Company Credit Research Articles

Accounting conservatism and the cost of bank credit in Brazil

This study investigates whether the adoption of conservative accounting practices leads to a reduction of the cost of bank credit for Brazilian companies. The study is based on a sample of 1,300 firms and 813 thousand loan contracts, in the period from 2000 to 2009. We used models that associated the cost of credit to measures of conservatisms and a set of control variables. We did not obtain any statistically significant evidence of a relationship between the conservatism measures and the interest rates charged on bank loans, confirming the research hypothesis. The Brazilian institutional environment of weak legal protection of creditors and the low demand for good-quality accounting information restrict the benefits generated by conservatism and cause lenders not to stimulate the adoption of conservative practices by companies, by lowering their interest rates. Since companies do not perceive benefits associated with reporting conservative numbers, the use this practice is restricted in Brazil.

Pricing and Hedging of Coco's

Contingent convertible bonds are typical hybrid products in that they are exposed to different types of risk: interest rate risk, equity risk and conversion risk. We first develop a general framework for their pricing and hedging that can be specified in different ways. Then we focus on intensity-based and first-passage time models driven by a finite-dimensional Markov process. The two approaches are qualitatively different. But both allow to price contingent convertibles and calculate dynamic hedging strategies with holdings in related instruments such as fixed income products, the issuing company's stock and credit default swaps. As case studies we consider contingent convertibles issued by Lloyds Banking Group in December of 2009 and Rabobank in March of 2010.

The Impact Of Basel III On Italian Banks Loan Rates: An Accounting-Based Approach

This paper empirically investigates the impact of the new capital requirements imposed under Basel III on bank lending rates.A general accounting equilibrium model is developed in order to map the change in the average interest rate on bank loans which is required to preserve the economic performance and the market value of financial institutions under the new regulatory framework.The study refers to the Italian banking system. According to our estimates, the long-term impact of heightened capital requirements on bank loan rates is likely to be modest.In our baseline scenario, we find evidence that each percentage point increase in the capital ratio can be recovered by increasing interest rates with which borrowers are charged by only 5.75 basis points. We conclude that the Italian banking system should be able to adjust to the higher capital requirements imposed by Basel III through a set of operative and commercial levers with no significant effects on the cost of credit for companies and consumers.

Flight rescheduling responding to large‐area flight delays

PurposeThe purpose of this paper is to focus on disruption management responding to large‐area flight delays (LFD). It is urgent for airways to reschedule the disrupted flights so as to relieve the negative influence and minimize losses. The authors try to reduce the risk of airline company's credit and economic losses by rescheduling flights with mathematic models and algorithm.Design/methodology/approachBased on flight classifications of real‐time statuses and priority indicators, all flights are prioritized. In this paper, two mathematic programming models of flight rescheduling are proposed. For the second model, an optimum polynomial algorithm is designed.FindingsIn practice, when LFD happens, it is very important for the airline company to pay attention to real‐time statuses of all the flights. At the same time, the disruption management should consider not only the economic loss but also other non‐quantitative loss such as passengers' satisfaction, etc.Originality/valueIn this paper, two mathematic programming models of flight rescheduling are built. An algorithm is designed and it is proved to be an optimum polynomial algorithm and a case study is given to illustrate the algorithm. The paper provides a theory support for airways to reduce the risk brought by LFD.

The Performance of New Private-Label Mortgage Loan Modifications after 2009

This paper presents summary statistics and a preliminary analysis of the success rate of loan modifications made in 2010 and January 2011 to residential mortgages securitized in private-label residential mortgage-backed securities. We find that these more recent private-label loan modifications had a higher overall success rate, compared to similar modifications made in earlier years. Consistent with prior literature, having a fixed-rate mortgage, a prime mortgage, a higher Fair Isaac & Company (FICO) credit score, and/or a lower interest rate at origination were positively correlated with lower redefault rates post-modification. Borrowers with interest-only and teaser-rate loans performed slightly better than other borrowers after receiving loan modifications. Similarly, modifications of purchase loans did worse not only than plain vanilla refinance loans, but also worse than debt consolidation and cash out refinance loans. Modifications of private-label mortgages in the four “sand states” – Arizona, California, Florida, and Nevada – did better than modifications in other parts of the United States, although the difference was small. Surprisingly, modifications of fully documented loans performed worse, while modified no-documentation loans performed best. Finally, we confirm that capitalizations of arrears performed worse than interest rate reductions and principal modifications, with the latter appearing to be the most effective.

