LV Thạc sỹ_Improving the credit rating system at ACB bank

List of Tables and FiguresTable 1: Classification of Total Outstanding Loans Table 2: Classification of Company Size Table 3: Company size scores Table 4: Credit Scores for Credit Assess

I would like to send a sincere thanks to my lecturer, Prof…, National Economics University for guiding and enabling me to complete my theisis I give a sincere thanks to Ms…, Deputy Manager of the

Center, for her wholehearted supports to me during my internship I thank for the warm welcome spirit everybody at the Center have given to me and help me to complete my thesis.

Acknowledgement 1

ABSTRACT 6

CHAPTER I – INTRODUCTION 7

1.1 Rationale 7

1.2 Research Objectives 8

1.3 Research Methodology 8

1.4 Premises and Limitations of research 9

CHAPTER 2 – THEORETICAL BACKGROUND 10

2.1 Introduction to Credit risk 10

2.1.1 Definition of credit risk 10

2.1.2 Causes of credit risks 10

2.1.2.1 Instability economic environment 10

2.1.2.2 Ineffective macroeconomic management 11

2.1.2.3 Immature credit information management system at the nation scale 11

2.1.2.4 Limited legal framework 12

2.1.2.5 Credit risk from the side of the borrower 12

2.1.2.6 Credit risk from the commercial bank 13

2.2 Purposes of Credit Rating System 13

2.3 Principles of Credit Rating System 14

2.4 International experiences of CRS 15

2.4.1 Fitch Ratings Corporate Rating Methodology 15

2.4.2 Moody’s Rating Methodology 18

2.4.3 Standard & Poor’s corporate rating system 21

CHAPTER 3 – CREDIT RATING SYSTEM AT ACB 24

3.1 Introduction to ACB 24

3.1.1 Foundation and development of Asia Commercial Bank 24

3.1.2 Organizational Structure 25

3.2 Business result analysis of ACB from 2008 to 2011 26

3.3 Credit Rating System at ACB 32

3.3.1 Introduction of Credit Rating at ACB 32

3.3.2 Credit Rating Process 33

3.3.3 Collecting Information 34

3.3.4 Evaluating Collateral 36

3.3.5 Defining business area 36

3.3.6 Evaluating Company Size 37

3.3.7 Scoring Financial Criteria 38

3.3.8 Scoring Nonfinancial criteria 41

3.3.9 Calculating total score 44

3.4 Strengths and Weaknesses of the ACB Credit Rating System 46

3.4.1 Strengths and achievements 46

3.4.2 Weaknesses 48

3.4.3 Reasons 50

3.4.3.1 Lack of information 50

3.4.3.2 Lack of comparison with external credit rating agencies 51

3.4.3.3 Weak control of the credit rating process at branch levels 51

Chapter 4 – Recommendations & Solutions 52

4.1 Rating methodology recommendations 52

4.1.1 Adjusting quantitative analysis to include industry specialize 52

4.1.2 Modifying weighting nonfinancial criteria method 54

4.1.3 Increasing role of cash flow analysis in quantitative analysis 55

4.1.4 Using Stress Testing 56

4.2 Managerial recommendations 57

4.2.1 Increasing the awareness of Credit rating system to all employees 57

4.2.2 Refining the internal information system at ACB 58

CONCLUSIONS 59

REFERENCES 60

APPENDICES 61

Appendix 1 61

Appendix 2 62

Appendix 3 63

Appendix 4 64

List of Tables and Figures

Table 1: Classification of Total Outstanding Loans

Table 2: Classification of Company Size

Table 3: Company size scores

Table 4: Credit Scores for Credit Assessment

Table 5: Credit Scores for Loan Categorizing

Figure 1: Organizational Structure of the Asia Commercial Bank

Figure 2: Total Outstanding Loans from 2006 – 2011

Figure 3: Net Interest Margin from 2006 – 2011

Figure 4: Asset and Deposit’s growth from 2007 – 2011

Figure 5: Composition of Outstanding Loans Portfolio

Figure 6: Credit Process

Figure 7: Credit Rating Process

Diagram 1: Nonfinancial Analysis

Diagram 2: Credit Assessment for company without financial statementDiagram 3: Credit Assessment for company with financial statementDiagram 4: Loan Categorizing for company without financial statementDiagram 5: Loan Categorizing for company with finanacial statement

