There is a paradox at the heart of the treasurer’s role in many global corporations. Over the past few years, treasurers have gained a higher profile through managing the corporate fallout from successive liquidity, credit, sovereign, and banking crises. At the same time, their ability to protect their firm is threatened by a key aspect of those same world events: a rise in counterparty risk, in particular bank counterparty risk across the company’s global operations.
On the one hand, corporations are building global supply chains and moving into fast-growing new markets. At the same time, they are becoming reliant on key suppliers, major new customers and regional banking systems in new geographical locations that treasurers are unfamiliar with and cannot easily gain comfort about.
Where the business goes, the treasurer must follow. This holds true even in the face of a growing risk that counterparties may fail and hurt profitability, or destroy the liquidity that the corporation has worked hard to build through its operations.
In conversations with treasurers at particularly resilient companies, we have found some common threads that reveal best practices. Three recommendations serve as useful starting points to help make counterparty risk more visible:
- Explore the complete local banking credit environment and its trends rather than looking solely at the counterparties to which the firm is exposed. This has helped treasurers understand the bigger picture and to generate fresh ideas for better managing business cash flows (e.g. increasing or reducing local pooling of cash in line with the risk of counterparty failure).
- Broaden credit analysis to cover more potential counterparties so that treasurers can identify the best (or ‘least worst’) credits in each country of interest. Treasurers say that taking a proactive approach helps them to understand their counterparty options in advance of business requirements. Implementing this broader analysis results in a more efficient approach to making credit assessments.
- Probe the limitations of current information and practices, often developed to cope with counterparty risk in more mature markets. For example, is the treasury team over-reliant on ratings to assess bank risk when there are few rated counterparties in emerging areas of business? If the team mends any gaps through balance sheet analysis, do time and resource constraints allow them to fully account for the country-specific industry and economic risks associated with each banking system? Improvements in this area are seen as helping treasurers to anticipate any major changes in the local banking system.
In this article we have applied these ideas to uncover insights into eastern European bank counterparty risk. This is a hot topic as the banking crisis and economic slowdown in the EU drives up risk across the continent. However, treasurers can apply the approach outlined here to a much wider set of geographic regions and industry sectors where their corporation’s business is becoming concentrated and where counterparty risk is less than transparent.
The topics explored in this article in relation to eastern European bank counterparties include:
- Which banking systems in eastern Europe have improved or deteriorated over the past five years?
- Can a small number of bank public ratings act as a good proxy for the strength of a country’s wider financial system?
- Where are the banks with the best creditworthiness found in the region?
Eastern Europe Banking System: With Opportunity Comes Challenge
The eastern European region has become both a significant market and an important part of the supply chain for many global corporations, partricularly those headquartered in Europe. This study focuses on 11 countries: Belarus, Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Russia and the Ukraine.
Industry experts say that counterparty risk is a major threat in the region for two main reasons. The first is the level of country risk, with many eastern European countries scoring poorly on World Bank indicators for ‘rule of law’ and ‘control of corruption’. At levels of 57.0% and 51.8% respectively (with 100% being the best score), these are substantially below western Europe averages of 92.2% and 90.7%.1 When banking system risks are high, they can become a driving factor in determining counterparty credit profiles.
The second challenge is a relative lack of transparency in the eastern European financial system and, most particularly, the disinclination of eastern European banks to be rated by international rating agencies.
Credit Scores: An Effective Alternative When Ratings are Scarce
As an example, Standard & Poor’s (S&P) produces around 60 bank ratings for the whole eastern European region. Figure 1 compares this to the number of quantitatively derived scores that S&P Capital IQ produced for the present study. The five-fold increase in the number of entities covered, to over 280, helped us generate a more comprehensive survey of bank credit profiles in the region.
Figure 1: Number of S&P Public Ratings Versus Number of S&P Capital IQ Credit Scores
Source: S&P Capital IQ
The dispersion of credit ratings and credit scores from country to country is very telling (see Figure 2). Russia dominates in terms of the number of credit ratings (i.e. 32) because of its larger economy; some 80% of the Commonwealth of Independent States’ (CIS) gross domestic product (GDP) of $US2.2 trillion in 2011.
Notwithstanding, rated banks form a minority of the country’s 922 banking counterparties and account for only 3% of total banking counterparties. In the 10 other countries, rating coverage is paltry, with Latvia, Romania and Estonia having no rated banks in 2012.
Figure 2: Number of S&P Credit Ratings Versus S&P Capital IQ Credit Scores by Country
Source: S&P Capital IQ
Note: The size of the bubbles reflect the average credit score of banks by country: the larger the bubble, the better the average credit quality of the banks in each country. Bubbles further to the right indicate countries with a greater number of public ratings by S&P.
