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THE CHANGING FACE OF

BANK ANALYSIS
Recent Developments in the
Discipline
WHY DO BANK ANALYSIS?
Bank analysis is a developing discipline.
Old perception that as banks rarely default they are
strong counterparties is out of date.
Define what is meant by bank default?
Basel 2/Portfolio Management mean that capital allocation is
more sensitive to overall portfolio quality, including that of banks.
Increased ability to collateralize counterparty risk in the
derivatives market.
Decisions need to be taken about hedging credit risk in the credit
derivatives market.
Banks role in structured finance/securitization transactions
requires a more pro-active approach.
No longer enough to just consider whether a bank will
default or not.
BANKS DONT DEFAULT OFTEN
Although only limited bank defaults have occurred in
recent years, with the Argentina crisis, the number has
increased in recent years.
FITCH DEFAULT DATA
In the period of 1990 2003, banks rated
by Fitch defaulted less frequently than
corporates rated by Fitch.
Average Cumulative Default RatesWorldwide
One-Year Two-Year Three-Year Four-Year Five-Year
(%) Bank Corp. Bank Corp. Bank Corp. Bank Corp. Bank Corp.
AAA 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
AA 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.04 0.00 0.09
A 0.00 0.05 0.04 0.21 0.05 0.34 0.06 0.48 0.07 0.59
BBB 0.19 0.38 0.63 1.26 0.79 1.98 1.32 2.84 0.72 3.28
Investment 0.03 0.12 0.11 0.43 0.13 0.67 0.16 0.90 0.09 1.04
Grade
High Yield 2.36 4.33 5.27 7.27 3.99 7.35 6.73 8.79 8.97 9.31
All Ratings 0.27 0.77 0.58 1.44 0.47 1.65 0.50 1.94 0.48 2.08
Source: Fitch Ratings, Fitch Bank Failures Study 1990 - 2003: March 2005
FITCH TRANSITION DATA
Measures number of ratings in each category
which were still in that category 12 months later.
For AA and A ratings, banks more stable.
AAA rated banks less stable with more downgrades, which will
accelerate with the end of the Landesbank guarantee.
Average Annual Worldwide Corporate (incl. Banks) Transition Matrix;
1990 2003
(%) AAA AA A BBB BB B CCC C D Total
AAA 96.54 3.31 0.14 0.00 0.00 0.00 0.00 0.00 100.00
AA 0.09 90.99 8.47 0.40 0.03 0.03 0.00 0.00 100.00
A 0.03 2.50 91.78 5.29 0.24 0.02 0.10 0.05 100.00
BBB 0.00 0.25 4.85 89.26 3.97 0.87 0.40 0.40 100.00
BB 0.07 0.13 0.20 7.33 79.39 8.06 2.71 2.11 100.00
B 0.00 0.00 0.00 0.51 8.09 83.83 5.01 2.57 100.00
CCC - 0.00 0.00 0.00 0.44 0.00 10.62 58.85 30.09 100.00
C
Average Annual Worldwide Bank Transition Matrix; 1990 2003
(%) AAA AA A BBB BB B CCC - C D Total
AAA 93.40 6.60 0.00 0.00 0.00 0.00 0.00 0.00 100.00
AA 0.10 92.11 7.63 0.10 0.00 0.05 0.00 0.00 100.00
A 0.00 4.02 92.66 3.25 0.04 0.04 0.00 0.00 100.00
BBB 0.00 0.63 9.01 87.74 1.99 0.42 0.00 0.21 100.00
BB 0.00 0.60 0.30 12.61 68.17 12.91 4.50 0.90 100.00
B 0.00 0.00 0.00 0.40 14.23 82.21 2.77 0.40 100.00
CCC - 0.00 0.00 0.00 0.00 0.00 18.46 61.54 20.00 100.00
C
Source: Fitch Ratings
FITCH BANK FAILURE DATA
Failure (intervention) vs. Default (bankruptcy) of Banks
Support is key to preventing default of banks.
Support is more likely to be available to banks than non-bank corporates.
Data below shows that bank failures are MORE LIKELY
than corporate defaults.
The difference increases with the time period under examination.

