LV Thạc sỹ_Improving credit rating system of BTMU for japanese companies in Vietnam

- Access modern theoretical basis on borrower rating system, its application in commercialbanks and experience in borrower rating system of some leading Credit Rating Agencies inthe worl

First and foremost, we would like to express our sincere gratitude to our supervisor, PhD

…, Faculty of Banking and Finance of National Economic University for her guidance,stimulating recommendations and encouragement in order to complete our thesis Thanks toher patience, enthusiasm and constant support, we can complete our thesis timely andexcellently

Secondly, we would like to convey our thanks to Viet Belgum Master Programme withrespectable professors, teachers for their meaningful lectures and kindly assistants to MBAstudents They have imparted valuable knowledge and experiences to us through manyinteresting projects, documents and case study

Our next gratitude should be sent to the Bank of Tokyo-Mitsubishi UFJ, Ltd., Hanoi Branchwhere we have been working for about 5 years for giving us not only working experiencebut also cooperation in supporting our pursue of master degree The Bank has provided usthe ways to approach a research problem and the need to be persistent to accomplish anygoal

We wish to also acknowledge the contributions from officials of some of the commercialbanks that we liaised with for sharing their time to support us the figures and informationconcerning our study

Last but not least, we would like to thank my families for their support and encouragement

as well as our dear colleagues and classmates who always keep contact and exchange ideasand documents to pursue our interest

LIST OF ABBREVIATION

BIDV Bank for Investment and Development of Vietnam

BTMU The Bank of Tokyo-Mitsubishi UFJ, Ltd

CFO Cash flow from operations

CIB Corporate and Investment Banking

CIC Credit Information Center

CRAS Credit rating agencies

CSR Corporate Social Responsibility

EBITDA Earnings before interest, tax, depreciation, amortization

EBITDAR Earnings before interest, tax, depreciation, amortization and rental or

lease expenditure

FDI Foreign Direct Investment

FFO Funds Flow from operations

FOCF Free Operating Cash Flow

G-CARS Global Credit Application & Rating System

IAS International Accouting Standards

IASB International Accouting Standards Board

IFRS International Financial Reporting Standards

JCR Japan Credit Rating Agency, Ltd

M&A Merger and Acquisition

Moody’s Moody’s Investor Service

MPI Ministry of Planning and Investment

MUFG Mitsubishi UFJ Financial Group

ODA Official Development Assistance

S&P Standard & Poor’s

SBV State Bank of Vietnam

VAS Vietnam Accouting Standards

Vietcombank Joint Stock Commercial Bank for Foreign Trade of Vietnam

TABLE OF CONTENTS

LIST OF TABLE

LIST OF FIGURES

INTRODUCTION

1 Rationale of the study

Leafing through any local newspaper, one will see news of the national stock market orfinancial changes running the headlines Turning in any local TV channel, one will findeconomics and financial reviews dominating golden broadcasting hours Since Vietnamaccelerated its development speed, the country’s swollen wounds of wars has no longerbeen a popular topic; instead, everyone has been talking about business and finance It can

be evidenced that in recent years, Vietnam has been one of the fastest-growing economies

in Asia in recent years, with GDP growth averaging 7.1% annually between 2000 and 2011.Vietnam banking industry, therefore has been developed rapidly and reformed substantiallyover the past few years in which credit activities – the core activity of commercial bankshas booming with a lot of diversified type of products and contributed a major part ofbank’s revenue However, the accumulation of revenues from credit activities alwaysaccompany with credit risks which must be taken by the bank Other than lending, banksare increasingly facing credit risks in various financial instruments including acceptances,

interbank transactions, trade financing, issuance of guarantees, etc Credit risk therefore isone of great important factors must be seriously taken into account by the bank whengrating credit limit to customers Hence, it is vital for any commercial banks to strengthentheir own policies of credit risk management with the aim to earn profit correlative withaccepted risk.

Present in Vietnam since 1993 with the first representative in Hochiminh city, The Bank ofTokyo-Mitsubishi UFJ, Ltd., (BTMU) since then has being approached and step by stepcaptured Vietnamese finance market The main activity of BTMU in Vietnam is tofinancially support Japanese corporates’ subsidiaries established in Vietnam For the past 10years, BTMU has been extending credit limits to hundreds of Japanese corporates and thisnumber shall continue increasing in the time to come It is witnessed that BTMU has gain alot of achievements on its business through the sound supply of financing to Vietnammarket as well as strict compliance with Vietnamese and Japanese laws and regulations.However, on the other hand, BTMU’s activities in Vietnam have been facing with manydifficulties due to the instability of economy, especially the recent slowdown of globaleconomy BTMU must be more cautious before making any credit decisions However, thenumber of applications for roll-over/restructuring loans to BTMU has increased so far Lack

of an efficient and consistent system of credit risk evaluation is the main reason for theseproblems And gradually its credit rating system shows some existents which have beenpotentially hiding credit risks

