Moody's Corporation · NYSE:MCO
Moody's — Technical Presentation (February 2019)
30 slides from Moody's's technical presentation, February 2019
Slide 1: Credit Earnings Volatility and Share Price Performance: Implications of IFRS 9 and CECL
Credit Earnings Volatility and Share Price Performance: Implications of IFRS 9 and CECL Portfolio and Balance Sheet Research February, 2019
Slide 2: Presenters
PRESENTERS Amnon Levy, Managing Director, Moody's Analytics Dr. Amnon Levy heads the group responsible for research development and quantitative services related to Moody’s Analytics portfolio and balance sheet solutions. Pierre Xu, Director, Moody's Analytics Pierre Xu is a director of research at
Slide 3: Does Risk Management Add Value?
Does Risk Management Add Value? In order for risk management to matter, $ stable performance must be valued at a premium, compared to more volatile. Credit Earnings Volatility and Share Price Performance 3
Slide 4: Enter CECL and IFRS 9: Today's Agenda
Enter CECL and IFRS 9 Today’s Agenda 1 The relationship between accounting rules, credit earnings volatility and share price performance – How does the market interpret the volatility in financials? 2 Implications of credit portfolio management on share price performance – To what extent can credit
Slide 5: Why Earnings Volatility Matters
Why Earnings Volatility Matters » Impacts capital surplus and solvency » High volatility is associated with: – Concerns of opacity and questionable business practices – Concerns of questionable portfolio composition » Ultimately, volatility: – Impacts cost of capital – Limits business opportunities
Slide 6: Do Accounting Rules Add Value?
Do Accounting Rules Add Value? The Accounting Review Forthcoming Do the FASB’s Standards Add Shareholder Value? Khan, Li, Rajgopal, and Venkatachalam Market reactions are higher for firms where estimation risk is reduced. Credit Earnings Volatility and Share Price Performance 6
Slide 7: How Much Does Earnings Volatility Matter?
How Much Does Earnings Volatility Matter? Journal of Financial Economics Volume 90, Issue 3 | March 2008 Do Investors Value Smooth Performance? Rountree, Weston, and Allayannis “ ” The magnitude of the effect is substantial with a 1% increase in cash-flow volatility, resulting in approximately a 0.1
Slide 8: Observations From the Market
Observations From the Market WE EXPLORE the relationship between dynamics in WE CONTROL FOR financial statements and equity value of public US bank holding companies – Capital Structure from 2002 to 2017; roughly, 6000 › Debt-to-Assets Ratio observations. – Systematic Risk … where Equity Value = rat
Slide 9: Valuation and Components of Earnings Vol
Valuation and Components of Earnings Vol Dependent Variable: Ln(Equity Value) Beta t value* Ln(Volatility of interest income ) -0.028 -1.64 Ln(Volatility of interest expense) -0.062 -4.22 » A 1% increase in volatility of charge off will lead to a 12 Ln(Volatility of change in loss allowance) -0.080
Slide 10: Equity Valuation and Volatility
Equity Valuation and Volatility Cross Sectional contribution of credit earnings volatility in 2015 Q2 0.8 Ln (Charge Off Volatility) Ln (Equity Value) 0.6 0.4 0.2 0 -0.2 -0.4 -0.6 -0.8 -14 -12 -10 -8 -6 -4 -2 0 0.8 Ln (Change in Allowance Volatility) Ln (Equity Value) 0.6 0.4 0.2 0 -0.2 -0.4 -0.6 -0
Slide 11: Sensitivity of Equity Value to Volatility
Sensitivity of Equity Value to Volatility Variation across the credit environment 0.1 1.2 SD(Credit Earnings Volatility Regression Coefficient 0 1 -0.1 0.8 -0.2 0.6 -0.3 0.4 -0.4 -0.5 0.2 -0.6 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Year Sensitivity of Equity Value to Cred
Slide 12: Sensitivity of Equity Value to Volatility
Sensitivity of Equity Value to Volatility Variation across the credit environment 0.2 1.4 1.2 Regression Coefficient 0 Market Price of Risk 1 0.8 -0.2 0.6 0.4 -0.4 0.2 -0.6 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Sensitivity of Equity Value to Credit Earnings Volatility Market
Slide 13: Enter CECL and IFRS 9: Today's Agenda
Enter CECL and IFRS 9 Today’s Agenda 1 The relationship between accounting rules, credit earnings volatility and share price performance – How does the market interpret the volatility in financials? 2 Implications of credit portfolio management on share price performance – To what extent can credit
Slide 14: The Value of Credit Risk Management
The Value of Credit Risk Management The negative relationship between earnings volatility and valuation motivates exploring how much value a prudent credit risk management practice can add to a financial institution. We evaluate a credit risk management strategy: – Start with the same initial portfo
Slide 15: Reinvestment Policies
Reinvestment Policies Allocation of free cash-flow generated by a credit portfolio Interest Income Recovery from Defaults Matured Loans Free Cash is Used to Optimized reinvestment Originate Loans policy: Minimize earnings volatility Credit Earnings Volatility and Share Price Performance 15