The low number of ratings in each country makes it more difficult for treasurers to assess the strength of the underlying banking system as a whole, and the strength of individual counterparties. It may be tempting for treasurers to assume that the few available ratings reflect the general creditworthiness of the local financial system and, by implication, of other banks. Figure 3 shows why this is a dangerous assumption. While the Czech Republic’s few rated banks gain a AA (one bank) and a A (two banks), our quantitative analysis reveals a much broader dispersion of credit quality across 17 notches of the rating scale, with one bank showing a credit score as low as ccc-.2
Figure 3: Bank Credit Scores and Ratings in the Czech Republic
Source: S&P Capital IQ
The broad dispersion of credit quality means that the probability of a Czech banking counterparty falling into default over a one-year period ranges from a reassuringly low 0.02% (aa credit score) to a very high 44.86% (ccc- credit score).3
Clearly, in the Czech Republic, it is crucial that treasurers are aware of the significant number of speculative grade banks and take the time to assess the strength of potential counterparties.
What Does the Negative Space Tell Us?
While the lack of public credit ratings is restrictive, ratings remain
an important analytical benchmark as they can provide valuable
information on credit trends (Table 1). For example, the average public
credit rating of banks in Poland and the Czech Republic indicates a good
performance during a turbulent period for the global economic
environment. According to S&P: “The banking sector in Hungary is expected to be marginally
profitable in 2012 after posting losses in 2011.”4
in both Latvia and Romania have ceased to be rated: Latvijas Krajbanka
in 2009 and National Bank of Romania (NBR) in 2012. In both cases they
were the sole rated bank in that country. The former gave up its credit
rating in the middle of the crisis, while the latter did so more
The decision to become unrated is sometimes interpreted
as a sign of potential credit weakness. While credit scores are not
directly comparable to public credit ratings, the credit score for NBR
in 2012 is bb-, showing a relevant decline from its BBB- former public
credit rating of the previous year.
Table 1. S&P Public Credit Rating
Source: S&P Capital IQ
Note: Table of the average credit rating of rated banks in each country as produced by S&P.
However, as noted earlier, it is difficult to gauge banking system strength and key regional trends by looking solely at movements in the ratings of the small number of rated banks, particularly as rated banks are often not representative of the banking credit spectrum as a whole.
Spotting the Best, the ‘Least Worst’ and the Weakest Counterparties
In the Czech Republic, the rated banks are the strongest counterparties in the sample of banks we looked at for that country. This is not necessarily the case for every country, or for the region as a whole. This is particularly important when treasurers are trying to identify the best (or ‘least worst’) bank counterparties in relatively riskier countries.
Banking counterparties in the Ukraine have a generally poor credit profile with an average credit score of ccc+ and some banks scoring as low as ccc- (Figure 4). S&P considers the Ukrainian economy to be “fragile, constrained by ‘very high risk’ in economic resilience and economic imbalances that make it vulnerable to a shortage of external finances.”
The same commentary notes: “Inherited policy weaknesses, political constraints to structural reforms, and ‘extremely high’ credit risk, reflecting a significant share of lending in foreign currency and sizable nonperforming loans.”5
Figure 4: Bank Credit Scores and Ratings in the Ukraine
Source: S&P Capital IQ
The two rated banks in the Ukraine occupy the upper-central part of the available credit spectrum with a rating of B-. However, our analysis indicates that it is possible to find a bank with a score of b+ in the Ukraine: JSC the State Export-Import Bank of Ukraine. As this indicates, treasurers with access to the right tools and information may be able to find counterparties of a reasonable credit quality even in poorly performing economies.
It is easy for treasurers to expect the best when dealing with a country with a strong economy and a well-regarded banking system. The Polish economy has a large domestic market and thus is less reliant on export-led growth than the rest of the region. According to S&P “…the implementation of a fiscal stimulus package helped the country to escape recession in 2009: the only country in the EU to do so. Polish banks take little part in volatile and risky banking activities and banking regulation and underwriting practices have strengthened in recent years”.6
At first sight, our analysis of Polish banks (Figure 5) appears in line with these positive observations: Polish banks cluster around the middle of the rating scale from a- to bb. However, there is a notable set of three outliers with credit scores of b-: Bank Pocztowy, Invest-Bank and LUKAS Bank. Bank Pocztowy withdrew its initial public offering (IPO) for PLN320m in September 2011 and instead opted for a much smaller bond issuance of PLN47m, which it attributed to challenging market conditions.7
Figure 5: Bank Credit Scores and Ratings in Poland
Source: S&P Capital IQ
From Credit Trends to Counterparty Review
Treasurers that S&P Capital IQ has worked with mentioned that the immediate advantage of the kind of credit analysis shown in Figures 3-5 is that it helps them to understand the risk associated with specific counterparties and pick out the banks to approach or avoid.
However, treasurers will also find value in the bigger picture available from a broader set of analyses when making strategic decisions. For example, by examining trends over time, treasurers may be able to prepare for the credit impairment of key counterparties or, conversely, identify countries that will soon offer attractive counterparties and business opportunities. Furthermore, a high degree of volatility in counterparty credit trends may suggest the need for more frequent monitoring and regular review of counterparties.
