Copyright © 2005 Global Insight

Sector Risk Ratings

A Unique Tool for Active Sector-Based Risk Management

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Introduction to Global Insight’s World Industry Service (WIS) Sector Risk Ratings (SRR)

Why Focus on Sector-Level Risk? Quantifies the sector impact on credit quality relative to that from country or geography Accommodates the greater role of global supply chains and trade in business operations Sector benchmarks link macroeconomic events to impacts on companies and portfolios New Basle II regulations—new requirements for internal risk measures and controls Current phase of business cycle portends changes in credit quality & bankruptcies

What are WIS Sector Risk Ratings? SRR are derived from WIS’ globally consistent sector benchmarks and forecasts

SRR indicate changes in sector-level credit quality across countries and industries Validation of SRR with bond defaults and corporate bankruptcies, country and globally

How to Use WIS Sector Risk Ratings? Monitor changes in risk ratings across sectors and within a set of countries/geographies

Use framework and navigation facilitates to “drill down” for more granular information on “flagged” sectors or countries

Perform stress testing and correlations for active portfolio risk management Quantitative drivers for forecasting loss reserve requirements, bankruptcies, and defaults

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What Are WIS Sector Risk Ratings (SRR)?

Comparative metrics for each sector and country, history and forecast

Globally consistent sector benchmarks of credit and operating risks

Ratings are created from structural and cyclical indicators that conform

with standard credit risk frameworks

User-friendly tool for risk management and stress testing

Scientific, transparent construct, and long track record

SRR Measure and Rank Sector-Based Credit and Operating Risks

Unique SRR methodology provides globally consistent, forward-looking benchmarks of credit quality for each sector and country

A composite rating from lowest (1) to highest (10) is created for each sector, built up from 40 separate risk factors

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Growth Risk Growth in real revenue Growth in sales Volatility, turning points

Profitability Risk Pricing strength Operating profitability Free cash flow and variability Return on invested capital Fixed asset turnover Degree of operating leverage

Supply Risk Capital intensity Capacity overhang Depreciation cost of sales

Market Structure Risk Industry structure Dependence on suppliers and customers Dependence on energy and labor Barriers to entry and exit Technology and substitution

Economic & Country Risk Sector cyclicality Sector interest rate sensitivity Country-level sovereign risks (From

Global Insight’s Global Risk Service):– Exchange rate– Equity markets– Regulation policy– Tax policy

Composite Risk Ratings Are Built Up from 40 Individual Risk Factors that Reflect and Predict Changes in Credit Quality

Sector risk factors are derived from the standard credit risk framework used in corporate lending and fixed income portfolios

Sector risk factors show the influence of industry structure, stage in lifecycle, and sovereign/ macroeconomic environment on industry risk profiles

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The Top-Down Consistency and Credit Framework of WIS SRR Provide Sector Benchmarks that Complement Traditional Bottom-Up Analysis

SRRs Provide a “Top-Down” Complement to Standard “Bottom-Up” Credit Risk Frameworks for Corporates

• Risk ratings and underlying data are credit benchmarks for companies, “peer groups,” and portfolios

• Risk metrics include income statement and cash flow items, metrics of industry structure, and commercial environment

• Transmit “high-level” macro economic events down to sector-level risks and credit benchmarks

• Link macro and industry views directly to portfolio exposures for simulation, stress testing, and active risk management

Credit Risk Framework Top Down Bottom UpMacro & Sector Company Financials

A) Internal Liquidity & Solvency Poor Good

B) Business & Operational Risk Excellent Average

Growth Risk Excellent Average

Operational Characteristics Excellent Good

Oversupply Risk Good AverageC) Industry Risk Excellent Average

Industry Structure Risk Excellent Good

Sector's Political & Economic Risk Excellent Average

D) Financial Risk Average Good

Capital Structure Average Excellent

Rating & Equity Risk Good Good

E) External & Market Liquidity Excellent Average

F) Country & FX Risk Excellent ---

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Example of Composite Risk Rating for One Sector Shown Over Time and Across Several Geographies

(Sector Ratings between 1 and 10 — Least to Most Risk)

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4

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1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005E

2006E

2007E

U.S. EMU U.K.

