Risk Identification & Risk

Management
Learning Objectifies
• To Identify risks associated with
 RISK IDENTIFICATION
• It’s one of the steps in the risk management
process which is derived from derived from
significant business activities and from
documents like balance sheet, profit and loss,
business plan, central bank report and so on
 TOOLS OF RISK IDENTIFICATION
• Risk Register
• SWOT Analysis
• Work Flow Chart
• Check List
• Expert Judgment
• Observation
• Brain Storming (Invite participants from credit and
operations)
 Risk Management in AMLP
• The objective of risk management is to
optimize the trade off between loss and gain.

•
RISK MANAGEMENT TOOLS
Transfer
Avoid

Reduce Accept
 ..continued
• Using all the risks you have identified
previously, please use ATRAC tools to manage
them. (Invite Participants)
 RISK MANAGEMENT IN AMLP
• Lessee’s Creditworthiness
• How do we assess lessee’s creditworthiness?
– Balance sheet, income statement, cash flow statement – historical
– Financial ratios and indicators
• Debt service coverage
• Profitability
• Indebtedness
• Operational efficiency
• Liquidity
2. RISK MANAGEMENT IN AMLP

Lessee’s
creditworthine Asset
ss risk
Lease risks

Supplier
risk

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LESSEE‘S CREDITWORTHINESS

►How do we assess lessee’s creditworthiness?

 Balance sheet, income statement, cash flow statement – historical
 Financial ratios and indicators
o Debt service coverage
o Profitability
o Indebtedness
o Operational efficiency
o Liquidity
 Projected income statement and BEP
 Projected cash flow statement with 3 scenarios – realistic, optimistic and
pessimistic

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 Lessee risks
• Risks typical for (larger-scale) farmers:
– Dependence on the weather
– Prone to fast spreading diseases
– Long production cycle
– Irregular cash flow
– Outdated methodology
– Limited access to modern machines and implements and agro-
chemicals. Limited access to irrigation
– Potentially limited access to high-quality maintenance
• Risks typical for agricultural service providers:
– Collecting accounts receivables
– Potentially limited access to high-quality maintenance

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 Supplier risk (Cont’d)*
– The specifications of the asset delivered might differ from the
lessee’s initial order.
• In which case the supplier, with the approval of the lessor,
agrees to replace it or to compensate the lessee for accepting a
slightly different asset from the expected one.
– The supplier requires the lessee/lessor to put a substantial advance
payment in order to initiate the process and order the
manufacturing of the asset to the producer.
• In the case of the AMLP, the lessee deposits 20% of the total
cost of machine and implements in a blocked account with DBE.
– DBE then opens the Letter of Credit (LC) in favor of the exporter/
manufacturer/ overseas reseller. In this case, DBE starts carrying all
the risks associated to this transaction once the LC is opened.
• Then, DBE, the supplier and the lessee sign a “Tripartite
contract for purchase and lease of capital goods”.
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 Asset risk*
1 Type of capital goods

2 Value

3 Loss of value

4 Procurement

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 1

Type of capital goods

The preferred capital good for the lessor under the AMLP is a
“standard” capital good, which has the following characteristics:
– Wider usage.
– Regular and on-going demand, high utilization rate, with
little or no idle time (e.g. a tractor).
– Easy to market and sell on a secondhand market.
– Satisfies the minimum ISO Standards.
– Strong brand, model and dealer reputation.
– Separate and easily movable from one farm to another
– After-sales service, repairs and maintenance facilities and
spare parts are available and accessible.
– Warranty type and duration match international standards.
– Has the required capacity and power to lift and operate the
implement.
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 2

Value
• Determining the value of the asset at the inception of the lease
reliably is a key success factor for the lessor.
– If the asset was overvalued from the very beginning, then
the lessor might be forced to sell the asset at a loss at a
later stage, in case of repossession.
• DBE, in the case of the AMLP:
– Takes every precaution to make sure that the quote/pro-
forma invoice they get from the supplier is realistic.
– Ask for two additional quotes from other selected/partner
suppliers, to check for any potential over-invoicing or price
rigging.