Our more comprehensive review allowed us to look at the average credit scores of a significant proportion of banking counterparties in each country for the past five years, and identify more clearly which countries are at the top of the class and whether they are likely to maintain this position into the future.
Using a subset of the data discussed thus far, Figure 68 sets out the results for countries with counterparty quality below the regional banking sector average (black dotted line), while Figure 79 features the above average countries.
The first thing to note is the degree of divergence between countries, not only in terms of credit strength but also in terms of volatility. These divergences highlight why eastern Europe should not be treated as a block.
Figure 6: Focusing on Countries Below Regional Average
Source: S&P Capital IQ
Figure 6 shows that Belarus and the Ukraine are the weakest performers in the region. This is no surprise, given that their overheated credit booms of 2003-2008 were followed by damaging corrections internally and across the global financial environment. A large gap exists between their poor performance and Estonia, which matches the regional average in three of the five years. Despite outperforming its below average peers, this creates another issue for treasurers in that the strength of the Estonian banking system seems much more irregular.
With the exception of Estonia, most countries below the region average start and end with roughly the same scores, ranging sideways in a narrow band. While in absolute terms this would suggest no improvement over the five-year period, effectively it points to them having overcome the worst of the global financial crisis. Understanding the level of deterioration and speed of recovery could prove useful in future downturns within the region, or for broader applicability when comparing recovery across different geographic regions.
Figure 7: Focusing on Countries Above Regional Average
Source: S&P Capital IQ
It is clear from Figure 7 that the banking sectors of three above-average countries – Russia, Lithuania and Bulgaria – have more volatile credit profiles. Lithuania underwent a sharp improvement in 2010, leapfrogging Russia and Poland into first place. When looking at the fundamental data from these banks we identified improvements in profit metrics from 2009 onwards, coupled with diminishing loan loss provisions. In the same year Bulgaria witnessed a deterioration that saw it dip below the regional average. While Russia’s credit strength fluctuated, it begins and ends in roughly the same place, pointing to a recovery from the 2008 financial crisis. These fluctuations can make all the difference to treasurers.
The dotted line indicating the regional average changes very little. But both Figure 6 and Figure 7 show that to take the region as a whole would leave treasurers open to significantly different counterparty risks depending on the year, country and counterparty in question.
Treasurers must follow their businesses around the globe, but they can take back control over the risk this generates by discriminating carefully between counterparties. As shown, treasurers can achieve this even in parts of the world where public ratings are rare and where country and banking system risks are important.
By building up a broader picture of risk, treasurers can identify the best counterparties and avoid the worst, while also constructing a strategically valuable picture of credit trends in the regions and sectors where their corporation’s business is growing. Access to reliable data and tested models is paramount if the treasury team is to be efficient and maximise the number of counterparties that it can analyse.
Finally, this broader picture of risk trends will allow treasurers to construct a counterparty review and monitoring programme that focuses the treasury team’s resources wherever they are most urgently required.
Making and Extending the Analysis
The key requirements to maximise the outcomes when applying a quantitative approach to global counterparty analysis are:
- Fundamental data (financial statements) for the analysis has to be timely and accurate.
- The modelling approach should be sector/geography specific and must account for industry, economic and country risk in a sophisticated way to ensure accuracy and granularity of results.
- Speed and efficiency of the credit scoring process is important if corporations are to broaden credit analysis across their portfolio of actual and potential counterparties and, ideally, enable more frequent analysis.
The credit scores discussed in this article were derived by applying CreditModel for Banks, a proprietary, sector-specific modeling approach to a set of selected balance sheet items for each banking-counterparty. The model includes risk factors specifically designed to capture country, economic, industry and banking system risk, which have been independently calibrated for each country.
1 Percentiles were taken from World Bank interactive website, where 100% is the best score and 1% the poorest.
2 The wide dispersion of banks across the credit spectrum may help explain why the stronger banks solicited credit ratings, i.e. to differentiate themselves from competitors. Conversely, this differentiation is less important for banks in the Ukraine (see Figure 4), a country with a much narrower dispersion that clusters around six notches at the speculative end of the scale.
3 Scores and associated probabilities of default were generated using the 2012 Credit Model for Banks from S&P Capital IQ.
4 Quote from S&P commentary ‘Banking Industry Country Risk Assessment: Hungary, 4 May 2012’.
5 Quote from S&P commentary ‘Banking Industry Country Risk Assessment: Ukraine, 15 May 2012’.
6 Quote from S&P press release ‘BICRA on Poland Maintained at Group ‘5’’, 9 November 2011.
7 Quote from Bank Pocztowy company key development page, dated 30 September 2011.
8 These country averages were calculated taking into consideration 31 banks from Belarus, Estonia, Hungary, Latvia, Romania and Ukraine.
9 These country averages were calculated taking into consideration 50 banks from Bulgaria, Czech Republic, Lithuania, Poland and Russia.
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