In addition to that, in the recent few years, there has witnessed a lot of bankruptcy andM&A of giants in the financial market due to the impact of the global economic turmoil.The main reason is that many financial institutions and Credit Rating Agency have failed inevaluating creditworthiness and assigning credit rating to their borrowers Under thatcircumstance, credit rating system has soon recognized as of great importance in thefinancial market BTMU’s credit rating system with many existing discrepancies, thereforeneed to be improved to have more accurate and efficient assessment on its borrower Inorder to strengthen the credit risk management, it is necessary to improve the currentborrowers’ credit rating system of BTMU to adapt with new global trend of development aswell as Vietnamese market condition

2 Research objectives/Research questions

The research has 3 main objectives:

- Access modern theoretical basis on borrower rating system, its application in commercialbanks and experience in borrower rating system of some leading Credit Rating Agencies inthe world as well as financial institutions in Vietnam

- Evaluate borrower rating system of BTMU for Japanese companies in Vietnam; analyzeits achievement and limitation in some actual situations

- Based on the mentioned study and evaluation, in refer to the strategy of development,propose recommendation to improve credit rating system with a view to strengtheningcredit risk management for Japanese corporate at BTMU in Vietnam

This research will answer the following questions:

- What is credit rating system and how important is it to a bank’s activities?

- Why does BTMU in Vietnam still fail to evaluate exactly and efficiently support to creditrisk management policy for Japanese companies?

- What is the strength and limitation of this system?

- How can the bank improve the system in order to enhance effectively its policy of riskmanagement whereas still make full use of strength?

3 Research methodology

This study is done based on the combination of some different types of methodology:

- Literature review on credit rating system, credit risks, credit activities to summarizetheoretical issues and the importance of this matter

- Comparison of credit rating systems among famous credit rating agencies and commercialbanks in Vietnam

- Conducting case study research on some situations actually happening in BTMU inVietnam’s business activities to find out some holes and inconsistency of this rating system

- Using qualitative method with secondary data from BTMU’s database

4 Research scope and structure

This study targeted to the credit rating system of BTMU currently being applied in Vietnamfor Japanese corporate customers only The information and figures were collected from

2007 to Jun 2012

This study is structured with three chapters as following:

Chapter 1: Theorical background on credit rating system for companies in Commercial banks

This chapter shall mention about the theoretical study on credit rating systems as well asexperience of some international Credit Rating Agencies and Commercial Banks inVietnam

Chapter 2: Credit rating system in BTMU for Japanese companies in Vietnam

- Introduction about BTMU in Vietnam

- Introduction about BTMU’s credit rating system for Japanese customers

- Research on some actual cases of rating assigning for corporate of BTMU

- General assessment on BTMU’s rating system: achievements as well as existentissues

Chapter 3: Recommendations to improve the credit rating system of BTMU for Japanese companies

In this chapter, through BTMU’s development strategy, some recommendations to improveBTMU’s credit rating system are proposed

CHAPTER I: THEORETICAL BACKGROUND ON CREDIT RATING SYSTEM FOR COMPANIES IN COMERCIAL BANKS

1.1 Credit rating system for companies

1.1.1 Definition of credit rating

Credit rating is a process which estimates the credit worthiness of a debtor, especially

a business (company) or a government It is an evaluation made by a credit rating agency or

a commercial bank of the debtor's ability to pay back the debt and the likelihood of default

In credit agencies, the credit rating represents the credit rating agency's evaluation ofqualitative and quantitative information for a company or government; including non-publicinformation obtained by the credit rating agencies analysts Credit ratings are not based onmathematical formulas Instead, credit rating agencies use their judgment and experience indetermining what public and private information should be considered in giving a rating to

a particular company or government

In banks, the internal credit rating summarizes the risk properties of the bank loan portfolioand is used to manage their risk Internal ratings can also be considered to containevidences of the private information that banks possess, and distinguishes them frompublic ratings of credit bureaus and bond rating agencies The internal ratings areexplicitly meant to reflect borrower default risk, not facility risk, nor the expected loss rate.Internal ratings are the outcomes of a judgmental process that, depending on the type offirm (quoted or not) and the size of the exposure, was supported by quantitative tools.The credit rating system is a “system to objectively evaluate credit risk (i.e the probability

of future credit losses for the Bank) of borrowers and facilities (transactions) to whichbanks extend credit

1.1.2 The purpose of credit rating

As mentioned previously, a credit rating is a comprehensive tool for assessment of anobligor’s creditworthiness, of reliability of its debt obligations and for establishing fee forrelevant credit risk It allows the rating’s bearer to show potential investors and partners itscreditworthiness without divulging any confidential information, and to make relationsbetween obligor and investor highly transparent and efficient Assignment of credit ratingenables quantification of credit risk, thus further realizing integrated control andmanagement of the credit risk with other risks such as market risk, etc

A high credit rating enables the obligor to get resources at lower rates, although a creditrating itself, whatever level it is, is a benefit for the obligor, since it exhibits informationtransparency of the entity rated

1.1.3 The importance of credit rating

Today credit ratings are the most reliable source of information on creditworthiness of apotential business partner A rating report contains impartial information, which isnecessary for analysis of investment risks