Abbreviation

3 CIC The Credit Information Center

The Vietnamese banking industry has come a long way since the country began its economic and financial reform program a decade ago The number of financial

institutions has risen quickly, following of many efforts from the Vietnamese

government to build and develop an advanced and efficient market

Banking firms, especially commercial banks, are always considered to be a back bone

of the whole financial system, which call for the greatest attention and supervisions

As the nature of banking business, credit risk is one of the major risks banks faced with There have been so many investments and human sources which commercial banks have devoted for their interenal credit rating systems so that they can depend onthis background and facilitate all other financial services

The main focus of this thesis is the internal credit process which is performed at the Asian Commercial Joint-Stock Bank First, an owverview of credit scoring techniquesand of corporate rating methodologies was given, by studying the interpretations and creiteria of some most famous credit rating system in the world After having an understanding on how these systems work, the theisis analyzed the internal credit rating system performed at the Asian Commercial Bank Next, an assessment of strengths and weaknesses of the rating method was given The last part of the thsis focused on the recommendations to improve the credit rating systems of the banks

For recent years in Vietnam, the economy and financial market have experienced arapid emergence; many investments and credit needs also follow the trend, and haveincreased considerably This turns the role of commercial banks as credit conciliatorsmore critical than ever Manufacturers and non-finance business, for the lack ofexpertise and knowledge or the unwillingness to reveal factual information, can hardlyprovide their credit status All must depend on banks internal evaluators to truly accessthese customers; and for their specific orientations, each bank normally builds itsparticular standard and criteria For ACB, the task is in hand of its “Credit RatingCenter for Business Customer-North Division”; and it’s so-call Credit Scoringcompendium full of quantitative and qualitative guidelines to rate business customers.All benchmarks set by this center are applied for every branch and subsidiary of ACB.Having much personal interest in banking industry and credit rating, I have chosen it

as my graduate thesis Writing about it, I would serve for the purpose of introducing,understanding the system’s advantages and disadvantages, and therefore realizingwhat can be improving in the Credit Scoring system at ACB Such paper will provide

deeper insight and individual opinions about credit rating as the center of attention inall commercial banks.

I present here my paper “Improving the Credit Rating System at Asia CommercialJoint-Stock Bank”

1.2 Research Objectives

This study aims:

 To understand how ACB measures the creditworthiness of its businesscustomers

 To analyze the strengths and weaknesses of the Credit Rating System

 To provide recommendations to improve the Credit Rating System

Qualitative Evaluation

A qualitative evaluation shall be utilized for this research including careful analysis ofobtained data to prepare different evaluation methods (i.e SWOT analysis) to analyzehow to best capture the creditworthiness using the system

Quantitative Evaluation

The research will study the performance of the ACB bank in general and of the CreditRating Center in particular during the period from 2006 to 2011 Quantitative toolsused are ratios analysis and trend analysis

1.4 Premises and Limitations of research

The premises of research are:

 The overview of Asia Commercial Bank

 The factors including in the Credit Rating System

 The quality and performance of the Credit Rating Center

computer-CHAPTER 2 – THEORETICAL BACKGROUND

***

2.1 Introduction to Credit risk

2.1.1 Definition of credit risk

Like other companies operate in the market, banks have to face with many underlyingrisks In banking industry, typical risks are Credit risk, Liquidity risk, Foreignexchange risk, Interest rate risk, Market risk, Operational risk, Regulatory risk

Credit risk, also known as default risk, is the biggest risk facing a commercial bank

By definition, credit risk is the risk of loss of principle or loss of financial rewardsresulted from borrower’ failure to repay the loan or to meet contractual obligations.Credit risk in Vietnam is defined in Decision 493/2005/QD-NHNN dated 22 April

2005 by the State Bank of Vietnam: “Credit risk in banking activities of the creditinstitutions mean the possibility of losses to be incurred in banking activities of creditinstitutions due to their clients’ failure or incapability to fulfill obligations ascommitted”

Estimation from State Bank of Vietnam indicates that the percentage of bad debt tototal outstanding loan in the banking system in 2011 is roughly 3.3%, higher than thepercentage of 2.14% of 2010

2.1.2 Causes of credit risks

2.1.2.1 Instability economic environment

As one participant of the market, commercial banks are affected largely by the currenttrend of the surrounding environment When the market is rising, businesses makemore money, and banking industry grow faster Similarly, when the market is stumble,most of the banks are deemed to be affected

In recent years, two financial crises swept through Vietnamese economic, causedmany difficulties to this young market Although we have seen some positive recovery

in recent period, such as the deceleration of the inflation rate in the second half of

