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Challenges of international data and benchmarking

Valentino Pediroda modeFinance

email: [email protected]

twitter: @vapediroda tel: +39 331 1921018

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.

SUMMARY

MORE Rating

Class Rating Macro class Assessment

AAA

Healthy companies

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

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

A 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.

BBB

Balanced companies

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

BB 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.

B

Vulnerable companies

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.

CCC 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.

CC

Risky companies

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

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

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

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).

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.)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.

Look at fundamentals

MORE looks at the fundamentals and the equilibrium

MORE: Multi Objective Rating Evaluation

Ratios definition and choice

From quantitative definition to qualitative definition

Financial and economical equilibrium

RATING EVALUATION

Statistical Analysis

Fuzzy Logic

Multi Criteria Decision Making

The model

Fuzzy logic

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

Ratio value

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ratin

gcla

ss

B

AAA

D

A

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.

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.

MORE Confidence Level

MODEL 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).

VALIDATION VALIDATION OF THE CREDIT SCORE MODEL

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

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

more than 200 countries.

Comparable Data

Official Sources

Includes countries with

different characteristics

modeFinance

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

engineering techniques.

Comparable Objective Transparent

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 [email protected] - www.modefinance.com

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