Average Cumulative Default and Failure Rates; 1990 - 2003


(%) 1-Year 2-Year 3-Year 4-Year 5-Year
All Corporate Defaults 0.77 1.44 1.65 1.94 2.08
All Bank Defaults 0.27 0.58 0.47 0.50 0.48
All Bank Failures 0.77 1.70 2.78 3.98 5.52
Source: Fitch Ratings
1990 2003 BANK FAILURES
Breakdown of Fitch data on bank default
and failures by geography and timing
shows some concentrations.
DEFINING THE OBJECTIVE OF
BANK RISK ANALYSIS
Each institution defines its own risk appetite via its risk
management guidelines.
Do these specifically address the objective of bank risk?
Does risk appetite focus on ultimate recovery, default or volatility?
Ultimate recovery implies the institution can tolerate defaults, as long
as the recovery rate is high. Note that recovery rates for banks are
not generally available and could be low. Not time sensitive.
Default implies the institution does not want to be involved in
remediation of problem credits, but can tolerate a bank counterparty
failing as long as it does not default on its debt.
Volatility implies the institution does not want any counterparty to
come close to failure, as its portfolio is particularly rating sensitive and
it would seek to avoid credits which are downgraded. Portfolios
subject to Fair Value/Mark to Market Accounting are most likely to fall
into this category.
WHAT SHOULD THE ANALYST
BE LOOKING FOR?
Bank analysts should be looking both a banks underlying
financial condition & also the probability of support.
Rather than looking just at the current rating and financial
conditions, analysts need to take a view on the expected
development of that rating in the future.
Downgrades can lead to the capital charge on the analysts own
institution increasing.
Downgrades can lead to the counterparty facing increased
collateral calls on its derivatives portfolio, which for a non-retail
funded bank could have a negative impact on liquidity, leading to a
downward spiral of downgrades.
Banks included in CDOs may be subject to a technical
definition of default, which could include payment delays.
Banks are less susceptible to payment delays than corporates.
This could still change the nature of the underlying analysis.
BANK ANALYSIS FOR
SECURITIZATION
Banks & their subsidiaries play many different
roles in securitization:
Seller/Servicer of the underlying assets.
If it is not possible to transfer servicing of the assets, the bank
must survive the deal in its current form.
Derivatives Counterparty.
Credit Enhancers.
Liquidity Providers.
GIC Providers.
Trustee/Custodians.
Paying Agent.
SELLER/SERVICER ANALYSIS I
For most roles, the bank can be analysed in
the normal manner.
Different approach required for seller/servicer
analysis.
Success of the securitization relies on the actions
of the bank.
If bank mismanages assets, securitization will fail.
Focus on ability and stability of the bank, not its
ultimate survivability.
SELLER/SERVICER ANALYSIS II
Does the bank have the necessary skills to
manage the assets?
Are the assets part of its core business?
e.g. residential mortgages originated by a UK building
society (Northern Rock, Halifax, Abbey National, etc).
e.g. credit card receivables from a specialist card lender,
such as MBNA or Capital One.
Are the assets non-core?
e.g. wholesale loans/CDOs managed by Abbey National plc
prior to its problems and sale to BSCH.
SELLER/SERVICER ANALYSIS III
Ability to manage the assets rests on retention of the
right staff and maintenance of the correct IT platform.
Is the bank making good profits?
Can it afford to invest in keeping a good technical platform?
Is the bank able to retain good staff?
Is it cutting costs, which might alienate key staff members
needed to service the assets?
Is it maintaining market share?
Bank might not be able to originate replacement assets if its
product range is no longer competitive.
What is the motivation for securitization?
Is the bank trying to hide problems by selling assets?
Is securitization a long term part of the banks funding and capital
management?
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