2011, the damages the crises causes are still hurtful In the publication of the AnnualReport on Vietnamese corporation in 2011 by Vietnam Chamber of Commerce andIndustry (VCCI) and World Bank, the number estimated that during 2011, there arenearly 80,000 enterprises declared bankrupts Thus, credit risk management inVietnam is an important subject in banking industry

2.1.2.2 Ineffective macroeconomic management

Macroeconomic management comprises a set of policies including monetary, fiscaland exchange rate policies, which support the government in achieving short term andlong term national objectives

In Vietnam, the weak strategic and irresolute efforts to build good government havekept Vietnam in the group of countries with most corruption and ineffectivegovernment among the East Asian countries Misallocation and heavy dependence onexternal and natural resources, complex and overlap regulation framework,bureaucracy and pervasive corruption are some illustrations of the weak management

of the Vietnamese government

2.1.2.3 Immature credit information management system at the nation scale

The Credit Information Center (CIC) of the State Bank of Vietnam is the state-ownedorganization working in the field of collecting, processing, storing and forecastingcredit information in Vietnam Only from 2006, the center started to provide creditrating products, specialized in credit rating on enterprises From this point to date, thecenter has worked at its utmost efforts to improving products quality However, withonly 15 years in experience, credit information provided is still very simple and doesnot comprehend all characteristics of a typical enterprise While most banks and creditinstitutions consider the CIC as one source of information, the low qualityperformance of the center thus increases the credit risk banks have to face

2.1.2.4 Limited legal framework

Legal environment is understood as a system of laws and legislation related toactivities of banks in general and credit operations in particular Credit relations have

to be recofnized by law; law of credit must comply with the conditions and level ofsocioeconomic development In recent years, the government has provided manyamendments and supplements to the laws and regulations to support the developmentand operation of banking industry, yet the process to bring new regulations intopractices faces with many difficulties For example, Vietnam has regulation forforeclosure of the borrowers’ assets in case of loan default However, bank is abusiness entity and does not own enforcement power to foreclosure the asset of theborrower Thus, the process to collect and recover damage from default loan takeslong and troublesome for bank

2.1.2.5 Credit risk from the side of the borrower

- The borrowers don’t have enough management experiences or abilities to useeffectively the borrowing fund When the customers make loan to expand its business,they lose control and fail to carry out business plan

- The borrowers use window dressing on their financial status and accounting books tohide their weakness and potential lost When the credit rating agencies rely onuncorrected information, they will increase the credit risk the bank has to face.

- The borrowers use borrowing funds for different purposes to one stated in the loanrequest When the customers borrow money to invest in higher risk investments, such

as investment in real estate or the stock market, they will increase the real risk of theloan

2.1.2.6 Credit risk from the commercial bank

- In the credit decision process, the bank has to make credit assessment of theproposed plan In most of the case, the clients will try to make their investments tolook very promising with very low risk If the bank does not fully understand theimportant of the assessment step, but rely on the relationship and credit history of theclients with the bank, in many cases, the bank will accept some loan requests withhigher risk than the bank’s credit policy

- The supervision of the bank on outstanding loan is loose While the Credit rating andassessment process of the loan request are very detail and focused, many banks put alight weight on the reassessment of the carried out loan This process is very important

to keep tight control on how the clients use the funds, and whether do they meet withthe obligations of the loan contracts Fail to keep track of the performance of theclients will increase the risk to the bank

- The limitation of professional knowledge of credit clerks is another source for creditrisk If the Credit rating and assessment process are done by unsophisticated staffs, thebank will bear higher credit risk Moreover, unethical issues of some employees alsoincrease the credit risk Recently, many business crimes in the bank industry involvewith the collaboration between outsiders and the staffs to embezzle money or deceivebank with false loan requests

2.2 Purposes of Credit Rating System

(1) To limit credit risk

Bank cannot subtract credit risk from credit activities completely However, creditrating system is the mean bank use to assess the credit risk Through the credit ratingresults, ACB will decide whether or not the customer is accepted for the loan request;

or decide necessary actions on current loan clients

(2) To support customer policy

The Credit Rating System aims not only to define the creditworthiness of the customerbut also to decide the customer policy ACB use with the customers Customers withhigh credit ratings will receive more incentives than customers with low credit ratingresults

(3) To perform industry risk management and other macroeconomic risk controlBase on the credit ratings of many customers in the same industry, or by other meansstudy the overall industry and macroeconomic risk

(4) To perform debts classification process

The Bank has to perform classification of debts and set up and use of reserves forhandling credit risks, as simulated in the Decision No 493/2005/QD-NHNN TheBank has to base on the results of loan categorizing to make reserves

2.3 Principles of Credit Rating System

- The center of credit rating is the determination of the likelihood to default ofthe subject Credit rating system summarizes relevant information and theircombined effects to the subject’s credit worthiness into rating symbols Thepurpose of Credit rating system is to make relative ranking of credit worthiness

of different enterprises

- Credit rating use both qualitative and quantitative information and theircombined effects to assess the credit worthiness of the subject.

