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The Handbook of Credit Risk Management: Originating, Assessing, and Managing Credit Exposures

ISBN: 978-1-118-42146-8
352 pages
December 2012
The Handbook of Credit Risk Management: Originating, Assessing, and Managing Credit Exposures (1118421469) cover image

Description

A comprehensive guide to credit risk management

 

The Handbook of Credit Risk Management presents a comprehensive overview of the practice of credit risk management for a large institution. It is a guide for professionals and students wanting a deeper understanding of how to manage credit exposures. The Handbook provides a detailed roadmap for managing beyond the financial analysis of individual transactions and counterparties. Written in a straightforward and accessible style, the authors outline how to manage a portfolio of credit exposures--from origination and assessment of credit fundamentals to hedging and pricing. The Handbook is relevant for corporations, pension funds, endowments, asset managers, banks and insurance companies alike.

  • Covers the four essential aspects of credit risk management: Origination, Credit Risk Assessment, Portfolio Management and Risk Transfer.
  • Provides ample references to and examples of credit market services as a resource for those readers having credit risk responsibilities.
  • Designed for busy professionals as well as finance, risk management and MBA students.

As financial transactions grow more complex, proactive management of credit portfolios is no longer optional for an institution, but a matter of survival.

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Table of Contents

Preface xiii

Acknowledgments xxi

Part One Origination

Chapter 1 Fundamentals of Credit Risk 3

What Is Credit Risk? 3

Types of Transactions That Create Credit Risk 5

Who Is Exposed to Credit Risk? 9

Why Manage Credit Risk? 18

Chapter 2 Governance 21

Guidelines 22

Setting Limits 25

Skills 26

Oversight 29

Chapter 3 Checklist for Origination 33

Does the Transaction Fit into My Strategy? 34

Does the Risk Fit into My Existing Portfolio? 35

Do I Understand the Credit Risk? 36

Does the Seller Keep an Interest in the Deal? 37

Are the Proper Mitigants in Place? 38

Is the Legal Documentation Satisfactory? 38

Is the Deal Priced Adequately? 39

Do I Have the Skills to Monitor the Exposure? 40

Is There an Exit Strategy? 40

Part Two Credit Assessment

Chapter 4 Measurement of Credit Risk 45

Exposure 45

Default Probability 50

The Recovery Rate 60

The Tenor 62

Direct versus Contingent Exposure 63

The Expected Loss 63

Chapter 5 Dynamic Credit Exposure 65

Long-Term Supply Agreements 66

Derivative Products 68

The Economic Value of a Contract 71

Mark-to-Market Valuation 73

Value at Risk (VaR) 76

Chapter 6 Fundamental Credit Analysis 79

Accounting Basics 80

A Typical Credit Report 88

Agency Conflict, Incentives, and Merton’s

View of Default Risk 97

Chapter 7 Alternative Estimations of Credit Quality 103

The Evolution of an Indicator: Moody’s Analytics EDF™ 104

Credit Default Swap Prices 110

Bond Prices 116

Chapter 8 Securitization 119

Asset Securitization Overview 120

The Collateral 123

The Issuer 127

The Securities 128

Main Families of ABS 131

Securitization for Risk Transfer 135

Credit Risk Assessment of ABS 137

Warehousing Risk 138

Part Three Portfolio Management

Chapter 9 Credit Portfolio Management 143

Level 1 145

Level 2 149

Level 3 153

Organizational Set-Up and Staffing 155

The IACPM 156

Chapter 10 Economic Capital and Credit Value at Risk (CVaR) 159

Capital: Economic, Regulatory, Shareholder 160

Defining Losses: Default versus Mark-to-Market 163

Credit Value at Risk or CVaR 165

Creating the Loss Distribution 171

Active Portfolio Management and CVaR 179

Pricing 181

Chapter 11 Regulation 183

Doing Business with a Regulated Entity 184

Doing Business as a Regulated Entity 189