It is an opinion formed by credit evaluators of a borrower’s potential to repay debt Everyrating grade comes with its possibility of default, which in turn assists investor/lender totake informed investment decision Various financial, non-financial parameters, past credithistory and future outlook are determined before coming to a rating For a commercialbank, credit rating help to give out a estimation about the possibility of credit riskoccurrence which is an economic difference between what the borrower can promise torepay and what the commercial bank really receive

Firstly, credit rating helps reducing information asymmetry One way to describe the role ofcredit ratings is in terms of how information, or the lack of it, affects the actions ofparticipants in financial markets In short, credit ratings can help reduce the knowledge gap,

or "information asymmetry," between borrowers and lenders The essential subject matter

of this information asymmetry is a borrower's creditworthiness A borrower knows its owncreditworthiness better than a lender does And because creditworthiness is not a directlyobservable attribute, a lender generally has to estimate it from attributes that are observable,using various approaches One is to perform its own analysis; another is to use credit ratingsfrom independent rating agencies; and another is to use information and analysis provided

by third parties or other analysts In conclusion, credit ratings help close the informationgap Of course, this problem is one of gradations, rather than absolutes A lender has someability to distinguish between high-risk and low-risk borrowers, but that ability is imperfect.Although the lender may be able to correctly characterize potential borrowers most of thetime, it will inevitably mischaracterize some In addition, borrowers' riskiness spans acontinuum; there are not merely two categories Although a lender can adjust the interestrates it charges based on its assessments of borrowers' riskiness, these adjustments may besuboptimal because the assessments may be imprecise or inaccurate

Secondly, credit ratings help to improve market function and efficiency Credit ratingscontribute to the operation of markets, rather than on the effect on specific marketparticipants in specific transactions Essentially, credit ratings reduce the ability of oneinvestor to outperform another by making better judgments about creditworthiness Themost obvious role of credit rating is to serve as an unbiased, independent "second opinion"that an investor can use to confirm or refute his or her own analysis

Therefore, credit rating can provide banks with safety and soundness by facilitatinginformative decision making Credit rating allows banks to manage and examine risk to

optimize return by making important decisions relating to credit limit, loan pricing, creditadministration, etc Higher risk credits with worse credit rating shall be controlled morestrictly and regularly by providing banks with more detailed and even confidentialinformation about their current business performance.

1.1.4 Credit rating system of credit agencies

A credit ratings agency (CRA) is a company that assigns credit ratings for issuers of certaintypes of debt obligations as well as the debt instruments themselves CRAs specialize inanalyzing and evaluating the creditworthiness of corporate and sovereign issuers of debtsecurities (in this dissertation, we will focus on corporation only) Rating agencies' role inthe market is significant, but it is also specialized and somewhat limited The main flow ofinformation in the capital markets is from issuers to investors A secondary flow ofinformation comes from exchanges, data vendors, and trading desks in the form of pricesand trading flows Rating agencies provide a third source of additional informationconsisting of independent credit opinions

The Big Three credit rating agencies are Standard & Poor's (S&P), Moody's, and FitchGroup S&P and Moody's are US-based, while Fitch is dual-headquartered in New YorkCity and London Moody's and Standard & Poor's market share was around 40% each, andFitch's market share was around 15%; the Big Three therefore held 95% of themarket However these figures understate the dominance of Moody's and S&P, since thenorm for debt issuers is to obtain ratings from these two, and only occasionally turn toFitch, for example if Moody's and S&P disagree

1.1.4.1 Credit rating system of Moody Investor Service (Moody’s)

Moody's Investors Service is a leading provider of credit ratings, research, and risk analysis.Moody's commitment and expertise contributes to transparent and integrated financialmarkets The firm's ratings and analysis track debt covering more than 110 countries,11,000 corporate issuers, 22,000 public finance issuers, and 94,000 structured financeobligations

(a) Moody’s rating methodology

Moody’s methodology begins with rating the creditworthiness of borrowers whose loanswill be present in the portfolio The second step in the procedure is to consider thediversification of the loans that make up the portfolio Moody’s uses a proprietary systemcalled “Diversity Scores” which summarizes into one number, the extent to which a loanportfolio is diversified across borrowers and industry groups The purpose of diversification

is to control the extent to which it is likely that defaults among borrowers would be

correlated and hence likely to occur concurrently rather than as independent events TheDiversity Score system operates by quantifying the level of credit support (subordination)which is required to achieve a particular level of credit rating given a loan portfolio of agiven average quality rating and level of diversification by issuer and industry Basiccriteria required in evaluating diversification in Moody’s observance are inter-industrycorrelation, intra-industry correlation, default risk, recovery rates, possibilities in ratingchanges.