Improving company credit ratings by reinforcing the quality of independent directors

The independent, director-related, provisions of Taiwan’s Securities Exchange Act of 2006 was stipulated in an effort to enhance supervision efficiency and strengthen internal governance through the independence and expertise of independent directors. However, it has not been determined whether the academic expertise, professional experience, and competence of independent directors can enhance supervision efficiency and improve a company’s credit ratings. We collected primary and secondary data from databases and found that independent directors’ competence is negatively related to credit rating and that independent directors that have served in a company longer improve the company’s credit ratings. Classifying the sample according to the seat ratio of independent directors to non-independent directors in the board of directors revealed that companies with independent directors with more experience or longer average terms, have better credit ratings when there is a high percentage of independent directors. When there are a low percentage of independent directors, academic expertise is positively related to credit ratings. This finding is in conflict with the purpose of the law, which was implemented so that independent directors with expertise would improve corporate governance. To clarify the unexpected discrepancy, we conducted multiple tests of expertise and competence and found that the credit ratings of a company will be worse if its independent directors have academic expertise, but only when there is a high percentage of independent directors on the board. Independent directors with a combination of academic expertise and competence can help improve the company’s credit ratings. This study found that seat ratio is the most important factor in order for the expertise of independent directors to play a role. Although independent directors have legal rights to oversight, the enhancement of corporate governance is limited in companies with a low seat ratio of independent directors, as they cannot control the vote in board proceedings if their opinions differ from those of the internal directors and managers. The study also found that independent directors should have a combination of academic expertise and competence. The independent directors are expected to help businesses with their professional knowledge. However, since independent directors are professionals from outside of the company, their competence is the key factor in their ability to use their professional knowledge to serve the company. The longer an independent director serves a company, the better his or her understanding of the risks facing the company will be and the more likely his or her suggestions will be to improve the governance environment to a degree that will influence the credit rating agencies. The findings of this study can provide a reference indicator for governmental agencies in amending relevant regulations and for enterprises in selecting independent directors. Key words: Corporate governance, independent director, credit rating.

STRUCTURAL MODEL FOR DETERMINING ENTERPRISE GROUP'S INTEGRATED LINES OF CREDIT

A line of credit is one of the most flexible financing tools for companies. Banks give companies lines of credit to strengthen their profitability and competitive ability. On the other hand, companies draw the lines of credit that will increase banks' credit risk. It is very difficult for banks to determine the lines of credit for an enterprise group. Based on principle of credit risk evaluation and structural model, this paper first defines bank's tolerable default risk and lines of credit, and then analyzes integrated lines of credit of parent and subsidiary companies. The results of this research indicate that the lines of credit of single company is related to its asset value growth, and integrated lines of credit of an enterprise group is also related to member's asset value growth and the associated relationships. Furthermore, this study shows that the integrated lines of credit of an enterprise group can be determined by the weighted sum of member's lines of credit and the computational formula of weight. This study provides a quantitative analysis tool to ascertain the enterprise group's integrated lines of credit and analyze how the associated relationships affect the integrated lines of credit.