How Regulation Matters: Key Regulation Directives 190

Chapter 12 Accounting Implications of Credit Risk 201

Loan Impairment 202

Loan-Loss Accounting 203

Regulatory Requirements for Loan-Loss Reserves 205

Impairment of Debt Securities 206

Derecognition of Assets 207

Consolidation of Variable Interest Entities (VIEs) 208

Accounting for Netting 209

Hedge Accounting 211

Credit Valuation Adjustments, Debit Valuation

Adjustments and Own Credit Risk Adjustment 212

IFRS 7 213

Part Four Mitigation and Transfer

Chapter 13 Mitigating Derivative Counterparty Credit Risk 217

Measurement of Counterparty Credit Risk 217

Mitigation of Counterparty Credit Risk through Collateralization 218

Legal Documentation 225

Dealers versus End-Users 226

Bilateral Transactions versus Central Counterparty Clearing 227

Prime Brokers 229

Repurchase Agreements 230

Final Words 232

Chapter 14 Structural Mitigation 233

Transactions with Corporates 234

Segmentation of the Commercial Loan Market

Senior versus Junior Debt

Secured versus Unsecured Loans

Covenants

Events of Default

Transactions with Special Purpose Vehicles 240

Impact of Structural Mitigants on Default Probability

Impact of Structural Mitigants on Recovery Rates

Senior/Subordinated Structures

Credit Enhancement

Chapter 15 Credit Insurance, Surety Bonds, and Letters of Credit 249

Credit Insurance 250

Surety Bonds 255

Letters of Credit or LoCs 258

The Providers’ Point of View 263

Chapter 16 Credit Derivatives 267

The Product 267

The Settlement Process 270

Valuation and Accounting Treatment 274

Uses of CDS 276

Credit Default Swaps for Credit and Price Discovery 280

Credit Default Swaps and Insurance 280

Indexes, Loan CDSs, MCDSs, and ABS CDSs 280

Chapter 17 Collateral Debt Obligations (CDOs) 283

What Are CDOs? 283

Collateralized Loan Obligations or CLOs 286

Arbitrage CLOs 287

Balance Sheet CLOs 290

ABS CDOs 292

Credit Analysis of CDOs 296

Chapter 18 Bankruptcy 301

What Is Bankruptcy? 301

Patterns of Bankrupt Companies 303

Signaling Actions 306

Examples of Bankruptcies 307

About the Authors 311

Index 313

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Author Information

Sylvain Bouteillé is Head Key Account Management and a member of the management team of the North American division of Swiss Re Corporate Solutions. In 1996, he joined Swiss Re in Zurich, Switzerland, in the newly created credit risk management division. In 1998, Bouteillé moved to New York where, as U.S. Head of Credit Risk Management, he was responsible for credit risk aspects of all insurance and capital markets transactions. In 2003, he became U.S. Head of Structured Credit Underwriting, where he originated and structured credit derivatives and financial guaranty reinsurance transactions. Since 2008, Bouteillé has been working with risk managers of Fortune 500 companies to develop traditional and non-standard insurance solutions. Bouteillé holds an MS in civil engineering from ENTPE (France) and an MBA from INSEAD (France).

Diane Coogan-Pushner is Distinguished Lecturer and Director of the Graduate Program in Risk Management at Queens College, City University of New York. She began her career in financial services at the World Bank and held increasingly senior positions in finance and strategy at AT&T and PricewaterhouseCoopers. Coogan-Pushner moved to Swiss Re, and as Managing Director, originated and structured reinsurance transactions and other risk transfer solutions for insurance clients. Other credits include roles as a portfolio manager for a hedge fund and for a private equity fund both dedicated to financial services. She has served as a director for an insurer and as a member of S&P's Insurance Ratings Advisory Council, and consults to financial institutions in their asset management strategy. She received her PhD in economics from Boston University in 1992 and is a CFA charterholder.

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