Quantitative data are financial information of the subject, including Liquidityratio, Operating efficiency ratio, Leverage ratio and Profitability ratio

Qualitative data focuses on subjective non-quantifiable information, such asmanagement expertise, industry cycle, supports from external sources…

- Credit rating between different subjects can be relatively compared Subjectswith higher credit rating are considered by credit rating system to be morecreditworthy than subjects with lower credit rating

2.4 International experiences of CRS

2.4.1 Fitch Ratings Corporate Rating Methodology

Fitch’s corporate ratings make use of both qualitative and quantitative analysis toassess the business and financial risks of corporate entities

Qualitative analysis

Industry risk

Fitch determines and issues rating within the context of subject’s industryfundamentals Industries that are in decline, highly competitive, capital intensive,cyclical or volatile are inherently riskier than stable industries with few competitors,high barriers to entry, national than international competition and predictable demandlevels Major industry developments are considered in relation to their likely effect onfuture performance The inherent riskiness and or cyclicality of an industry may result

in a ceiling for ratings of business entities in that industry

Operating environment

Fitch analyzes the risk and opportunities of one subject based on a social,demographic, regulatory and technological changes The effects of geographicaldiversification and trends in industry expansion or the consolidation are required tomaintain a competitive position

Also important are the stage of an industry’s life cycle and the growth or maturity ofproduct segments In rating cyclical companies, Fitch analyzes credit-protectionmeasures and profitability through the cycle to identify the mid-cycle rating of theentities When there are fundamental changes in financial policies or structuralchanges in the operating environment, Fitch will decide if it is needed to a ratingchange.

Market position

Another factor in Fitch’s credit rating is the market position of the companies Marketposition determines the ability of a business entity to survive the competitivepressures It includes the company’s position in the key markets, its level of productdominance and its power over the market price A company with high level of marketposition is rated higher in Fitch’s ratings

Management

Fitch’s assessment of management quality focuses on corporate strategy, riskmanagement, funding policies and corporate governance Corporate goals areevaluated to determine if management is short term goals oriented or optimizing forlong term performance

Although any assessment of the quality of management is subjective, financialperformance over time provides a more objectives measure Fitch assessesmanagement’s track record in terms of its ability to create a healthy business mix,maintain operating efficiency and strengthen market position Fitch also givesmanagement significant credit for delivering on past projections or maintaining pastprojected strategies when evaluating future growth plans

Accounting

While Fitch’s rating does not include an audit of an issuer’s financial statements, itexamines accounting policies and the extent to which they accurately reflect anissuer’s financial performance Relevant areas include consolidation principles,valuation policies, and inventory costing methods, depreciation methods, incomerecognition and reserving practices, pension provisions, treatment of goodwill and off-balance-sheet items The overall aim is to judge the aggressiveness of the accountingpractices and restate figures, where necessary to make the company’s financialscomparable with those of its peers Fitch also analyzes the differences among nationalaccounting standards and the effects these differences have on the financial results ofissuers within the same industry.

Because different accounting systems create huge different in analyzing, Fitch makesadjustments to ensure comparability of company to its peer group Such adjustmentsinclude adjustments for revenue recognition, asset values, leased property,contingency reserves, treatment of goodwill, provision for deferred taxes and off-balance-sheet liabilities

Quantitative analysis

The quantitative analysis of Fitch’s corporate ratings focuses on the business entity’policies in operating strategies, acquisitions and diversifications, financial leverage,dividend policy and financial goals The main objective of the analysis is thedetermination of the business’s ability to generate cash

Cash flow focus

Fitch emphasizes cash flow measures of earnings, coverage and leverage Analysis ofcash flow from operations provides a more accurately view than the studying of stand-alone ratios In addition, Fitch regards the analysis of trends in a number of ratios asmore relevant to any individual ratio, which represents only one performance measure

at a single point in time Fitch considers measures such as equity and capital are less relevant to a Credit Rating because they are based on book value and

debt-to-do not reflect the company’s debt-servicing ability as transparently as those based oncash flow generation.