(b) Corporate rating scale

Figure 1.1: Coporate Rating scales for short-term and long term of Moody’s

Source: Moody’s rating symbol and definition, http://www.moodys.com

1.1.4.2 Credit rating system of S&P

(a) S&P’s rating methodology

Standard & Poor’s uses a format that divides the analytical task into several categories,providing a framework that ensures all salient issues are considered For corporates, thefirst several categories are oriented to fundamental business analysis; the remainder relate

to financial analysis As further analytical discipline, each category is scored in the course

of the ratings process, and there are also scores for the overall business risk profile and theoverall financial risk profile A rating is, in the end, an opinion Indeed, it is critical tounderstand that the rating process is not limited to the examination of various financialmeasures Proper assessment of debt protection levels requires a broader framework,involving a thorough review of business fundamentals, including judgments about thecompany’s competitive position and evaluation of management and its strategies Clearly,such judgments are highly subjective; indeed, subjectivity is at the heart of every rating Attimes, a rating decision may be influenced strongly by financial measures At other times,business risk factors may dominate If a firm is strong in one respect and weak in another,the rating will balance the different factors Viewed differently, the degree of a firm’sbusiness risk sets the expectations for the financial risk it can afford at any rating level InS&P methodology, corporate credit analysis factors include:

• Business risk:

S&P’s business risk analysis involve industry characteristics, competitive position andmanagement evolution Industry analysis shall focus on the dynamics of that business, thestrength of industry prospects, as well as the competitive factors affecting that industry The

many factors assessed include industry prospects for growth, stability, or decline, and thepattern of business cycles It is critical to determine vulnerability to technological change,labor unrest, or regulatory interference Competitive position is the key of business analysis

as a company’s rating is affected crucially by its ability to achieve success and avoid pitfalls

in its business The last factor, management is assessed for its role in determiningoperational success and also for its risk tolerance

• Financial risk:

Financial risk is evaluated largely through quantitative means, particularly by usingfinancial ratios and indicators such as: Financial policy, Profitability and coverage, Capitalstructure/leverage and asset protection, Cash flow protection, Financial Flexibility

Figure 1.2: Standard & Poor’s risk factors for corporate ratings

(b) S&P rating scales:

S&P’s credit rating symbols provide a simple, efficient way to communicatecreditworthiness and credit quality

Figure 1.3: Rating scales for corporate of S&P

Source: SP_ CreditRatingGuide

1.1.4.3 Credit rating system of Fitch:

(a) Fitch’s methodology

Fitch’s corporate ratings reflect both qualitative and quantitative factor encompassing thebusiness and financial risks of the corporate Fitch’s analysis typically covers at leastthree years of operating history and financial data, as well as the agency’s forecasts offuture performance These are used in a comparative analysis, through which the agencyreviews the strength of the corporate business and financial risk profile relative to that ofothers in its industry and/or rating category group

For qualitative analysis, there are some key rating factors in this issue: industry risk,operating environment, company profile, management strategy/governance, groupstructure

For quantitative analysis, Fitch’s financial analysis emphasizes cash flow measures ofearnings, coverage and leverage Sustainability of cash flow from operations provides acompany with both internal debt-servicing resources and a stronger likelihood ofachieving and retaining access to external sources of funding Fitch regards the analysis

of trends in a number of ratios as more relevant than any individual ratio, whichrepresents only one performance measure at a single point of time

Fitch uses a variety of quantitative measures of cash flow, earnings, leverage andcoverage to assess credit risk, in which EBITDA is still an important measure ofunlevered earnings capacity, and the most common used measure for going-concernvaluations As such, EBITDA plays a key role in Fitch’s recovery analysis fordefaulted loan The key credit metrics used to analyze credit default risk are: Funds flowfrom operations; Cash flow from operations (CFO); Free cash flow (FCF); EBITDAR(earnings before interest, tax, depreciation, amortization, and rental or lease expenditure)and other leverage and coverage ratios: EBITDAR/Fixed charges cover, FFO/interest cover, CFO/interest cover, FFO/Fixed charges, Adjusted debt/operatingEBITDAR…

(b) Fitch’s rating scales for corporate

Figure 1.4: Rating scales table for corporate of Fitch’s

Source: h t t p :// www f i t c h r a t i n g s c o m

1.2 Credit rating system for companies in commercial banks

In general, credit rating systems in commercial banks and in credit rating agencies have

some points in common In both the organizations, it is the system to help in estimating thecredit worthiness of a debtor, especially a business (company) or a government Throughthe credit rating system, credit rating agencies or commercial banks can evaluate thedebtor's ability to pay back the debt and the likelihood of default The credit rating systemreflect both qualitative and quantitative factor encompassing the business and financialrisks of the corporate Credit rating is measured against a uniform scale so that each

“borrower rating,” "facility risk rating”, and/or “structured finance rating, assetsecuritization rating” can be compared The same credit rating represents the same level ofcreditworthiness, regardless of borrower or type of facilities (transactions)