Manufacturing SMEs' Credit Collection Period and its Determinants: Some Evidence from Malaysia

Manufacturing SMEs' Credit Collection Period and its Determinants: Some Evidence from Malaysia Collection period is the length of time taken by a company's credit customers to pay their debts. During this time, company resources are tied up as it is effectively financing its customers' purchases out of its own funds. Credit collection period is, therefore, an important factor that might have an impact on the cash flows, and hence, the survival of a company. An attempt has been made in this paper to explore the profile of credit collection period among small and medium-sized manufacturing enterprises in Malaysia. Besides that, we also identify some determinants of this credit collection period. The study is based primarily on secondary data derived from financial statements of manufacturing SMEs from 2001 through 2004. The findings of this study indicate that liquidity, efficiency, profitability, industry sub-sector and size have some influence over the credit collection period.

The Value of Non-Financial Information in SME Risk Management

Within the commercial client segment, small business lending is gradually becoming a major target for many banks. The new Basel Capital Accord has helped the financial sector to recognize small and medium sized enterprises (SMEs) as a client, distinct from the large corporate. Some argue that this client base should be treated like retail clients from a risk management point of view in order to lower capital requirements and realize efficiency and profitability gains. In this context, it is increasingly important to develop appropriate risk models for this large and potentially even larger portion of bank assets. So far, none of the few studies that have focused on developing credit risk models specifically for SMEs have included qualitative information as predictors of the company credit worthiness. For the first time, in this study we have available non-financial and 'event' data to supplement the limited accounting data which are often available for non-listed firms. We employ a sample consisting of over 5.8 million sets of accounts of unlisted firms of which over 66,000 failed during the period 2000-2007. We find that qualitative data relating to such variables as legal action by creditors to recover unpaid debts, company filing histories, comprehensive audit report/opinion data and firm specific characteristics make a significant contribution to increasing the default prediction power of risk models built specifically for SMEs.

The DEA Method in Managing the Credit Risk of Companies

The subject of the present paper is a new procedure of forecasting credit risk to companies in the Polish economic environment. What favors the suggested approach is the fact that in Poland, unlike in western countries, the DEA method has not yet been implemented in assessing credit risk faced by companies. The research described in the paper has been conducted on the basis of comparing the proposed DEA method with the currently used procedures, namely the point method, discriminative analysis and linear regression. To verify and compare the efficiency of various methods of company credit risk estimation, the efficiency of the classification of companies has also been examined. The study has involved an analysed sample (a teaching sample) as well as a test sample which was not taken in model building. To conclude, the DEA method facilitates forecasting financial problems, including bankruptcy of companies, in Polish economic conditions, and its efficiency is comparable to or even greater than that of the approaches implemented so far.

Counting biodiversity waste in industrial eco-efficiency: fisheries case study

The foundation for the creation of eco-efficiency metrics for industrial impacts on biodiversity is considered. Because biodiversity is the essence of life itself, these metrics are essential for effectiveness in the theory and practice of eco-efficiency, particularly in the case of primary natural resource extraction industries such as fishing and forestry. The case of fishing is examined, with particular attention to by-catch, lost nets, and habitat damage caused by mobile fishing gears. It is appropriate to examine fishing because industrial era impacts on marine biodiversity have been severe and are driving large and deleterious changes in marine ecosystems. For discarded by-catch, it is proposed that an eco-efficient metric for the value per unit mass of discarded fish can be set to be equivalent to that of the market value of the utilized catch. In estimating the eco-efficient value of the catch, the value of the discarded fish is then subtracted from the market value of the catch. Fish killed in lost nets can be treated similarly. It is more difficult to address marine habitat damage by mobile fishing gear, which has the highest potential for ecological injury. By using the approach proposed, negative eco-efficiencies are obtained under circumstances in which the collateral damage to biodiversity exceeds the economic benefit obtained. This is a logical outcome given the long-term effects of biodiversity decline. A metric is also proposed for assessing whether avoidance of harm to biodiversity, in the form of switching fishing gear, is required. Lastly it is proposed that metrics might be developed to provide eco-efficiency credit for companies taking effective actions to improve, or actively participate in, ecosystem-based fisheries management.