Earnings and Cash flow

Key elements in determining a business entity’s overall financial health are earningsand cash flow, which affect the maintenance of operating facilities, internal growthand expansion, access to capital and the ability to survive in a stumble businessenvironment Fitch’s analysis focuses on the stability of earnings and continuing cashflows from the company’s major business lines Sustainable operating cash flowprovides assurance for the company to service its debt and finance its operations andcapital expansion without relying on external funding

Capital structure

Fitch analyzes capital structure to determine the business entity’s level of dependence

on external financing Several factors are considered, including the nature of itsbusiness environment and the principal funds flows from operations Becauseindustries differ significantly in their need for capital and their capacity to supporthigh debt levels, the financial leverage is assessed in the context on industry norms

Financial flexibility

Having financial flexibility provides a company with the ability to meet its service obligations and manage in the periods of downturn without destroying thecredit quality A commitment to maintaining debt within safe range, the ability toredeploy assets and revise plans for capital spending, strong banking relationships andaccess to debt and equity markets are factors contribute to the financial flexibility Incontrast, factors that diminish financial flexibility are large proportion of short-termdebt in capital structure, significant unfunded pension obligations, contingentobligations and unfunded other post-employment benefits other than pensions Each

debt-of these can cause drains on cash flow, which can severely reduce and eliminate thefinancial flexibility

2.4.2 Moody’s Rating Methodology

In 1909, John Moody set out a simple credit rating system for railroad bonds thatsummarized different features of credit worthiness – both quantitative and qualitative.Moody’s ratings are intended to provide investors with a framework for comparing thecredit quality of debt securities Credit rating represents an enormous amount ofinformation, including financial strength, default frequency, loss severity, andtransition risk

There are some basic principles applied in Moody’s rating methodology:

Emphasis on the qualitative:

Quantification is integral to Moody’s rating analysis However, Moody’s ratings arenot based on a defined set of financial ratios or rigid computer models Rather, theyare the product of a comprehensive analysis of each individual issue and issuer byexperienced, well-informed impartial credit analysts

Focus on the Long-Term:

Since Moody's ratings are intended to measure long-term risk, the analytical focus is

on fundamental factors that will drive the subject's long-term ability to meet debtpayments, such as a change in management strategy or regulatory trends

Therefore, the ratings of Moody’s are not intended to ratchet up and down withbusiness or supply-demand cycles or reflect last quarter’s earnings report It would bethe long-term credit worthiness of the subject that the rating presents

Global Consistency:

Moody’s provides global rating services Its approach incorporates several checks andbalances designed to promote the universal comparability of rating opinions.Internationally, ratings are normally limited to the sovereign ceiling rating of thenation in which the issuer is domiciled Moody’s equips its approaching team with

global industry specialists and analysts, and regional and other perspectives, in everyrating decision.

Level and Predictability of Cash Flow:

In every sector, the foundation of Moody's rating approach rests on the answer to onequestion: What is the level of risk associated with receiving full and timely payment

of principal and interest on this specific debt obligation and how does that riskcompare with that of all other debt obligations?

The analysis focuses, therefore, on an assessment of the level and predictability of thesubject's future cash generation in relation to its commitments to repay debt holders.Its main emphasis throughout the rating analysis is on understanding strategic factorslikely to support future cash flow, while identifying critical factors that will inhibitfuture cash flow The subject's capacity to respond favorably to uncertainty is also akey Generally, the greater the predictability of the subject's cash flow and the largerthe cushion supporting anticipated debt payments, the higher the rating will be

Reasonably Adverse Scenarios:

In coming to a conclusion, rating committees routinely examine a variety of scenarios.Moody's ratings deliberately do not incorporate a single, internally consistenteconomic forecast They aim rather to measure the issuer's ability to meet debtobligations against economic scenarios reasonably adverse to the issuer's specificcircumstances

"Seeing Through" Local Accounting Practices:

Moody's analysts deal frequently with different accounting systems internationally; it

is not based solely on any particular accounting standard

In examining financial data, Moody's focuses on understanding both the economicreality of the underlying transactions and on how differences in accounting

conventions may – or may not – influence true economic values For example, in theanalysis of assets the concern is with their relative ability to generate cash, not withthe value as stated on a balance sheet.

