Modefinancelondon20130919 bis

Challenges of international data and benchmarking Valentino Pediroda modeFinance email: valentino.pediroda@modefinance.com twitter: @vapediroda tel: +39 331 1921018

SUMMARY

Topic How can we provide a credit scoring which is coherent and comparable across different sectors and countries?

The collaboration between Bureau van Dijk and modeFinance gives an answer to this important topic.

What is credit rating?

Credit rating is an opinion of the economic and financial quality of a company based on relevant risk factors.

A different probability of default (within one year, two years and three years) is associated with each credit rating class (indicated by symbols: traditional AAA to D).

MORE Rating Class

Rating Macro class

AAA AA

Healthy companies

A BBB BB

Balanced companies

B CCC

Vulnerable companies

CC C D

Risky companies

Assessment The company's capacity to meet its financial commitments is extremely strong. The company shows an excellent economic and financial flow and fund equilibrium.

The company has very strong creditworthiness. It also has a good capital structure and economic and financial equilibrium. Difference from 'AAA' is slight.

The company has a high solvency, The company is however more susceptible to the adverse effects of changes in circumstances and economic conditions than companies in higher rated categories.

Capital structure and economic equilibrium are considered adequate. The company's capacity to meet its financial commitments could be affected by serious unfavourable events.

A company rated 'BB' is more vulnerable than companies rated 'BBB'. The company faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions.

The company presents vulnerable financial signals. Adverse business, financial or economic conditions will be likely to impair the company's capacity to meet its financial commitments.

A company rated 'CCC' has a dangerous disequilibrium in its capital structure and financial fundamentals. Adverse market events or inadequate management are highly likely to affect the company's solvency.

The company shows signals of high vulnerability. In the event of adverse market and economic conditions, the company's strong disequilibrium could increase.

The company shows considerable danger signs. The company's capacity to meet its financial commitments is very low.

The company no longer has the capacity to meet its financial commitments.

Main problems:

- different accounting standards; - different economic behaviors for the different countries; - different economic behaviors for the different sectors; - lack of complete financial data for the bankrupt companies; - “holes� in the financial data (BS, P&L).

How can we develop a credit score model in order to overcome those elements?

Different accounting standards Mainly two different standards exist: Continental and Anglo-Saxon.

The main difference is the classification of the costs.

Different accounting standards How to minimize the differences based on the different accounting standards in the credit scoring?

Mainly we have to develop two different models with different financial ratios: Ratio for financial interest coverage: EU: EBIT/Interest paid UK: GrossProfit/Interest paid Important: in many cases the chosen accounting standards don’t depend on the country, but it is a choice made by the company.

(Netherland, Russia, etc.)ďƒ IT difficulties.

Different countries we would like to have a credit scoring that is coherent among different countries, so the user doesn’t loose time for the companies’ comparison, ……….but…….

Solution Settings of the ratios in order to homogenize the evaluation and make it coherent among the different countries.

ROE > 20% in India  optimum ROE ROE > 35% in Turkey  optimum ROE

Small problem‌‌.

We cannot do this for every ratio! If you observe total leverage (the ratio which represents the total debts of a company), the distribution is different among the countries‌.but debts are debts.

Solution settings of the ratios which are depending on the particular economic behavior of the country.

Different sectors Of course, we cannot forget taking into account even the commercial sectors’ financial behaviors inside the selected country.

Solution Similar to the country tuning

Small number of bankrupt companies Unfortunately not in every country, the information on defaulted companies can be found. This missing information limits the typology of models for credit scoring which can be used.

Solution Impossible to use models which are based on understanding the differences between active companies and the companies that have defaulted (machine learning methods).

Also not possible to translate a model from a country to another one.

We can only use the methods which try to act like the financial analyst behavior.

“Holes� in the financial data Unfortunately, there are not information on the companies in default in every country. This missing information limits the typology of models for credit scoring which can be used.

Solution Even in this case, we have to introduce numerical model which try to mimic the financial analyst behavior, who understand a company credit risk even if there are missing information.

MORE: Multi Objective Rating Evaluation

MORE looks at the fundamentals and the equilibrium

Look at fundamentals

The model

Ratios definition and choice

Statistical Analysis

From quantitative definition to qualitative definition

Fuzzy Logic

Financial and economical equilibrium

Multi Criteria Decision Making

RATING EVALUATION

Fuzzy logic

Penality rating class

D

B

A AAA

Ratio value

We directly translate the financial ratio value into a rating classes: with high non-linearity and without monotone problems

Thanks to all the information in Bureau van Dijk products (80 Million companies in more than 200 countries), we can understand the economical behavior of every ratio, sector and country.

MORE Confidence Level

Even if there are missing data, we can provide the MORE rating with the confidence level associated.

Confidence level is a reflection of the variations in availability of financial data across Europe due to filing regulations and suggests the degree of financial details that the MORE rating is able to take into account for each company.

The Confidence level represents the ratio between the available information over the total information.

We subdivided the database in 9 sectors for each country.

By performing for each sector an accurate statistical analysis, which highlights the differences among the economies of different countries, we have selected about 15 indicators (which change from sector to sector).

MODEL

VALIDATION OF THE CREDIT SCORE MODEL

VALIDATION

UK, Germany, Finland, Italy: almost same results (Gini Index > 70) The model is able to recognize the bankrupt companies with the same accuracy in different countries: comparable credit scoring evaluation.

ORBIS (and others) + MORE BvD

modeFinance

ORBIS contains the financial data of more than 100 million public and private companies from more than 200 countries.

MORE revolutionizes the way to produce a credit rating. The assessments are based on analysis of the fundamentals using modern engineering techniques.

Comparable Data

Official Sources

Includes countries with different characteristics

Comparable

Objective

Transparent

WHERE WE ARE

Trieste, Italy AREA Science and Technology Park The leading Science and Technology Park in Italy.

Established in 1978.

Key point: only companies with high innovative technologies. modeFinance Headquarter Building A AREA Science Park, Padriciano 99 34012 Trieste ITALY Ph. +39 040 3755337 - Fax +39 040 3755176 info@modefinance.com - www.modefinance.com