However, there are several differences between the two systems Firstly, it is the difference

in position to the debtors For banks, the credit rating system is a “system to objectivelyevaluate credit risk (i.e the probability of future credit losses for the Bank) of borrowersand facilities (transactions) to which the bank extend credit” The bank itself is the lender

or insider in the credit relationship with the corporate being evaluated Meanwhile, thecredit rating agency is a third party or outsider in the credit relationship with the corporatebeing evaluated As a result, to some extents, credit rating agencies can give independentand objective credit opinions which are not affected by credit relationship Secondly,internal ratings at banks contains evidence of the private information that banks possess,and distinguishes them from public ratings of credit bureaus and bond ratingagencies Meanwhile, credit rating agencies encounter some difficulties in approachingdetailed and private information related to the business performance as well as plan of thedebtors However, credit rating agencies are more specialized and can conduct researches

in larger scale (such as industry research, country research or macro economy research)than banks That’s why in some cases banks refer to the industry evaluation or otherinformation provided by credit agencies

1.2.1 Basic principles/features

Credit rating is used to estimate the worthiness of the credit for the company, country or anyindividual company Credit rating is been done after considering various factors such asfinancial, non-financial parameters, and past credit history The rating which gets done issimple and it facilitates universal understanding Credit rating also makes it widelyaccepted as the symbols which are used are generalized and made common for all Theprocess of credit rating is very detailed and it involves lots of information such as financialinformation, client's office and works information and other management information Itinvolves in-depth study

1.2.2 Main components in rating companies

Before granting a borrower rating, commercial banks must take in consideration of sixfactors which has been known as “6 Cs of credit”:

Character

This criterion is measured by the borrower’s credit and payment history With this factor,lender can measure the level of determination and desire of the borrower to repay hisloan It is very important because there are some cases that borrowers try to delay loanpayment although they are able to pay Therefore, the lender is more likely to give loan

to customers who have integrity, honesty and creditability For corporate customers, thiscriterion is judged through the character of its management as they reflect the behavior ofthe business

The information needed to analyze “character” factor can be from various sources such

as employers, previous lenders, financial records, etc… and especially, the perception ofthe credit officers dealing directly with the borrower Hence, “character” is the leastobjective factors among 6 Cs

Ca

p a c i t y t o p a y

This means that borrowers must have the income to pay and the ability to pay back thecredit Lenders can evaluate the borrower’s repayment capacity based on theassessment of the projected cash flow available for loan repayment currently and duringthe loan tenor This factor calculates the actual source of payment from the borrower,because no matter how well-known and prestigious the borrower is, he still can facedefault situation if he has no financial position to pay the loan

Ca

p i t a l ( m o n e y )

Capital is the difference between how much money the borrower owes (debt) and howmuch money (income) he earns Thus, lenders tend to give loan to borrowers whoseearning is more than debt Capital herein does not only reflect the borrower’sfinancial strength but also indirectly indicated his commitment and confidence inbusiness performance It is normally assumed that the more borrower participates in thebusiness, the more committed he is to make his business succeed and repay the loan.Accordingly, this is the most objective factor among the 6Cs

C

o ll a t e r a l

Anything owned by the borrower that can be valued and realized by the lender as asecurity tool for the lending is called collateral (like money, a home, or jewelry).Collateral can be taken away or repossessed in case the borrower fails to repay the debt.However, as banks do not specialize in asset liquidation, collateral is the last and worstway that they can fall back on when the risk in future turns unrecoverable.

C

o n d i t i o ns

This factor refers to the environment in which the borrower will utilize the loan, generateincome and repay the loan It includes many components with different parties involvedsuch as the kind of business, the borrowers experience on this business, competitors,material price volatility, etc Conditions here include internal factors and externalfactors These factors can be analyzed by SWOT model

C

o n f i d e n c e

A successful borrower gives confidence to the lender by addressing all the lender'sconcerns A good credit and payment history, good debt to income balance and stableconditions will help in providing a lender with confidence in the borrower Thus, it issaid that this is the most important C since it helps credit staff interpret all the other Cs,and finally give out right decision

1.2.3 Credit rating system in some main banks in Vietnam

In this part, credit rating system of some leading commercial banks in Vietnamwill be considered as sample for the current rating system popularly being used bydomestic banks The credit rating of Vietcombank and BIDV will illustrate this point

1.2.3.1 Credit rating system for corporate at Vietcombank

Currently, Vietcombank is using credit rating model with one variable based onquantitative and qualitative analysis Before analysis, corporate will be divided intodifferent types of business (including state-owned company, foreign-invested companyand others), industries (such as agriculture – forestry – aquaculture, trading andservices, industrial production, and construction) and business size (big, medium andsmall)

(a) Quantitative analysis

There are four main groups of financial analysis with 13 indicators as follows:

- Liquidity ratio: quick ratio, current ratio

- Activity ratio: working inventory in months, trade gap in months of sales, assetturnover

- Leverage ratio: Total liabilities / Total asset, Total liabilities / Contributed capital

- Profitability ratio: tax earnings / Revenue, tax earnings / Total assets, tax earnings/Contributed capital

Pre-On the basis of industry and business size, the company will have a financial ratingscore which depends on the result of these above indicators in correlation with itsbusiness type These financial indicators are evaluated according to guideline of StateBank of Vietnam and Vietcombank’s credit policy Each indicator will have five valuegaps, respectively 20, 40, 60, 80, and 100

- Management capacity: to consider and evaluate experience of the company in thisindustry, experience of Directors, internal audit policy, management ability of Board ofManagement, forecast of business strategy and vision in the future

- Credit relation: to analyze company’s history of loan payment in the past by thefrequency of on-time loan repayment, how many times of loan extension or overdueloan…

- External factors: to judge the direct impact of other elements to business performancelike industry prospect, prestige, competition status or government regulations

- Other activity factors: to review other factors including diversification potentiality,income from export activities, level of dependence on providers and customers, after taxprofit…

Each indicator will have five value gaps respectively 4, 8, 12, 16, 20 And total score

for non- financial analysis will be the sum of these indicators’ results, taking intoaccount the coefficient of each indicator for each business type.