2.4.3 Standard & Poor’s corporate rating system

Credit rating services has its history back to 1860 when Standard & Poor’s wasfounded as an independent, publicly owned corporation It currently a leading creditrating services organization and a major publisher of financial information andresearch services on U.S and foreign corporate and municipal debt obligations TheCredit rating system of S&P is a criteria-based approach to assign and monitor creditratings globally The broad criteria apply to all type of companies – privately orgovernment owned, securitize structure and all type of assets classes These criteriaused for ratings by S&P are:

Creditworthiness before external support

The most important step in analyzing the creditworthiness of a corporate orgovernmental enterprise is measuring the resources to fulfilling its obligations withthe size and timing consideration It may include the estimation of future income andcash flows, economic conditions, the regulatory environment and macroeconomic

projections and forecasts For business entities, future income and cash flows comeprimary from ongoing operations or investment.

The assessment of resources considers both the expected level of future income andtheir potential variability The assessment includes both qualitative and quantitativefactors:

The quantitative side of the analysis focuses primarily on financial analysis andevaluation of the subjects’ accounting principles and practices For business entities,key financial factors generally include profitability, leverage, cash flow adequacy,liquidity and financial flexibility For financial institutions and insurers, other criticalfactors include assess quality, reserves, asset-liability management, capital adequacyand off-balance sheet items Trends overtime and peer comparison may be part of thequantitative analysis

On the qualitative side, the analysis of business entities focuses on various factors,including: country risk, industry traits, and entity-specific factors such as experiences

of manager team, brand images and corporate values Country risk assessmentcaptures the financial and operating environment that applies broadly to businesses in

a particular country, including its physical, legal and financial infrastructure Industrytraits comprise growth prospects, volatility, and technological change, as well as thedegree and nature of competition Entity-specific factors include diversification of thebusiness entities’ products and services as well as risk concentrations, especially withfinancial institution S&P also takes into analysis the entities’ operationaleffectiveness, overall competitive position, strategy, governance, financial policies,risk management practices, and risk tolerance

External support

In addition to the stand-alone creditworthiness, Standard & Poor’s analysis considerthe potential amount of external support or influence that could enhance (or diminish)the credit worthiness of the subjects rated Guaranties derived from contractualsupports may increase the credit worthiness of the business entities, but only when

they satisfy stringent conditions and guarantees full and timely payment of theunderlying obligations.

Apart from formal guarantees, S&P also considers the potential support from affiliatedentities It considers both the degree of strategic importance of subsidiaries oraffiliates to determine the likelihood and degree of support by a stronger parent andthe capacity to provide support

In some cases, external support can have a negative influence on an entity’screditworthiness A weaker parent company may drain cash flows or assets from astronger subsidiary and reduces the creditworthiness of the subjects Similarly, asovereign government can be a negative factor for a company’s creditworthiness if itintervenes by withdrawing resources or limiting the company’s financial flexibility

Analysis of specific instruments

The analysis of specific instruments includes consideration of priorities of an entity’scapital structure The analysis may apply when company uses different classes ofsecuritization and debts in its capitalizing funds Based on the payment priorities andpotential effects to the company’s assets in case of default, the analysis assigneddifferent instruments to ranks above or below the company’s senior, unsecured debt

CHAPTER 3 – CREDIT RATING SYSTEM AT ACB

***

3.1 Introduction to ACB

3.1.1 Foundation and development of Asia Commercial Bank

Asia Commercial Joint-Stock Bank (ACB) was established under the BusinessLicense No 0032/NH-GP dated 24 April 1993 by the State Bank of Vietnam andEstablishment Permit No 533/GP-UB dated 13 May 1993 by the People’s Committee

of Ho Chi Minh City ACB started operations on 04 June 1993 The founders of ACB,possessing financial strength, business knowledge, entrepreneurial experience andsharing a common business principle for “managing the development of the enterprise

in a safe and effective way”, cemented unity in the organization

Year 2000 marked the beginning of the first part in ACB’s reengineering companystructure, which separated business activities from support activities