Global Insight’s Sector Risk Ratings Show the Level and Direction of Change in Sector Risks Over Time and Across Countries

• Composite SRR shows the level and direction of operating and credit risks.

• Which geographies lead into or lag behind global sector risk changes?

• What is the outlook for future sector risk migrations?

• How does the outlook compare with historical performances?

Communication Equipment

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Change in Risk Measures

Sector Risk Levels:

Falling Risk

Static Risk

Rising Risk

Low Risk

Moderate Risk

Yellow Flag

High Risk Potential

Recovery?

Red Flag

WIS Sector Risk Ratings Facilitate Active Management of Sector-Based Credit Risks

Which Sectors Have High Risk Profiles?Which Sectors Are Improving or Deteriorating? • Monitor Sector Risk

Profiles through changes in the composite risk ratings

• Flag strategic sectors or ones with changing risk profiles for deeper investigation

• “Drill down” to the 40 individual sub-factors and underlying sector data to see the drivers for changing risk profiles

• Compare sector risk factors on a global and country basis, compare risks across sectors

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Color-Coded Monitor of Changes in Sector Risk Rankings: Example of Within One Country Over Time

ISIC Sector Description

ISIC Code

2004 Sales (Mill US $)

2005 Composite Risk Rating

2005 Rank* of Composite Risk Rating

Change in Rating**: 2006 – 2004

Change in 2006*** Composite Risk Rating

Basic Industrial Chemicals

3511 119912 5.4 46 0.9 -0.4

Computing Machinery

3825 73015 5.6 49 -1 -0.8

Energy Mining 2a 258486 6.6 70 2.3 -0.1

Watches & Clocks

3853 724 6.6 68 -0.3 0.5

US Example of WIS Sector Risk Ratings with Rankings Across Industries

** Represents the change in Composite Risk over the specified time periods

High Risk Sectors (6.1 — 10.0) expected to Improve

High Risk Sectors (6.1 — 10.0) expected to Degenerate

Moderate Risk Sectors (4.6 — 6.0) expected to Degenerate*** Represents the change in Composite Risk from the previous forecast

* Represents the rank for a given sector across all 71 industries

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Use Navigator to “Drill Sown” to 40 Individual Risk Factors to Investigate Changes in Sector Risk Profiles

WIS SRR Navigator Allows Easy “Point-and-Click” Web Access to all of the Sector Risk Rating Factors and Benchmarks For All Countries, All Sectors Global Insight offers a variety

of methods for access to the WIS and the Sector Risk Ratings. One of them is the WIS Sector Risk Ratings (SRR) Navigator

The WIS SRR Navigator provides easy point-and-click access to the Risk Ratings, both history and forecast

Data retrieval results are displayed in Microsoft® Excel, and queries can be saved for easy update and alteration

WIS SRR Navigator supplies instant, Web-based updates

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WIS Sector Risk Ratings Correlate with Standard Measures of Credit Quality

Composite Risk Ratings Have Current and Leading Indicator Relationships with Corporate Bankruptcies (Correlation Coefficient over 1990-2003)

0.000.100.200.300.400.500.600.700.800.90

Japan Germany UK

Contemporary Correlation between Composite Risk Rating & Corporate Bunkruptcy

Year Ahead Correlation between Composite Risk Rating & Corporate Bankruptcy

All of the data shown are available in Global Insight data bases

Source: World Industry Service Sector Risk Rationgs; UK National Statistics, Financial Statistics Freestanding Table Number: fsfreFSF, Total Company Insolvencies; Japan - Release by Teikoku Data Bank, Business Failures, Total Number of Cases; Germany - Statistisches Bundesamt Business Failures, Total Company Insolvencies;

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0.40

0.50

0.60

0.70

0.80

0.90

Fran

ce

Japa

n

Sw

eden

Nor

way

Ger

man

y

Finl

and

Several of the WIS Ratings Components Correlate Well with Bankruptcies (Example of Revenue Growth Risk Factor)

Correlation Coefficient Between the Number of Corporate Bankruptcies and the Sub-factor for Real Revenue Risk Ratings, the “All Corporate” Sector (1993-2004)

• “Real revenue” growth is consistently correlated with corporate bankruptcies across a variety of countries

