Course Details
Course Outline
10 days course
Fundamentals of Credit Risk
- The key macro and micro financial concepts behind, and drivers of, credit risk
- Measurement of credit risk and adverse outcomes
- Assessing credit risk and default probability of loan portfolios
- Key determinants for managing credit risk:
- Probability of default (PD)
- Exposure at default (EAD)
- Loss given default (LGD)
- Credit migration and transition matrices
- Fundamental analysis of financial statements, key ratios, and qualitative characteristics of the balance sheet
- Off balance sheet and contingent credit risk
- Market-based approaches, bond spreads, swap rates
- Counterparty credit risk
- Credit scoring, credit risk modelling, risk profiling and assessing creditworthiness
Credit Ratings Methodologies and Application
- Review of ratings classifications systems of the major Credit Ratings Agencies (CRAs)
- The principal credit ratings agencies – Moody’s, Standard & Poor’s, Fitch
- Overview of the ratings methodologies – issuer analysis, historical data, business cycles
- Commercial paper ratings
- Sovereign ratings – approach to developed markets and emerging markets
- Conflicts of interest - representing credit issuers but designed to protect credit purchasers
- Why did the CRAs perform so poorly in the rating of collateralized debt obligations (CDOs) and other derivatives?
- Ratings migration matrices – use by banks in determining credit risk value at risk (VaR)
- Impact of upgrades/downgrades on market perceptions of creditworthiness
- Dodd-Frank Act de-emphasis on reliance by financial firms on external ratings
Capital Charges and Accounting Principles
- Review of the distinction between the banking book and the trading book
- Basel III attempts to address regulatory arbitrage
- Treatment of securitizations and off-balance sheet exposures
- Available for Sale issues – impacts on liquidity, high-quality liquid assets (HQLA), rigidity of balance sheets
- Detailed examination of IFRS 9 – implementation timetable, further revisions?
- Recognition of expected losses and early warning of asset impairment
- Amortized cost – held to maturity requirements
- Fair value though other comprehensive income (FVOCI)
- Fair value through profit or loss (FVPL)
Counter-Party Credit Risk
- Examine the various facets of credit risk which hinge on losses sustained from the failure of an obligor to honour contractual obligations
- Distinguish the separate components of credit risk:
- Probability of default by obligor – how reliably can it be estimated?
- Probability of downgrade or widening credit spreads of counterparty
- Recovery rate – what percentage of obligation can be recovered after default?
- Credit exposure – estimating loss magnitude about capital buffers
- Determination of a credit default event, ISDA Master Agreement, Credit Support Annex
- Understand the concepts of credit rating and scoring and critically examine how useful, such techniques are for determining the actual risk of default.
- New components in the Basel III framework for addressing issues related to default and deterioration of the credit quality of counterparties
- Credit Valuation Adjustment (CVA) and Debt Valuation Adjustment (DVA)
- Explanation of key concepts of Expected Exposure (EE), Expected Positive Exposure (EPE), Wrong Way Risk (WWR)
Measuring Credit Risk and Techniques for Credit Risk Modelling
- Credit Metrics, credit scoring and credit rating systems
- Quantitative modelling of credit risk using stochastic processes
- Estimating probability of default – KMV Model, distance to default techniques
- Explain how debt and equity can be understood as options on the firm
- Techniques for modelling default risk of CDO’s, CMO’s and other structured vehicles
- Lessons from SIVs and another off-balance sheet financing on credit risk management
- Adapting VaR measures to include a metric for default value at risk
- Credit Migration matrices - scaling over different time frames
- Integrating Credit VaR (CVaR) and Market VaR
- Portfolio CVaR – joint probabilities of default – copula techniques
- Techniques for estimating LGD and recovery rates
Sovereign Credit Risk
- Principal factors used to determine credit worthiness of a sovereign
- Issues relating to sovereign bonds under different jurisdictional frameworks
- Deterioration in public balance sheets –high debt/GDP ratios
- The linkage between sovereign risk and risks to the local banking system
- Macro-economic drivers of ratings - global imbalances, surplus/deficit nations
- Role of sovereign Credit Default Swap (CDS) market – is it still vital or declining?
- Sovereign debt re-structuring- bailouts/bail-ins
- Protection to different stakeholders – seniority of claims, the preferred status of central banks
- Collective Action Clauses (CACs)
- Sovereign domino thesis and financial contagion
Stress Testing Methods, Benefits and Limitations
- Overview of sensitivity of credit to market risk, interest rate risk, systemic risk
- Explanation of the techniques for conducting stress tests
- Back testing using historical returns
- Stress testing using hypothetical returns
- Explanation of Principal Components Analysis
- Sizes of historical samples – are they sufficiently large to include wide variety of conditions?
- Benefits of more loosely coupled systems as less fragile.
Interpreting Credit Related Market Data
- Monitoring government bond yields and changes to the term structure of interest rates for USD, euro, sterling, and yen
- Theories of the yield curve
- Liquidity premium
- Safe-haven premium
- Credit spreads for investment grade and high yield instruments relative to government issues and inter-bank rates.
- Over Treasuries, over bunds, over gilts.
- SOFR, SONIA, ESTER, overnight indexed swap (OIS), Euro Overnight Index Average (Eonia)
- Option Adjusted Spreads (OAS)
- Credit Default Swap (CDS) rates – estimation of probabilities of default
- Measuring market sentiment – investor confidence indices, contrarian indicators
Credit Assessment and Financial Ratio Analysis
- Financial Statement Analysis
- Credit Assessment based on a detailed analysis of corporate balance sheets, income statements and cash flow statements
- Impact of Corporate actions - capitalization or consolidation, rights issues
- Financial ratios - Profitability, Liquidity, Asset turnover, Gearing
- Liquidity ratios, pay-out ratios, financial stability ratios, operational gearing
- Dividend policy, return on equity (ROE), Return on Capital Employed (ROCE)
- Earnings per share, P/E Ratios (historical and prospective)
- Dividend yield, Dividend/interest cover, Price/book
- Ratio-based Methods for Determining Credit Stress and Defaults
- Altman’s Z score model, KMV Model, Moody’s Analytics,
- Ohlson financial distress model, Risk Metrics, McKinsey Credit Portfolio View
Managing Credit Risk and Regulatory Capital Charges for Credit Risk
- Mechanics of credit derivatives and how they can be used for hedging portfolio credit risk
- Single name credit derivatives (unfunded and funded structures)
- Basket and Tranche CDS, index-based CDS
- Impact on regulatory capital from use of, and exposure to, credit derivatives
- ISDA documentation and legal framework for interest rate (IR) swaps, Credit Support Annex (CSA)
- Regulatory capital under Basel III
- New approaches to capital charges for credit risk under Basel III
- Stress testing – how to conduct stress testing with Monte Carlo Simulations
- Calculating capital charges for credit exposures
- Standardized approach
- Foundation internal ratings-based approach
- Advanced internal ratings-based approach