Rethinking downstream regulation: California's opportunity to engage households in reducing greenhouse gases

With the passage of the Global Warming Solutions Act of 2006 (AB32), California has begun an ambitious journey to reduce in-state GHG emissions to 1990 levels by 2020. Under the direction of executive order S-20-06, a mandated Market Advisory Committee (MAC) charged with studying market-based mechanisms to reduce GHG emissions, including cap and trade systems, has recommended taking an “upstream” approach to GHG emissions regulation, arguing that upstream regulation will reduce administrative costs because there are fewer agents. In this paper, we argue that, the total costs to society of a GHG cap and trade scheme can be minimized though downstream regulation, rather than the widely proposed upstream approach. We propose a household carbon trading system with four major components: a state allocation to households, household-to-household trading, households to utility company credit transfers, and utility companies to government credit transfers. The proposed system can also be considered more equitable than carbon taxes and upstream cap and trade systems to control GHG emissions from residential energy use and is consistent with AB32.

Emergence of Captive Finance Companies and Risk Segmentation in Loan Markets: Theory and Evidence

A seller with some degree of market power in its product market can earn rents. In this context, there is a gain to granting credit to purchase of the product and thus to the establishment of a captive finance company. This paper examines the optimal behavior of such a durable good seller and its captive finance company. The model predicts a critical difference between the captive finance company's credit standard and that of independent lenders (“banks”), namely, that the captive finance company will adopt a more lenient credit standard. Thus, we should expect the likelihood of repayment of a captive loan to be lower than that of a bank loan, other things equal. This prediction is tested using a unique data set drawn from a major credit bureau in the United States, and the evidence supports the theoretical prediction.

Demonstration of data mining approaches in credit risk evaluation

Ratios from financial statements provide useful information to describe credit conditions from various perspectives, such as financial conditions and credit status. A good quantitative model is crucial in scoring the company credit status. This study demonstrates the utilisation of several data mining algorithms, i.e., Backpropagation Neural Network (BPNN), decision tree, logistic regression and Monte Carlo simulation in credit-scoring problem. Results are favourable in this case study.

Risk and capital structure in Asian project finance

We develop and test hypotheses derived from a multi-level theoretical framework for understanding factors shaping the credit risk and capital structure of a quintessentially Asian form of investment known as project finance. It differs from other corporate financing approaches. A project company is separate and bankruptcy remote from the investing firm sponsors that create it. The project company relies extensively on debt capital provided by creditors to fund project operations. Creditors provide more (less) debt as a percentage of overall project capital when there is less (more) risk of project failure and non-repayment. We define a target risk framework identifying country-, industry-, syndicate-, firm-, and project-related factors shaping Asian project finance company credit risk and thus, project debt. In a sample of 238 project finance companies announced in 13 Asian countries from 1995-2004, we observe substantial effects on project capital structure with respect to country-level factors linked to institutional and macroeconomic theories, syndicate structure factors linked to agency theory, and lead sponsor experience and project size factors linked to learning and transaction cost theories. We argue that these and other determinants of project finance company credit risk and capital structure in Asia since the mid-1990s anticipate similar relationships now emerging elsewhere around the globe.

Risk Mitigation for Life Settlements

Investors seeking new structures for acquiring policies in the life settlement market encounter several underlying risks unique to the asset class. Those risks, described in this article, include contestability risk, missing body risk, insurable interest risk, incorrect-purchase-price risk, life insurance company credit risk, cost-of-insurance risk, and longevity risk. Some risks can be easily mitigated, but others require more complicated risk transfer mechanisms that combine financial products with insurance products. These products range from contestability coverage to more sophisticated mortality risk transfer constructs that blend equity derivative products with property casualty insurance. As the life settlement market evolves, risk mitigation will play an increasing role in reducing volatility and enabling predictable returns to allow for more institutional capital participation. Knowledge about the risks and the available risk mitigation solutions becomes a must for prospective investors interested in entering into the life settlement market. <b>TOPICS:</b>Other real assets, exchanges/markets/clearinghouses, credit risk management

Canadian Regulators Propose that Management Report on Internal Control: Moody's Will Apply Existing Methodology to Material Weaknesses Reported

