Bruce Gomme is a Managing Director at UBS Investment bank and is responsible for EMEA Emerging Market counterparty exposures. He has a wealth of experience in the credit risk analysis and management of a wide range of financial institutions and corporates.
Below, he shares his personal insight and experience, answering questions put to him on bank credit analysis in emerging markets:
Bankers Almanac: What financial and non-financial information would you normally want to have, in order to make a prudent and confident credit assessment and decision, in respect of a credit limit for a bank in an emerging market?
Bruce Gomme: The quality of local accounting standards varies in different countries but in general you really need to have IFRS accounts to make a confident credit assessment. However you also need other measurable items, such as lending and depositor concentration, restructured loans no longer reported as impaired, and potentially a more detailed breakdown of investment portfolios than is available in the financial accounts.
In terms of non-financial information there is no substitute for really understanding the dynamics of the local banking sector, the experience and strength of local regulators, and meeting local management to assess its experience, professionalism and risk appetite. Similarly you should seek to understand ownership factors and analyse related party transactions in that light.
Finally, banking is an industry of some importance for domestic governments and can be subject to support so you have to make your best analysis of the potential upgrade this can provide - but always keep in mind the size of the upgrade you determine relative to the bank's stand-alone financial strength and be prepared to revise all of these rating elements on a regular basis.
Bankers Almanac: Are there markets or sectors where it is still difficult to access sufficient, reliable financial and other background information? And what has the trend been in this respect, over recent years?
Bruce Gomme: For sure. Reliable information naturally tends to diminish as you move down the counterparty size scale, although there are exceptions.
Country credit ratings can be misleading if you try and rely on them as a proxy for institutional and data quality, as they are largely driven by financial standing and government debt levels. Having said that, you do generally have to be increasingly sceptical about the reliability and availability of information in lower-rated countries or those lower down the Transparency International scale.
Some countries, such as Turkey, have seen a marked improvement in the quality of information available. Elsewhere it sometimes feels that the opposite is true, as high profile problems have surfaced, but in reality it has been more a case of problems which were always hidden below the surface being exposed to the light of day by the going out of financial tides.
Bankers Almanac: In markets where data is scarce, what practical guidance might you offer other professionals in similar circumstances?
Bruce Gomme: I think that in all credit analysis you need to look for plausibility, consistency and credibility of information. That is particularly so in Emerging Markets and where there are holes in some of the information you would like to have.
Similarly, all credit analysis, where you are going to put money at risk based on your conclusions, needs to be 'risk-based' in terms of deciding how comfortably you can live with gaps in information based on the size and tenor of exposure plus the estimated counterparty rating you come up with.
Apart from that, use your initiative and common sense to find ways of validating your tentative conclusions through other public data or information that IS available and which might give you insight into the institution you are reviewing.
Finally, make a point of meeting management if at all possible and generally cultivate a broad range of contacts within the country in question to allow a basic reality check (or even specific information on your counterparty) to provide context for your tentative analysis plus generally to validate your initial conclusions.
Bankers Almanac: When and to what extent might you research the local legal system, as part of your credit assessment? What might this involve?
Bruce Gomme: All transaction types, whether loans, derivatives, repos or whatever, of course require analysis of the local legal environment as it affects the transaction in question.
Without an understanding of general contractual enforceability and how the local legal environment views specific documentation details, or of action available/required in the event of enforcement, you are taking significant risk, especially in more challenging legal jurisdictions.
The amount of business you expect to do in each country will determine whether you obtain this on an ad hoc basis or in advance and whether you regularly seek external advice or develop in-house expertise over time.
Bankers Almanac: How might one overcome the challenge of accurate risk assessment in markets where there is little or no reliable information?
Bruce Gomme: The general rule of thumb should of course be that you don't do business in markets where there is little or no reliable information, unless it is on a secured basis and you are satisfied you have a high probability of hanging on to the security in the event of need. This is true of all markets and sectors, not just emerging markets.
With banks, which in more frontier markets tend to be even more closely entwined with the government than elsewhere, you might take a view that support is likely, whatever the underlying strength of the institution, and use the sovereign rating as a proxy for the major banks. However in some countries sovereign information can also be relatively patchy and incomplete.
In circumstances where there is a clear business need to consider exposure (for instance in support of developed market clients that want to deal in the jurisdiction) the only other defence is to ensure limited concentrations and an adequate return on the business to compensate for the uncertainty.
Bankers Almanac: In your opinion, is there increasing confidence in a greater number of higher risk markets? If so, why do you think that might be?
Bruce Gomme: I'm not convinced that there has generally been a very material or fundamental change in many higher risk markets. It's typically more a case of improvements in financial metrics from the boom years (and often continuing high commodities prices) which has allowed such countries to build up reserve buffers and improve their financial position. Such windfalls do not always incentivise structural or institutional reform, or improvements in governance, even if the lack of high profile credit casualties may suggest the environment has improved.
Having said that, more frequent capital markets issues in the boom years and sometimes more recent experience of restructuring negotiations with international creditors has internationalised and improved reporting somewhat. There are also definitely some countries which have consolidated measurable progress, such as Turkey following its crisis in 2001 and Eastern Europe, through its gradual, if incomplete, convergence with Western Europe, (but in Europe the greatest strides have often been taken by the less high risk markets).
Bankers Almanac: What in your opinion are the 5 (or so) most important criteria that distinguish the higher risk entities from others?
Bruce Gomme: The most frequent indicators of higher risk entities are:
Bankers Almanac: How might a lack of information influence the ultimate credit decision?
Bruce Gomme: Lack of information is likely to lead to increased caution, expressed through smaller risk concentrations and a need for higher returns. It will typically give rise to a greater reliance on collateral and potentially covenants to bolster financial discipline and commercial leverage (if the quality of information and controls supports this).
Don't forget that rating agencies sometimes issue ratings which are caveated by explicit comments about lack of verified information in one or other respect. Although the agencies bear reputation risk if they are shown to be wrong after the event, you will be taking financial risk and so it's not enough simply to rely on rating agency supposition in such circumstances.
Bankers Almanac: How frequently would you recommend a counterparty in a particularly difficult market be reviewed?
Bruce Gomme: Financial information is often available less frequently in emerging markets than developed markets, which of course presents a problem to analysts concerned about adverse developments.
With banks, though, you can (and should) take a view on likely asset quality developments plus potential liquidity pressures from an understanding of the general operating environment and financial pressures on borrowers.
This is based on general economic analysis and leading indicators of potential difficulty. Such general assessment of trends and dynamics should be regular and continual. Nothing beats being tapped into local market conditions from diligent analysis and ideally a certain curiosity about the countries you are considering. As always, you are trying to understand what circumstances would be problematic for your counterparty and what the likelihood is of these circumstances arising.
Ultimately of course the depth and frequency of all risk analysis should be risk-based i.e. determined by its size and duration and the confidence you have (or not) in the stability of the counterparty you have assessed.
Bankers Almanac: Are there circumstances where you would extend risk to emerging markets, where credit could not be justified on the basis of the available financial information?
Bruce Gomme: This has to be an institutional decision on whether to take calculated, but uncertain, risks (without the ability for an adequate and confident risk assessment) in support of franchise. As with all such compromises avoidance of concentration and adequate reward for the additional uncertainty are key.
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