Loxon The increased role of credit risk mitigants

Loxon The increased role of credit risk mitigants and their evaluation under Basel II

Loxon Theoretical Background on Crisis

Loxon Conventional Risk Models • What is the maximum potential loss (L) in a credit portfolio due to defaults of the clients (on 1 year time horizon at 99. 9% probability level)? • L=∑AIA×LGDA • Conventional credit risk models (incl. Basel II formula) assume: • Only IA depends on the state of economy (X) • IA and LGDA are independent • LGDA and LGDB are independent

Loxon Crisis as multiple misfortune • LGDs become correlated with the general economic conditions (X) • EAD increases (due to higher exposure haircut, EPE) • Value of Collaterals (VC) decrease (increased collateral haircuts due to higher volatility and longer liquidation period, deteriorating guarantors, damaging physical collaterals, affected receivables, etc. ) • LGD=CCF×(EAD-VC) • Through increased systematic risk (X) new undiversifyable risks emerge • Recoveries after defaults are unprecedented operational risks less due to

Loxon Challenges in the Region

Loxon Typical problems • Data quality issues: inadequate or duplicated collateral • Lack of integration of collateral analytics • Cross-collateralization is not supported • Huge manual effort by analyzing and revaluating the portfolio • Revaluation of the portfolio is not supported • Portfolio-monitoring is not supported – deal and partner-group level coverage information • Differentiation of the real estates/assets and the collaterals established on these as well as registry of higher ranking liens • Lack of insurance registry (property insurance is prerequisite of B 2 eligibility of any physical collateral)

Loxon Basel II and credit risk mitigants

Loxon Main points of interest for Basel II • Debtor vs partners (issuer, protection provider etc) • Needed data for calculating losses and recoveries • Recoveries (internal, external, collaterals, other) • Collaterals • Manual and automatic revaluations (daily, yearly etc) • Eligibility • Coverage information • Shared collaterals • Allocation

Loxon Collateral registration Collateral contract COLLATERAL RE’s / ASSETS Insurance PARTNER / Group EXPOSURES

Loxon Collateral revaluation Manual revaluation • Periodical or ad-hoc (e. g. liquidation) • External or internal appraisal processes • Certification of external appraisals/appraisers • Key challenges • Revaluation dates, manage process, capture result, support escalation process Automatic revaluation • Mark-to-market revaluation of financial collaterals • Based on daily market prices and exchange rates • Uploaded fom external or internal sources, or recorded • Statistical revaluation of real estates and assets • Based on registered asset values and custom valuation schemes

Loxon Prerequisite of coverage - Allocation • Goal: Finding the distribution of collaterals among deals Allocation for RWA (Basel) Allocation for IFRS provisioning Allocation for supervisory purposes: provisions and RWA Allocation for CMD purposes

Loxon Revaluations

Loxon Collateral revaluation • One of the key factors for proactive collateral management • Based on Basel II and/or Bank internal rules • Automated revaluation • Registries for asset prices (state registry for mortgages or pledges, Eurotax, stock exchange etc) • Market prices or statistical model based approaches • Manual revaluation • Internal or external appraisers • Electronic document registry • Effective evaluation process

Loxon Real Estate Appraisals • Valuation approaches • Sales comparison approach (applicable for Owneroccupied single-family residences (semi-/detached or terraced houses) • Income capitalization approach, (applicable for commercial real estate, rented property etc) • Revaluation possibilities on statistical basis • Stored own data of the bank historically • Collect statistical data from external sources (like countrywide database)

Loxon Controling external appraisers • Prerequisite of reliable evaluations • Scoring approach • Scoreappraiser = ( D×CLD), • D: weight of score dimension • CLD: score dimension value • Score dimensions • Accuracy • Timeline • Professionalism towards client • Professionalism towards Bank

Loxon Pillar II – advanced analysis methods

Loxon Advanced analysis • Advanced analysis tools required to help in-depth portfolio evaluation • Analysis is executed on multiple, userdefined dimensions (e. g. sectors, regions, biggest clients, collateral types, etc. ) • Calculations usually result in a detailed report on customized segmentation of the portfolio

Loxon Portfolio Simulations • Supports mid- and long-term risk management decisions through forecasting the effects of possible scenarios on coverage, provision, RWA, EC, EL • Based on the prediction of possible future movements in: • asset prices • currency rates • ratings, etc.

Loxon Stress Test • Scenario analysis • Stress test (collapse of housing market, securities market, its combination) shows weaknesses of the collateral portfolio, low coverage, changes in RWA/EL/EC in case of shock scenario • Reveals concentration risk

Loxon Lending and Risk Management Systems Thank You Tamás Erni - LOXON solutions Mobile: +36 -70 -3169 -268 Email: tamas. erni@loxon. hu