Credit Risk Assessment, Modelling and Management

Course overview

Course outline

1. 1Day 1: Fundamentals of Credit Risk & Credit Ratings Methodologies and Application

   • 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, qualitative characteristics of the balance sheet
   • Off balance sheet and contingent credit risk
   • Market-based approaches, bond spreads, swap rates
   • Counter party 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
2. 2Day 2: Capital Charges and Accounting Principles & Counter-Party Credit Risk

   • 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 through 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 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 counter party
   • Recovery rate – what percentage of obligation can be recovered after default?
   • Credit exposure – estimating loss magnitude in relation to capital buffers
   • Determination of a credit default event, ISDA Master Agreement, Credit Support Annex
   • Understand the concepts of credit rating and scoring and critical examination of how useful such techniques are for determining actual risk of default?
   • New components in the Basel III framework for addressing issues related to default and deterioration of the credit quality of counter parties
   • 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)
3. 3Day 3: Measuring Credit Risk and Techniques for Credit Risk Modelling & Sovereign Credit Risk

   • 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 modeling default risk of CDO’s, CMO’s and other structured vehicles
   • Lessons from SIVs and other 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 creditworthiness of a sovereign
   • Issues relating to sovereign bonds under different jurisdictional frameworks
   • Deterioration in public balance sheets –high debt/GDP ratios
   • Linkage between sovereign risk and risks to 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- bail outs/bail-ins
   • Protection to different stakeholders – seniority of claims, preferred status of central banks
   • Collective Action Clauses (CACs)
   • Sovereign domino thesis and financial contagion
4. 4Day 4: Stress Testing Methods, Benefits and Limitations & Interpreting Credit Related Market Data and more

   • 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 US dollar, 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 issue 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 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 (historic 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
5. 5Day 5: Managing Credit Risk and Regulatory Capital Charges for Credit Risk and more

   • 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
   • Credit Value Adjustment (CVA) and collateral Management
   • Definition Credit Value Adjustment (CVA)
   • Defining credit exposure in relation to market risk impact on derivatives
   • Expected positive exposure and worst-case exposure
   • Nature of collateralization – ISDA treatment
   • Benefits of effective collateral management
   • Impact of netting and collateral on CVA
   • Eligible hedging instruments – no nth to default structures
   • Bilateral counter party risk and collateral
   • Over-collateralized positions and risk of counter party default