Loan Valuation Drivers Recovery Spreads & Fees Liquidity Amortization Default Probability Revolver Utilization Maturity Prepayment Investor Risk Appetite COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 6
EDF Values And Credit Spreads Move Together Industrial Companies - BBB Rated EDF vs Credit Spread 460 440 420 400 380 360 Spread Volatility: BBB credit spreads decline 60%, from 1993-1997, then widen back to their previous level by early 2001 EDF values show the same pattern 150 140 130 120 110 Credit Spread - Mean (bps) 340 320 300 280 260 240 220 200 180 100 090 080 070 060 050 040 EDF - Mean (bps) 160 YTWT EDF 140 120 100 80 Jan-93 Jul-93 Jan-94 Jul-94 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 030 020 010 000 7
CREDITMARK EDF Values And Daily Estimated Parameters Explain Bond Spreads 300 BBB BBB Universe 250 Spread (bp) 200 150 100 50 JA N9 9 FEB99 MA R 9 9 AP R9 9 MA Y 9 9 JU N9 9 JU L 9 9 AUG9 9 SEP99 OCT9 9 NOV9 9 DE C9 9 JA N00 FEB00 MA R 00 Median OAS (Over LIBOR) EIS AP R00 MA Y 00 JU N00 IS JU L 00 AUG00 OCT00 SEP00 With Market Implied LGD NOV00 DE C00 JA N01 FEB01 Full CMK MA R 01 EIS AP R01 IS MA Y 01 JU N01 Add Lambda for JU L 01 AUG01 SEP01 OCT 01 Add Size Premia JU L 02 NOV01 FEB02 JA N02 MA Y 02 JU N02 DE C01 MA R 02 OCT 02 SEP02 AUG02 Basic EIS 0 MAR99 FEB99 JAN99 SEP99 AUG99 JUL99 JUN99 MAY99 APR99 MAR00 FEB00 JAN00 DEC99 NOV99 OCT99 COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED SEP00 AUG00 JUL00 JUN00 MAY00 APR00 MAR01 FEB01 JAN01 DEC00 NOV00 OCT00 WWWMOODYSKMVCOM SEP01 AUG01 JUL01 JUN01 MAY01 APR01 MAR02 FEB02 JAN02 DEC01 NOV01 OCT01 SEP02 AUG02 JUL02 JUN02 MAY02 APR02 NOV02 OCT02 8
4/29/2003 6/25/2003 8/22/2003 10/20/2003 CREDITMARK Daily Estimates Of The Market Price Of Risk 065 060 055 050 045 040 035 030 025 020 015 010 Price of risk has varied by up to a factor of two over the last three years 005 000 COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 9 1/27/1999 3/26/1999 5/26/1999 7/26/1999 9/24/1999 11/22/1999 1/20/2000 3/27/2000 5/25/2000 7/24/2000 9/25/2000 12/1/2000 1/31/2001 3/29/2001 5/25/2001 7/24/2001 9/25/2001 11/20/2001 1/18/2002 3/19/2002 5/15/2002 7/12/2002 9/9/2002 11/4/2002 1/2/2003 3/3/2003 Date Market Sharpe Ratio
Moody s KMV Creates Lattice Model To Value Complex Loans Distance to Default (in StdDev) 15 12 9 6 3 0 Valuation Lattice Pi,j Prepay Lower Spreads Increased Usage Default 0 1 2 3 4 5 Time (in Payment Periods) COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 10
Lattice Model Results vs LoanX Marks 2000 1800 1600 1400 Count 1200 1000 800 600 400 200 0 <-10-10 -9-8 -7-6 -5-4 -3-2 ±1 2 3 4 5 6 7 8 9 10 >10 Difference (as a Percentage of Par) LoanX LoanX > Model Model Model Model > LoanX LoanX COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 11
In Most Cases, CreditMark Modeled Valuations are Are Close to To Loan Dealer Marks Within 1-2 Points, 12% Within Bid/Ask Spread, 16% Greater than 2 Points, 39% Within 0-1 Points, 33% CreditMark Lattice Values vs LoanX Marks COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 12
Multiple Data Sources Required Daily For Effective Loan Valuation EDF EDF Values Values CreditEdge CreditEdge RiskCalc RiskCalc Rating Rating Mapped Mapped CDS CDS Spreads GFI GFI CreditTrade CreditTrade Your Your Desk, Desk, etc etc Bond Bond Spreads TRACE TRACE EJV EJV Your Your Desk, Desk, etc etc Loan Loan Marks Marks LPC/LSTA LPC/LSTA LoanX LoanX Your Your Desk, Desk, etc etc Market-Based Model Model Parameters CreditMark Your Your Loan Loan Portfolio Data Data Loan Valuations COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 13
Ford Spreads 2002-2003 COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 14
Value Of Hypothetical Loan To Ford Motor Co Analyze New Deal: Ford Motor Company EIS CreditTrade CC EJV CC 100 98 96 94 Loan Value (% of par) 92 90 88 86 84 82 80 Mar-02 Apr-02 May-02 Jun-02 Jul-02 Aug-02 Sep-02 Oct-02 Nov-02 Dec-02 Jan-03 Feb-03 Mar-03 Apr-03 May-03 Jun-03 Jul-03 Aug-03 Sep-03 Oct-03 Nov-03 Dec-03 Date Loan Terms: Maturity 3/2007, Spread 75 bp, Commitment Fee 375 bp COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 15
In Summary, CreditMark Enables Mark-To-Market With Superior analytics that extract information from all credit markets for use in loan valuation Methodology for the valuation of revolving credit facilities and other loans with uncertain cash flows A platform that manages the loan valuation and data provision processes COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 16
Product Demonstration Contact a Moody s KMV representative for a demonstration of the following CreditMark features: Analyze New Deal Spread History Flexible Loan Portfolio Valuation Rules Loan Portfolio Valuation Results COPYRIGHT 2004 MOODY S KMV ALL RIGHTS RESERVED WWWMOODYSKMVCOM 17