Table 1.1: Coefficient of non-financial indicators for each type of company

applied in Vietcombank

Non-financial criteria State-owned

Foreign-invested company

Source: Vietcombank’s internal documents

After getting financial score and non-financial score, the final score will be calculated as follows:

Table 1.2: Coefficient of financial and non-financial indicators for each

type of company applied in Vietcombank

Foreign-invested company

3

Bonus for audited

financial statement + 6 point + 6 point + 6 point

Source: Vietcombank’s internal documents

(c) Rating scales

Based on the final score, the company will be granted credit rating with a scale of 10grades from the least risky (AAA) to the most risky (D) This rating scale can beillustrated in the following table:

Table 1.3: Corporate rating scales of Vietcombank

69.6 – 77.1 BBB Adequate payment capacity

62.0 – 69.5 BB Speculative, credit risk developing

39.2 – 46.7 CC High default risk, difficult to recover

Source: Vietcombank’s internal documents

1.2.3.2 Credit rating system for corporate at BIDV

(a) Overview of the rating system applied at

BIDV

BIDV has a separate software system for corporate rating which also analyzes financial factors and financial factors Basically, these analyses are the same withVietcombank’s current system; however, BIDV’s rating system has just been upgradedfrom the old one and got much more benefit and strength accordingly BIDV’s currentrating system divides its corporate customers into 35 types of industries and uses moreindicators with high level of complexity and comprehensiveness in analysis.Specifically speaking, financial analysis is evaluated through four groups with 14indicators; whereas, non-financial analysis is covered by five groups with 40 indicators.Thanks to that, the bank can hopefully give out exact and logical measurement and

non-assessment about corporate‘s business performance as well as risk evaluation.

Figure 1.5: Credit rating evaluation process for corporate customers at BIDV

Source: BIDV’s internal documents

The final score will be calculated based on result from financial and non-financialanalysis with coefficient for each group of indicators This coefficient is dependent onwhether their financial statement is audited or not

Table 1.4: Coefficient of financial and non-financial indicators in BIDV’s credit rating system

Criteri

a

Audited Financial Statemen

Non-audited Financial Statemen

Source: BIDV’s internal documents

(b) Rating scales for corporate at BIDV

Based on the final score, the company will be granted credit rating with a scale of 10grades Details of the rating scale applied for corporate when granting credit rating as

Table 1.5: Corporate rating scales of BIDV

70 – 74 BB Speculative, credit risk developing

65 – 69 B Highly speculative, credit risk present, with

limited margin safety

60 – 64 CCC High default risk, capacity depending on

sustained favorable conditions

55 – 59 CC High default risk, difficult to recover

Source: BIDV’s internal documents

In the banking industry, credit risk is widely regarded to be of paramount importance andmust be properly managed to preserve a bank’s assets, capital, and earnings Fundamental

to a robust credit risk management process is a credit rating system that is consistentlyapplied across the entire organization The credit rating system is the basis by which thebank standardizes the evaluation of credit risk across the portfolio The importance of therating system cannot be overstated, as credit ratings affect the loan origination process,portfolio monitoring, pricing, loan loss reserves, economic capital and regulatory capital.Simply put, credit ratings are the foundation of the credit risk and credit portfoliomanagement processes Till now in this chapter, we have just reviewed some moderntheoretical basis on borrower rating system, its application in commercial banks andexperience in borrower rating system of some leading Credit Rating Agencies in the world

as well as financial institutions in Vietnam The following pages of this dissertation

describe the credit rating system in the Bank of Tokyo – Mitsubishi UFJ, Ltd for Japanesecompanies in Vietnam.