• This is despite each country having its own unique definition of bankruptcies

• Norway: # of bankruptcies proceedings commenced; Finland: # of bankruptcy proceedings instituted; Germany: # of bankruptcies resolved

Source: World Industry Service; Teikoku Data Bank, Statistisches Bundesamt, INSEE, Statistics Norway, Statistica Centralbyran, Statistics Finland

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0.40

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nst

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alIn

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WIS Sector Risk Ratings Correlate with Sector-Level Bankruptcies in Japan

Correlation Coefficient Between the Number of Bankruptcies in a Sector and WIS Composite Risk Rating in the Same Sector in Japan (1990-2004)

Source: Source: World Industry Service; World Industry Service; Teikoku Data BankTeikoku Data Bank

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0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1993-1998 1993-2000 1993-2004

Contemporary Correlation between Composite Risk Rating & Corporate Bunkruptcy

Year Ahead Correlation between Composite Risk Rating & Corporate Bankruptcy

WIS Sector Risk Ratings’ Correlation with Bankruptcies in Germany Is Stronger in Recent Years

“Current year” and “year ahead” correlation coefficient between the total number of insolvencies in Germany and the WIS Composite Risk Rating for the total corporate sector

Sector Risk Ratings Anticipate Changes in Germany’s Corporate Insolvencies

Source: World Industry Service; Statistisches Bundesamt Business Failures, Total Company Number Insolvencies

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Global Insight’s Composite Risk Ratings and Bond Default Rates in North America

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3.4

3.8

4.2

4.6

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90

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91

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Global Insight's Composite Risk Rating for NorthAmerica Corporate Sector (LHS)

Moody's North America All-Corp. Bond IssuerDefault Rate (RHS)

WIS Sector Risk Ratings Correlate Well with Bond Default Rates in North America

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1990-2004

1995-2004

2000-2004

Correlation Coefficient Between WIS Composite Risk Rating for North America’s Corporate Sector and

Moody’s Bond Default Rate In North America

Source: World Industry Service, Moody‘s Investors Service Global Credit Research

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Global Insight’s Composite Risk Ratings and Bond Default Rates in Europe & CIS

3.6

3.8

4

4.2

4.4

4.6

4.8

5

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

E

2006

E

2007

E

2008

E

0

0.5

1

1.5

2

2.5

3

3.5

1-year Ahead WIS Composite Risk Rating for All European(incl. CIS) Private Non-Ag Sectors (LHS)

Moody's European All-Corp. Bond Issuer Default Rate (RHS)

WIS Sector Risk Ratings Correlate Well with Bond Default Rates in Europe and the CIS

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1994-2004 1999-2004 2001-2004

Correlation Coefficient Between WIS Composite Risk Rating for European

Corporate Sector and Moody's Corporate Bond Issuer Default Rate in Europe & CIS

Source: World Industry Service, Moody‘s Investors Service Global Credit Research

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WIS Composite Sector Risk Ratings and Global Corporate Bond Issuer Default Counts Globally

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3.5

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4.5

5

5.5

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6.5

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07E

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75

100

125

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175

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WIS SRR Profitability & Pricing Risk Factor (LHS)

Bond Issuer Default Counts (RHS)

WIS Sector Risk Rating Factors Correlate Well with Bond Default Counts Globally

0.000.100.200.300.400.500.600.700.800.90

1992-2004 1999-2004 2001-2004

Current Year Correlation

Year Ahead Correlation

Correlation Coefficient Between WIS Profitability/Pricing Risk and Bond

Issuer Default Counts Globally

Source: World Industry Service; Moody‘s Investors Service Global Credit Research

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Sector Risk Ratings Help Evaluate and Anticipate Changes in Credit Profiles of Companies and Portfolios

Quantify the Risk Profile of Key Sectors in a Loan or Bond Portfolio Is portfolio risk high or low? Is it improving or deteriorating? Identify groups of correlated industries that improve/deteriorate together Use rigorous framework for evaluating diversification and strategy

Monitor and Anticipate Changes in Sector Credit Quality Monitor composite ratings, flag sectors to “drill down” for deeper investigation

– Which risk factors are driving the change?– What is the geographical composition of the sector change?