ACB provides full line services in both consumer and business sectors ACB hascontinuously develops during 17 years in operation Especially in between 2004-2009,ACB has grown from 25,000 billion VND to 170,000 billion VND, proving thestrength of the bank ACB has expanded its branch network in order to target marketsnationwide and simultaneously established the following subsidiaries in 2009:Securities Company (ACBS), Asset Management Company (ACBA), LeasingCompany (ACBL), and Capital Company (ACBC) Up to 2011, ACB has 4subsidiaries with total revenue in 2009 reach VND 377 billion ACB continuouslyreceives honorable awards for its successful performance In 2009, the bank receivesthe awards “Best bank of Vietnam” from world-top journals such as: “GlobalFinance”, “Euromoney”, “Asiamoney” and “Finance Asia” In 2010 and 2011, ACB

receives award for “Best Bank of Vietnam” and “Best Company goes throughcrisis”…

3.1.2 Organizational Structure

Source: ACB’s Annual Reports

Figure 1: Organizational Structure of the Asia Commercial Bank

The organizational structure of ACB is a combination of a typical bank with a jointstock company Because ACB is a joint-stock company, its highest entity is theGeneral Shareholders Meeting The second highest layer in the company is the board

of management, who comprises the Board of Founders and Board of Directors, acting

on behalf of the Shareholders to run the company Shareholders have a SupervisoryBoard, a controller of the shareholders, whose main purposes are to assure thetransparency and to avoid conflicts of interest in the boards of management

Below the management level, ACB structure is very similar to a usual commercialbank ACB has 7 departments Consumer banking division takes care of individualsand household customers Commercial banking division is in charges of businesscustomers and institutional customers Treasury division, Business developmentdivision, Operations division, HRM division and IT center are supporting divisions ofACB The sub-departments are too details and not the main focus of this paper

3.2 Business result analysis of ACB from 2008 to 2011

3.1.1 Positive improvements in Operation Results

Strong performances in credit activities

The strength of ACB rests in its abilities to keep strong growth in lending activitiesover many years (see figure 2) The year 2011 marked another difficult year for theeconomy in Vietnam, as high inflation and bad debts issues were still storming overthe banking industry State Bank of Vietnam applied many restrictions andrequirements during 2011, such as to keep total credit growth at 20% growth andcredit growth in non-production lending below 16% by the end of the year Withstrong and accurate Credit policies, ACB has managed to keep the bank on the righttrack In 2011, total outstanding loans were VND 102,809 billion, increasing 18%comparing to loan balance in 2010

Source: ACB’s Financial Statements

Figure 2: Total outstanding loans from 2006 to 2011

Interest income increase in absolute term by 70% in 2011, resulted from the stronggrowth in outstanding loans Gladly, the net interest income in 2011 is VND 6,608billion, increase 60% compared to last year During years, the interest income andinterest expense at ACB have grown together, proving the abilities of the bank to keephealthy growth and to keep cost in control

Another result that proves the bank abilities to keep tight cost control is the netinterest margin Net interest margin of bank institution measures the gross margin ofinterest revenue yield from earning assets (which is mainly from customers’ deposit).Figure 3 shows the positive result of ACB from 2008 to 2011

Source: ACB’s Financial Statements

Figure 3: Net Interest Margin from 2006 to 2011

Stable growth in Asset and Deposit

Total asset of ACB increased at a fast pace in 2011 Looking back from 2006 to 2011,

it is clearly that ACB is on its way to recover from the financial crisis The asset growrate dropped in 2010 to only 22%, proving the difficulties the bank faced in the year,but then jumped back to high as 37% Total asset grew to VND 281,019 billion,increased approximately VND 80,000 billion

The growth in asset reasoned from the growth in total customers’ deposit Figureshows the total asset growth and deposit growth of ACB from 2007 to 2011

The year 2011 has seen many storms in the banking industry Due to high inflationand the devaluation of Dongs, the money inflow to banks reduced significantly, aspeople rushes to save money in other shelters like gold or Dollars All banks inVietnam have used many marketing campaigns, including attractive interest rate,terms, bonuses and promotion gifts to draw the funds ACB, with strong images and acustomer-focused culture, has proved its reputation

Asset and total deposit grew together, proving that ACB always focus on its mainactivities – providing deposits and savings services to customers

Source: ACB’s Financial Statements

Figure 4: Asset and Deposit Growth from 2007 to 2011

3.1.2 Outstanding risk management performance

In support of its expansion plan, ACB has made significant progress in systemdevelopment over the years, including the assistance of foreign shareholders In 2005,ACB had Standard Chartered Bank as a strategic stakeholder, providing consultingand assistant programmers in the areas of risk management, asset liabilitymanagement, balance sheet management and human resources Risk-based pricinghave been implemented on the output of the bank’s credit scoring and rating systems

By the end-2011, the total collateral value ACB held valued VND 255,816 billion,approximated 2.5 times total loans, mostly composed of real estate collateral