CHAPTER II: CREDIT RATING SYSTEM IN BTMU FOR JAPANESE COMPANIES IN VIETNAM

2.1 Introduction about BTMU in Vietnam

2.1.1 BTMU at a glance

Mitsubishi UFJ Financial Group (MUFG) is one of the world’s largest and most diversifiedfinancial groups with total assets of JPY218.9 trillion as of March 2012 The groupcomprises five primary operating companies, including The Bank of Tokyo Mitsubishi UFJ,Ltd., (“BTMU”) Mitsubishi UFJ Trust and Banking Corporation, Mitsubishi UFJ MorganStanley Securities Co., Ltd., Mitsubishi UFJ NICOS Co., Ltd and Mitsubishi UFJ Lease &Finance Company Limited

BTMU dates back to 1880 as the Mitsubishi Bank, Ltd was founded by formersamurai Iwasaki Yatarō, and was a core member of Mitsubishi Group companies Also, in

1880, the Yokohama Specie Bank was established, which was the forerunner of the Bank ofTokyo, Ltd In April 1996, the Mitsubishi Bank, Ltd and the Bank of Tokyo, Ltd mergedinto the Bank of Tokyo-Mitsubishi, Ltd and become the world's largest bank in terms oftotal assets In July 2004, Japan's fourth-largest financial group UFJ Holdings, Inc offered

to merge with Mitsubishi Tokyo Financial Group (MTFG) The merger of the two bankholding companies was completed on October 1, 2005, creating the Mitsubishi UFJFinancial Group The core banking units of MTFG and UFJ Holdings, the Bank of Tokyo-Mitsubishi, Ltd and UFJ Bank Ltd., respectively, continued to operate separately untilJanuary 1, 2006, when the two units combined to form the Bank of Tokyo-Mitsubishi UFJ,Ltd

BTMU has been rated by external credit agencies as below:

Table 2.1: BTMU’s rating by external Credit Rating Agencies

Bank of Tokyo Mitsubishi UFJ,

A-Short-term F1

BTMU established its first representative in Hochiminh City, Vietnam in 1993 One yearlater, Hanoi Representative was put into operation Currently, both branches have beenlicensed to provide comprehensive banking services BTMU in Vietnam with some mainfigures as below:

Beginning with only 20 staff members (including 3 Japanese Expatriates), throughnearly 20 years of its operation, BTMU in Vietnam is now developing remarkablyand largely with 400 staff members including 23 Japanese expatriates and its total assetsequivalent to USD 900 million as of December 31 2011 The number of customer is alsoincreasing year-on- year from about 50 at the starting point to more than 2,700 corporatecustomers and 2,000 individual customers currently, of which credit customers are around

400 ones Among corporate customers, there are 2,100 Japanese corporates as of 31 March2012

2.1.2 Banking products and services:

As an investment bank, BTMU provides a diversified range of products:

- Loans: Short term/long term loans, syndicated loan, ECA financing

- Funding and Investing Activities: Capital Debt markets, Investment Grade Bond Expertise

- Special Funding Needs: Advisory Services, Mergers & Acquisition, Lease Finance,Project & Trade Finance

- Transaction Banking: Forfeiting, MM, Foreign exchange

2.1.3 Credit activities performance in Vietnam

Figure 2.1: Transaction volume categorized by credit activities of BTMU in Vietnam

as of Jun 2012

Source: Internal documents of BTMU in Vietnam

It is seen from the chart that BTMU’s main product is loan which accounts for around 80%

of total credit balance, followed by Letter of Guarantee (15%) and Letter of Credit (5%)

In recent years, demand for borrowing has been increasing in both domestic and foreigncurrency

Figure 2.2: Composition of credit balance for all Vietnam by credit rating as of Jun

2012

Unit: USD mio

Source: Internal documents of BTMU in Vietnam

Most of BTMU’s customers are classified as normal customer (rating range from 1 to 7)showing no concern about the payment capacity of those customers and proving BTMU’shigh quality of credit portfolio Exposure to customers that are considered as close watch(rating from 8-1 to 8-3) was in the downward trend from more than USD 57 mio as of Mar

2012 to USD 49 mio in Jun 2012

Figure 2.3: Composition of Credit Balance by Industry of BTMU in Vietnam as of Jun –

2012

Source: Internal documents of BTMU in Vietnam

BTMU divide its customer’s business activities into 11 groups As of Jun 2012, lending toBanking Institution accounted for the biggest portion of 23.69% which is in line withBTMU’s strategy to enhance the relationship with local banks and develop interbankactivities Manufacturing-other comes into second place with 21.62%, equivalent toUSD182.52 mio Steel works which was used to be the targeted industry with the biggestportion of 31% (as of Jun 2011) of total BTMU’s limit granted to its customer has beenreduced gradually to only 11.51% as of Jun 2012 due to the stagnancy of recent steelmarket BTMU’s principle is to diversify the industry scales of its credit customer in order

to mitigate the industry risk

Figure 2.4: Composition of Credit Balance for Japanese Customers by rating

Unit: Mio of USD

BTMU applies the system of 15-grade scales when evaluating borrowers’ creditworthiness.Details of this rating system will be analyzed in the following parts of this thesis Borrowerswith rating from 1 to 7 are considered to be “normal”; 8-1, 8-2 and 8-3 is “close-watch”customers, rating 9 is “likely to become bankrupt”; 10-1 is “virtually bankrupt”, 10-2 is