Stress test the portfolio through simulation and “what if” scenarios

Forecast Changes in Bankruptcies, Defaults, and Loan Loss Requirements For individual sectors as well as for entire portfolio

Use SRR as Sector Benchmark for Corporate Credit Research Compare company risk prospects to that of its own sector peer group Analyze market prospects for key client markets into which it sells product

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WIS SRR Provides a Framework for Stress Testing Credit Portfolios Under Variety of Scenarios and Conditions

Evaluate the Impact of Stress Factors on Portfolio Credit Quality Given Certain Hypothetical Macroeconomic, Government Policy, and Industry-Specific Events

Derive the sector and portfolio impact of internal “house views” Analyze the potential impact on portfolio values of unlikely but

plausible events Evaluate expected portfolio losses over a given time horizon,

assess the capital adequacy of individual firms and industries Research the migration of the company credit ratings, changes in

expected losses, and economic capital on the industry level Address shortcomings of value-at-risk analysis

References for Stress Testing of Portfolios: Lopez, J., 2005 “Stress Tests: Useful Complements to Financial Risk Models”, FRBSF Economic Letter, June 2005, http://www.frbsf.org/publications/economics/letter/2005/el2005-14.html

Sorge, M. 2004. "Stress-Testing Financial Systems: An Overview of Current Methodologies." Working paper no. 165, Monetary and Economic Department, Bank for International Settlements. http://www.bis.org/publ/work165.htm

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WIS SRR Uses Two Common Techniques for Stress Testing of Sectors and Custom Portfolios

Global Insight Can Help: Develop rationale and design for

macro- and industry-level scenarios and simulations for the purpose of assessing impacts on credit quality in portfolio segments

Use our tools and economic models to simulate sensitivity tests and macro environments; derive the sector impacts on sales, pricing, profits, and capex; and calculate the changes in Sector Risk Ratings and the credit prospects for sectors and portfolios

Quantify likely changes in migration patterns in sector credit quality

1) Scenario Tests Risk managers identify portfolio’s key financial drivers and then formulate scenarios in which these drivers are stressed beyond standard VAR levels

Event-driven approach analysis addresses the manner in which plausible but unlikely events might affect the risk factors relevant to a portfolio

2) Sensitivity TestsAssess the impact of large movements in financial variables on portfolios without specifying the reasons for such movements

Examples include a 100-basis-point increase across the yield curve and a sudden, 20% depreciation of currency

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Typical Process for Stress Testing Portfolios — Flow Chart of Basic Steps for Stress Testing

Common Stress Factors include:

• Oil prices• GDP growth• Inflation• Interest rate• Currency• Policy

Use Impacts on Sector Sales, Profits, Capex, Free Cash Flow, and SRR Factors to Derive Changes in Credit Quality for Sectors and Custom Portfolios

Calculate impacts on key Financial Ratios Used in Agency Ratings:

• EBITDA interest coverage• Operating margins• Free cash flow/total debt• Return on invested capital

Use Global Insight’s Economic Models of Macro and Industry to Calculate the Response to a Range of Scenarios

WIS provides the link between macroeconomic scenarios and performance of portfolio exposures

Project movements in default migration

Develop groups of industries that are hurt or helped by scenarios

Simulate changes in sector correlations

Identify Stress Factors

Simulate Macro Models to Derive Industry Drivers

Simulation of Industry

Performances

Asses Impact On SRR and

PortfolioCredit Quality

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Why Use Global Insight for Sector Risk Ratings?

The SRR framework has been designed, tested, and used extensively by a number of banks in the United States and Europe for over 10 years. The original product, and subsequent improvements, were designed in collaboration with our banking clients and the RMA

Quantitative rigor provides a critical component for analysis and risk strategy; it provides a between link sector risk measures and custom portfolio analytics, active risk management

Unique and globally consistent coverage of all sectors in all countries

Global Insight is a global leader in custom analysis and sector stress testing

The product is delivered via Global Insight’s Web site, with easy navigation and monitoring of results across risk dimensions; includes telephone access to sector and country analysts

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Please contact us for a personal demonstration!

More Information?

Mark Killion, CFAManaging Director, World Industry Service1-610-490-2547mark.killion@globalinsight.com

Natasha MuravytskaEconomist, World Industry Service1-610-490-2558natasha.muravytska@globalinsight.com