TOOL G2
This tool will help you to understand why internal triggers are important in a credit proposal and decision.
A. Purpose of Internal Triggers
The aim of setting Internal Triggers is to set out benchmarks which will:
• Trigger early review / action on a positive or negative change in the client’s and / or structure risk profile.
• Compensate for a weak deal structure.
• Focus internal discussion on problem solving when the scenario changes.
• Remove the temptation for non-action if the client’s and / or structure risk profile change.
B. Internal Triggers Features
• Specific and measurable from available information to avoid fudging and delay in action.
• Prioritised on the most critical strengths and weaknesses (mitigants and risks) of the client’s / structure’s risk profile.
• Relate to both declines and improvements in client and deal structure risk profile.
• They should be set at time of credit approval.
• Client management should be committed to monitoring responsibility; information collection; and need for review / action if triggers are broken (first line of defence).
C. Types of Internal Triggers
Non-Financial (earliest)
• Sector
• Business drivers (linked to key assumptions in projections)
• Event (e.g. government, regulation, high impact low probability)
Financial
• Actual versus projections variances
• Financial covenants at tighter levels (should be standard practice)
• Reported financials
Structure
• Aggressive action by other stakeholders on debt priority
• Dilution via increased debt and guarantees
• Changes in collateral value
• Information flow
Financial Markets (sector and client)
• Moody’s Analytics Expected Default Frequencies (EDF’s)
• Relative share price movements
• Bond market implied ratings; movements in bond spreads
• Credit Default Swap implied ratings; movement in CDS prices
• Outlook-changes, watch-lists by rating agencies
Internal Administration (depends on bank products used and number of banks)
• Account statistics
• Treasury behaviour
• Relationship issues
• Business support problems
D. Internal Trigger Advantages
- Encourages dynamic rather than time based reviews.
- Focuses on earlier signals than in deal structures.
- Helps identify transition from normal banking risks to early warning signals.
- Set clear agreed benchmarks to combat commercial pressure / crisis denial.
- Takes little extra time at credit approval time.
- Prevents us being misled by conflicting / distorted information such as:
- Claims by management out of touch with reality or optimistic
- Speculative, technical movements in the financial markets
- Distorted / creative financial trends (e.g. acquisitions, window dressing)
E. Internal Trigger Drawbacks
- Good industry sector and client knowledge required.
- Information not always available.
- Sometimes event based rather than a specific measurement (e.g. regulation).
- There is no legal back up as with covenants.
- Relies on good monitoring and involvement of client management.
- It will not catch everything. Diligence for the unexpected is still required.