Slide 16: Data for CECL Benchmark Portfolios
Data for CECL Benchmark Portfolios Seven US banks’ portfolios from Moody’s CRD/LAS database » There are seven US banks with data from 2005 to 2016, covering both pre and post crisis periods. » The benchmark bank portfolios include non-real estate term loans and revolvers that have bank-provided net
Slide 17: Data for the IFRS 9 Benchmark Portfolio
Data for the IFRS 9 Benchmark Portfolio A synthetic loan portfolio consisting of loans to public European firms Instrument Characteristics NEW ORIGINATION LOAN MARKET determined by outstanding liabilities of publicly traded firms – some adjustments for financial firms MATURITY determined by current
Slide 18: Realized Default Loss of Seven US Banks
Realized Default Loss of Seven US Banks The CRM strategy reduces default risk during the crisis period 1.8% 1.6% Percent of Notional 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% Bank Portfolios Combined Optimized Portfolios Combined Average Volatility The CRM strategy reduces Variable Benchmark Optimized
Slide 19: CECL Loss Allowance of Seven US Banks
CECL Loss Allowance of Seven US Banks The CRM strategy results in less CECL loss allowance Financial Crisis 2015-2016 stock market selloff 3.0% 2.5% Percent of Notional 2.0% 1.5% 1.0% 0.5% 0.0% Bank Portfolios Combined Optimized Portfolios Combined Credit Earnings Volatility and Share Price Performa
Slide 20: Change in CECL Loss Allowance of US Banks
Change in CECL Loss Allowance of US Banks The CRM strategy lowers CECL loss allowance volatility 1.5% 1.0% Percent of Notional 0.5% 0.0% -0.5% -1.0% -1.5% Bank Portfolios Combined Optimized Portfolios Combined Average Volatility The CRM strategy reduces Variable volatility of changes in loss Benchma
Slide 21: The Implication of CECL
The Implication of CECL Loans with shorter maturity and lower PD are preferred under CECL 3.5 3 Maturity (Years) 2.5 2 1.5 1 0.5 0 Bank Portfolios Combined Optimized Portfolios Combined 6.0% 5.0% Annualized PD 4.0% 3.0% 2.0% 1.0% 0.0% Bank Portfolios Combined Optimized Portfolios Combined Credit Ear
Slide 22: Portfolio Default Loss Volatility by Bank
Portfolio Default Loss Volatility by Bank The CRM strategy lowers volatility in default loss Default Loss Volatility Implied Increase in Bank Equity Value Benchmark Optimized Bank 1 0.53% 0.20% (63% ) 7.6% Bank 2 0.36% 0.13% (64% ) 7.7% Bank 3 0.42% 0.41% (2.4% ) 0.3% Bank 4 0.77% 0.47% (39% ) 4.7%
Slide 23: Portfolio Loss Allowance Volatility by Bank
Portfolio Loss Allowance Volatility by Bank The CRM strategy results in less loss allowance Change in Loss Allowance Volatility Implied Increase in Bank Equity Value Benchmark Optimized Bank 1 0.48% 0.14% (71% ) 5.7% Bank 2 0.93% 0.27% (71% ) 5.7% Bank 3 1.08% 0.37% (66% ) 5.3% Bank 4 0.62% 0.25% (6
Slide 24: Realized Default Loss of European Portfolio
Realized Default Loss of European Portfolio The CRM strategy reduces risk during the crisis period 4.0% 3.5% Percent of Notional 3.0% (Quarterly) 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Default Loss - Benchmark Default Loss - Optimized Portfolio Average Volatility The CRM strategy reduces Variable default los
Slide 25: Realized Loss Allowance Under IFRS 9
Realized Loss Allowance Under IFRS 9 The CRM strategy results in less IFRS 9 loss allowance Dot-com Crisis Financial Crisis Euro Debt Crisis 2015-2016 stock market selloff 1.6% 1.4% 1.2% Percent of Notional 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% Loss Allowance - Benchmark Portfolio Loss Allowance - Optimized
Slide 26: Change in IFRS Loss Allowance
Change in IFRS 9 Loss Allowance The CRM strategy lowers CECL loss allowance volatility 0.6% Percent of Notional 0.4% 0.2% (Quarterly) 0.0% -0.2% -0.4% -0.6% Change in LA - Benchmark Portfolio Change in LA - Optimized Portfolio Average Volatility The CRM strategy reduces Variable changes in loss allo
Slide 27: Realized Portfolio Characteristics
Realized Portfolio Characteristics PD to Maturity and Proportion of Stage 2 2.0% Probability of Default 1.5% 1.0% 0.5% 0.0% Average PD to Maturity - Benchmark Average PD to Maturity - Optimized 25% Percent of Notional 20% 15% 10% 5% 0% Benchmark Stage 2 Proportion Optimized Stage 2 Proportion Credit
Slide 28: Credit Earnings Volatility, CECL, IFRS 9 and Share Price Performance
Credit Earnings Volatility, CECL, IFRS 9 and Share Price Performance Accounting rules can have a material impact on 1 valuation. Opacity and cost can have a detrimental impact on valuation. Earnings volatility is negatively associated with 2 valuation. For financial institutions both charge off and
Slide 29: moodysanalytics.com
Amnon Levy Pierre Xu Moody’s Analytics Moody’s Analytics Head of Portfolio and Balance Sheet Research Head of Portfolio Risk Analytics Amnon.Levy@moodys.com Pierre.Xu@moodys.com moodysanalytics.com
Slide 30: Credit Earnings Volatility and Share Price Performance
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