Customer loan book composition and quality

Source: ACB’s Financial Statements

Figure 5: Composition of Out Standing Loans Portfolio

Despite strong growth over the last five year, the composition of loans portfolioremains stable The bank continually focuses on lending on short term On average,short term loans accounts for 50% of total outstanding loan The bank extendsvirtually to all type of customer domestically; however most loans are dominated indomestic currency In 2011, loans in VND account for 74%, while loans in foreigncurrencies and gold accounts for 26% left

In 2011, gross loans to customers grew by 18% Since 2006, ACB has increased itsloan book from VND 17,396 billion to VND 102,809 billion, more than six-fold Thegrowth has, however, altered the quality of the loans portfolio Impaired loans (Group4-5) have increased significantly in 2011

However, 2011 has recorded no significant credit losses Therefore, ACB should focus

to improve its loans portfolio in the next year

Table 1: Classification of Total Outstanding Loans in 2010 and 2011

Source: ACB’s Financial Statements

Liquidity and funding

Structurally, ACB’s balance sheet remains relatively liquid While the outstandingloan portfolio is bias towards shorter maturities, the total deposit composition mainlycomposed of saving deposit The loans/ deposits ratio remained low and relativelystable at around 50%

In the normal course of business, the Bank makes various commitments and incurscertain contingent liabilities that are presented in the off-balance sheets The aggregateamounts of outstanding guarantees, letters of credit and other commitments at the end

of the year were VND 5,962 billion, increased 46% to last year Trading optionsactivities of 2011 reach VND 25,370 billion dropped 14% to last year Off-balancesheet activities of ACB during 2011 did not pose any significant losses

3.3 Credit Rating System at ACB

3.3.1 Introduction of Credit Rating at ACB

ACB Credit Rating Center (CRC for short) was established from the first day of the bank, with the main purpose was giving credit quality decisions for credit policies andsupporting the risk management policies Through 17 years of experience with many changes adapting to current business environment, CRC has proved its abilities with high quality results From 1992 to date, the percentage of doubtful loans and bad debts

in the loans and advances to customers of ACB has been always keeping under 0.5% Healthy loan outstanding portfolio is the major strength of ACB

The CRC – Northern division, is one in three branches of CRC It serves Northernregion, from North of Vietnam to Thanh Hoa provision

The main functions of Credit Rating, if be categorized by the current position of theloan, include: Before credit events (assessments of credit applications) and after creditevents (categorizing loan outstanding)

Before credit events – the assessment of credit applications

ACB CRC provides credit qualification report on new customers and credit loanapplications This report is one of the obligatory documents for credit assessmentprocess

The Credit Assessment report reflects ACB credit policies and risk managementpolicies By quantifying credit risk of customer, based on the scoring system, ACBcredit Rating Staff has a clear view on the credit situation This is an importantcriterion because it will affect the credit decision on the credit orientation of thecustomer

After credit events – the categorizing loan outstanding

Outstanding loan is the largest asset in the balance sheet of the bank Managers musthave a complete understanding on the current position of bank’s loan portfolio ACBCRC builds a customer credit information data system in order to provide such areference to managers:

- Supporting credit portfolio management by industry

- Providing industry risk analysis based on customer credit profiles at ACB

3.3.2 Credit Rating Process

The process to make business loan analysis, either for credit assessment or for loancategorizing, has to follow logical and accurate defined steps to help ACB CreditRating Staffs make rightful decision over applications The complete diagram of thecredit process has 6 steps, from the beginning where the customer came to ACB withloan request, and through the analysis system to the contract signing

Source: ACB’s Credit Books

Figure 6: Credit Process

This paper focuses on the Credit Rating, which is step 3 in this diagram, circled red in Figure 6 Credit Rating includes 8 tasks to be done, illustrated in Figure 7:

Source: ACB’s Credit Books

Figure 7: Credit Rating Process

3.3.3 Collecting Information

The first and very important step in Credit rating is collecting information fromcustomer Without sufficient and accurate information, the whole chain is worthless,and Credit rating report is meaningless As a result, at this first step, Credit RatingStaff has to carefully collect required information from customer Main sources tocollect information are:

- Customer’s loan application package: when customers come to ACB and requestloan, they have to submit application packages, which include basic information ofthe business: legal business certificate, licenses, documents related to businessperformance such as financial statement, business performance report, taxcompliance report, outstanding loan report at credit institutions…, business plans,detail project plans of the customers This source of information is very important