The reporting by Canadian public companies on the effectiveness of internal control over financial reporting has been the subject of considerable debate. Recently, regulators proposed that management of public companies disclose they have evaluated their company's internal controls and identify any material weaknesses in those controls. However, the latest proposal drops auditor reporting on companies' internal controls, a major change that differs from the US requirement and from the Canadian regulators' earlier proposal. Moody's welcomes formal evaluation of controls and disclosure of control problems, as material weaknesses in controls are sometimes relevant to a company's credit risk. We expect to apply the same methodology to considering control weaknesses cited by all companies, including Canadian, as we do with US companies reporting control problems. Based on our experience considering control weakness in the US to date, we expect that negative rating actions would result in certain cases in response to disclosures of material weaknesses in accounting controls by Canadian companies. Independent auditors' reports on internal control have been important in restoring confidence in financial reporting in the US in the aftermath of many high profile instances of misleading financial reports. We believe that auditor reporting on controls improves the quality of auditing, management reporting on controls and financial reporting generally. We will not differentiate the credit quality of companies solely as a result of different requirements for management or auditor reporting on controls as we have no objective or consistent means of doing so. Further, a country's infrastructure can promote quality reporting without reporting on controls if other elements of the infrastructure are working effectively. Our confidence in the financial reporting in a country ultimately depends on the frequency in which companies in that country engage in misleading financial reporting. High levels of severe reporting problems increase our perception of credit risk, regardless of whether the country requires reporting on controls.

INDUSTRY: RELAX FEDERAL LAWS

THE AMERICAN CHEMISTRY Council (ACC), a chemical industry trade group, is asking the White House to loosen a host of federal regulations to help revitalize chemical plants damaged by Hurricane Katrina. ACC has asked the Bush Administration to temporarily relax a number of clean air and hazardous waste regulations in the Gulf Coast disaster zone so chemical plants can more easily clean up and restart their operations. ACC is also seeking tax changes, including a new credit for companies that retain employees in the storm-ravaged areas. In addition, ACC is urging the government to take a raft of actions to curb consumption of natural gas, a key feedstock for the chemical industry. Jack N. Gerard, president and CEO of ACC, wrote in a Sept. 14 letter to President George W Bush, Our facilities report shortages, supply interruptions, and extremely high prices {of natural gas} as a result of the storm. ACC's energy recommendations include providing ...

The Rise and Evolution of the Chief Risk Officer: Enterprise Risk Management at Hydro One

This article describes the five-year implementation of enterprise risk management at Hydro One, a Canadian electric utility in a newly deregulated market. Starting with the creation of the position of Chief Risk Officer and the implementation of a pilot risk study involving one of the firm's subsidiaries, the ERM process has made use of a variety of tools and techniques, including the “Delphi Method,” risk trends, risk tolerances, and risk rankings. Among the most tangible benefits of ERM at Hydro One are (1) a better coordinated and more effective process for allocating capital and (2) a favorable reaction to the program by Moody's and Standard & Poor's, which has arguably improved the company's credit rating and lowered its cost of capital. But perhaps equally important is the company's progress in realizing the first principle of its ERM policy—namely, that “risk management is everyone's responsibility, from the Board of Directors to individual employees.” As a result, Hydro One's management feels that the company is much better positioned today to respond to new business developments than it was five years ago.

Relationship hindrance: why would consumers not want a relationship with a retailer?

Relationship marketing tactics, such as loyalty programs, company credit cards, and e-mail promotions, are becoming increasingly popular. Benefits offered to a consumer for engaging in relational exchanges include price decreases, special offers, personalized attention, and customized products. With such benefits, the assumption is that consumers will want to develop a relationship with an organization and be rewarded for their loyalty. However, consumers might patronize a retailer, be satisfied with the service and product delivery, and yet not want to develop a relationship with them. As such, the purpose of this study was to determine why seemingly satisfied customers do not want to engage in relationship marketing and loyalty enhancing programs with retailers.