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 Value (Cont’d)*
– Determining the value of the asset correctly is of paramount importance, on
top of the Free on Board (FOB) basis cost. These costs elements are:
• FOB cost of machinery and implements at port of loading.
• International freight.
• Marine insurance
• Freight forwarding agent’s cost.
• cost of customs clearance.
• import duties (if any).
• and VAT (if any),
• Inland transportation from Djibouti port to supplier’s warehouse plus
insurance thereon.
• cost of installation and commissioning.
• cost of production testing.
• cost of training employees.
• cost of maintenance contract (may be for the first year); and
• cost of consumables and recommended spare parts (may be for the first
year).
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 3

Loss of value*
• “Loss of value” means the gradual decrease of the asset’s fair
or market value (normal wear and tear), not the accounting
depreciation.
• Lessor must be able to estimate the market value of the asset
at any moment during the life of the lease contract and make
sure it does not drop below the remaining balance of the lease.
– In case this happens, then theoretically, the lessee would be
better off throwing the asset away and buying another one
of the same characteristics on the secondary market,
instead of repaying the lease until the end.
– If this happens, the lessor will repossess the asset, but will
sell it at loss.

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 Loss Of Value (Cont’d)*
• Almost all new assets lose between 10% and 20% of their value
immediately after their sale. Reasons being:
A. If somebody is selling a 2-months old tractor or machine, all
potential buyers may be suspecting a problem with the
asset,
B. The lessee immediately loses all the supplementary costs,
added by the supplier over the Cost, Insurance and Freight
(CIF) price and part of the CIF cost, as well, because the
machine and implements are deemed “used”, as opposed to
“new”.
• As time passes, the gap between the remaining lease balance
and the asset’s market value gets smaller and smaller, because
the obsolescence rate (“fair wear and tear”) is apportioned
throughout the “useful life” of the asset.
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 4

Procurement *
• In the case of the AMLP, most of the machines and implements are not available
ex-stock, they have to be procured by DBE from the producer/manufacturer or
foreign reseller, through the supplier. The procurement activity and delivery of the
asset to Ethiopia gives rise to risks which are borne by DBE. Those risks are:

A Counterparty credit risk

B Misspecification risk

C Maritime insurance risk

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 A

Counterparty credit risk

• The supplier asks for a down-payment before starting the
process for ordering the leased asset from the foreign
counterparty. The lessor may not be protected in this process.
• Therefore, to mitigate this counterparty credit risk, under the
AMLP:
– DBE, the supplier and the lessee sign a binding “Tripartite
contract for purchase and lease of capital goods”,
– Procurement will be done by irrevocable and confirmed
letter of credit (LC).
• Some suppliers/producers may insist on a down payment
although there is an LC.
– In these situations, the lessors normally ask for a similar
down payment from the lessee, thus transferring the
counterparty credit risk to the latter.
– In the case of the AMLP, the lessee has to make a down No 20
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 B

Misspecification risk
• The risk that when the asset is finally delivered it will not be in
conformance with the lessee’s order or specifications.
• This may happen for many reasons – human error, limited
knowledge by the lessee, bad advice by the supplier, etc.
However, the result is that the lessee gets a useless or less
productive asset than expected and hence does not want or
cannot afford to pay the leasing instalments.
• Lessors mitigate this risk by working with the supplier or
producer to compensate the lessee for this mistake.
– According to DBE policy, the lessee cannot refuse
acceptance of the asset, and this is an event of default.
– If there is a defect in the asset, at the time of delivery,
which reduces its usefulness to the lessee, the latter can
terminate the lease agreement and return the leased asset
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 C

Maritime insurance risk*

• International goods are shipped via maritime transport and
ships do sink, albeit rarely. Of course, the asset will be insured
before being loaded on the vessel.
• Nevertheless, in many countries’ insurance companies have
long history of trying to reduce the insurance coverage,
thereby reducing the potential insurance claim and payout
amount.
• They take all their time to settle the claim, at times avoid
paying it or prefer to go to court and going through a lengthy
and tedious court battle.
• Maritime insurance clauses are normally standard and follow
international maritime laws.

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 Thank you
• Open Discussions

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