“bankrupt” Most of BTMU in Vietnam’s credit customers are normal, which shows thehigh quality of credit activities and trust-worthiness of the customers The worst borrowers

in BTMU Vietnam is virtually bankrupt accounting for only 0.19% the total credit balanceand maintaining outstanding balance of USD 1.33 million In the recent quarters, creditbalance of Japanese customers in BTMU Vietnam still accounts for bigger share in the totalcredit balance This shows the more and more important role of Japanese customers inbanking activities of BTMU Vietnam Credit balance of Japanese customers as of June 2011went up thanks to the bright signal of recovery from both domestic and overseas market.Production capacity had to improve in order to meet market orders Thus, funding demandalso was in the up-trend

2.2 Status of credit rating system of BTMU for Japanese companies in Vietnam

Following globalization trend, many Japanese corporates have established their ownnetwork worldwide As recently Japanese investors find Vietnam very potential market,many Japanese companies are established in Vietnam as their subsidiaries These are 100%Japanese companies or joint venture with Vietnamese investors About 50% of Japanesecompanies in Vietnam are export processing enterprises (EPE) who export all products tooverseas The remaining ones manufacture spare parts or accessories provided to EPEs.Only a few ones produce goods to sell in Vietnam Therefore, Japanese subsidiaries inVietnam maintain close relationship and receive much support from parent company inJapan In terms of financial support, subsidiaries in Vietnam can get offshore loan fromparent company or a letter of guarantee issued by parent company for credit limits extended

at BTMU branches in Vietnam Japanese companies whose parent companies are big sizecorporation in Japan or existing clients of BTMU in Japan can easily receive credits fromBTMU in Vietnam For other Japanese companies whose parent companies are smallmedium size or being not clients of BTMU in Japan, many strict requirements must besatisfied in order to enter credit relationship with BTMU in Vietnam

2.2.1 Creditworthiness assignment for Japanese companies

According to BTMU’s procedure, borrower rating is an evaluation of creditworthiness(projected debt-service capacity, or the possibility of default) of a borrower in three or fiveyears In principle, credit ratings are assigned to all borrowers and all transactions whichBTMU extends credit to (Borrowers that BTMU provides credit facilities to with nooutstanding balance are also included) This is common for all companies, including bothJapanese and Non-Japanese corporates

2.2.1.1 BTMU’s rating scales:

Borrower ratings are divided into 15 ranks (1 to 10-2) in accordance with the level of creditrisk (projected debt-service capacity) In this framework, each rating rank is defined by aparticular description of “risk level” and “debt-service capability” and also clearlybenchmarked to quantitative criteria – the probability of default within a one year period,

by which the stability of the framework is secured

Table 2.2 BTMU’s rating scale for corporate customer FSA

Normal

1 1-S Borrower has the highest level of

creditworthiness In effect no credit risk

2

2-1 The capacity to meet financial commitments is

highly certain, but there are some elements thatmay result in lower creditworthiness in the future

2-22-3

3

3-1 The capacity to meet financial commitments is

sufficient certain, but there is possibility thatcreditworthiness may fall in the long run

3-23-3

4

There are no problem concerning the capacity tomeet financial commitments, but there ispossibility that creditworthiness may fall in thelong run

5-1 Creditworthiness is in middle range

5-2 There are elements that require attention if the

situation changes

6-1

There are no problem concerning the capacity tomeet financial commitments but long termstability is poor

6-2 Creditworthiness is relatively low

8-2 Business problem is serious and subsequent debt

repayment needs to be monitored closely8-3 Borrowers who fall under criteria of Rating 8-1 or

8-2 and have “Restructured Loans”

2.2.1.2 Evaluation Processes of Credit Ratings

In determining credit ratings, it is most important to accurately evaluate the credit risk ofboth borrowers and individual credit transactions Arbitrary factors such as businesspromotion policy should be eliminated since if those factors are incorporated to creditratings, the outcome could cause a delay in uncovering potential credit problems,inappropriate pricing practices not sensitive to risk, or problems in the loan recovery-process-One or all of these factors could result in substantially greater credit losses for theBank

a Assigning the Credit Rating

In assigning the credit rating, all relevant available information must be taken into accountconcerning the borrower and the facility (transaction) When adjusting for risk factors andoutlook, information must be current and must consider future economic changes.Furthermore, the less information the Bank has, a more conservative assignment of ratingsmust be assigned

b Credit Rating and Credit Supervision

The credit screening process is performed for the purpose of establishing a completeevaluation, in consideration of BTMU’s credit policy, business relations and profitability ofborrowers, as well as to determine credit risk Although business relations and profitabilityare importance factors in screening individual transactions, they should be excluded fromthe process of evaluating credit ratings

c Credit Rating and Business Policy

Business policy is used for the purpose of comprehensively determining a stanceconcerning the approach to borrowers and individual transactions This process takes intoconsideration BTMU’s credit policy and business relations, as well as the Bank’sprofitability as it relates to an individual borrower Assessments are made on the basis ofcredit risk, similar to those made during the screening of an individual transaction

In general, there are two aspects to business policy The first is related to the extent towhich a credit should be extended, or whether an unsecured credit is extended, based on anaccurate understanding of the structural nature of the demand of funds, in addition to anevaluation of business characteristics This analysis is performed with an understanding ofthe current and future status of problematic points within the customer’s organization The