Credit Risk Management In and Out of the Financial Crisis E-Book

Anthony Saunders

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 593

Veröffentlichungsjahr: 2010

Beschreibung

A classic book on credit risk management is updated to reflect the current economic crisis Credit Risk Management In and Out of the Financial Crisis dissects the 2007-2008 credit crisis and provides solutions for professionals looking to better manage risk through modeling and new technology. This book is a complete update to Credit Risk Measurement: New Approaches to Value at Risk and Other Paradigms, reflecting events stemming from the recent credit crisis. Authors Anthony Saunders and Linda Allen address everything from the implications of new regulations to how the new rules will change everyday activity in the finance industry. They also provide techniques for modeling-credit scoring, structural, and reduced form models-while offering sound advice for stress testing credit risk models and when to accept or reject loans. * Breaks down the latest credit risk measurement and modeling techniques and simplifies many of the technical and analytical details surrounding them * Concentrates on the underlying economics to objectively evaluate new models * Includes new chapters on how to prevent another crisis from occurring Understanding credit risk measurement is now more important than ever. Credit Risk Management In and Out of the Financial Crisis will solidify your knowledge of this dynamic discipline.

Leseprobe

Table of Contents

Title Page

Copyright Page

List of Abbreviations

Preface

PART One - Bubbles and Crises: The Global Financial Crisis of 2007-2009

CHAPTER 1 - Setting the Stage for Financial Meltdown

INTRODUCTION

THE CHANGING NATURE OF BANKING

REENGINEERING FINANCIAL INSTITUTIONS AND MARKETS

SUMMARY

APPENDIX 1.1: RATINGS COMPARISONS FOR THE THREE MAJOR RATING AGENCIES

CHAPTER 2 - The Three Phases of the Credit Crisis

INTRODUCTION

BURSTING OF THE CREDIT BUBBLE

PHASE 1 : CREDIT CRISIS IN THE MORTGAGE MARKET

PHASE 2 : THE CRISIS SPREADS—LIQUIDITY RISK

PHASE 3 : THE LEHMAN FAILURE—UNDERWRITING AND POLITICAL INTERVENTION RISK

SUMMARY

CHAPTER 3 - The Crisis and Regulatory Failure

INTRODUCTION

CRISIS INTERVENTION

LOOKING FORWARD: RESTRUCTURING PLANS

SUMMARY

PART Two - Probability of Default Estimation

CHAPTER 4 - Loans as Options: The Moody’s KMV Model

INTRODUCTION

THE LINK BETWEEN LOANS AND OPTIONS

THE MOODY’S KMV MODEL

TESTING THE ACCURACY OF EDF™ SCORES

CRITIQUES OF MOODY’S KMV EDF™ SCORES

SUMMARY

APPENDIX 4.1: MERTON’S VALUATION MODEL

APPENDIX 4.2: MOODY’S KMV RISKCALC™

CHAPTER 5 - Reduced Form Models: Kamakura’s Risk Manager

INTRODUCTION

DERIVING RISK-NEUTRAL PROBABILITIES OF DEFAULT

GENERALIZING THE DISCRETE MODEL OF RISKY DEBT PRICING

THE LOSS INTENSITY PROCESS

KAMAKURA’S RISK INFORMATION SERVICES (KRIS)

DETERMINANTS OF BOND SPREADS

SUMMARY

APPENDIX 5.1: UNDERSTANDING A BASIC INTENSITY PROCESS

CHAPTER 6 - Other Credit Risk Models

INTRODUCTION

CREDIT SCORING SYSTEMS

MORTALITY RATE SYSTEMS

ARTIFICIAL NEURAL NETWORKS

COMPARISON OF DEFAULT PROBABILITY ESTIMATION MODELS

SUMMARY

PART Three - Estimation of Other Model Parameters

CHAPTER 7 - A Critical Parameter: Loss Given Default

INTRODUCTION

ACADEMIC MODELS OF LGD

DISENTANGLING LGD AND PD

MOODY’S KMV’S APPROACH TO LGD ESTIMATION

KAMAKURA’S APPROACH TO LGD ESTIMATION

SUMMARY

CHAPTER 8 - The Credit Risk of Portfolios and Correlations

INTRODUCTION

MODERN PORTFOLIO THEORY (MPT): AN OVERVIEW

APPLYING MPT TO NONTRADED BONDS AND LOANS

ESTIMATING CORRELATIONS ACROSS NONTRADED ASSETS

MOODY’S KMV’S PORTFOLIO MANAGER

KAMAKURA AND OTHER REDUCED FORM MODELS

SUMMARY

PART Four - Putting the Parameters Together

CHAPTER 9 - The VAR Approach: CreditMetrics and Other Models

INTRODUCTION

THE CONCEPT OF VALUE AT RISK

CAPITAL REQUIREMENTS

TECHNICAL ISSUES AND PROBLEMS

THE PORTFOLIO APPROACH IN CREDITMETRICS

SUMMARY

APPENDIX 9.1: CALCULATING THE FORWARD ZERO CURVE FOR LOAN VALUATION

APPENDIX 9.2: ESTIMATING UNEXPECTED LOSSES USING EXTREME VALUE THEORY

APPENDIX 9.3: THE SIMPLIFIED TWO-ASSET SUBPORTFOLIO SOLUTION TO THE N-ASSET ...

APPENDIX 9.4: CREDITMETRICS AND SWAP CREDIT RISK

CHAPTER 10 - Stress Testing Credit Risk Models: Algorithmics Mark-to-Future

INTRODUCTION

BACK-TESTING CREDIT RISK MODELS

USING THE ALGORITHMICS MARK-TO-FUTURE MODEL

STRESS TESTING U.S. BANKS IN 2009

SUMMARY

CHAPTER 11 - RAROC Models

INTRODUCTION

WHAT IS RAROC?

RAROC, ROA, AND RORAC

ALTERNATIVE FORMS OF RAROC

THE RAROC DENOMINATOR AND CORRELATIONS

RAROC AND EVA

SUMMARY

PART Five - Credit Risk Transfer Mechanisms

CHAPTER 12 - Credit Derivatives

INTRODUCTION

CREDIT DEFAULT SWAPS

CREDIT SECURITIZATIONS

FINANCIAL FIRMS’ USE OF CREDIT DERIVATIVES

CDS SPREADS AND RATING AGENCY RATING SYSTEMS

SUMMARY

APPENDIX 12.1: PRICING THE CDS SPREAD WITH COUNTERPARTY CREDIT RISK EXPOSURE

CHAPTER 13 - Capital Regulation

INTRODUCTION

THE 2006 BASEL II PLAN

SUMMARY

APPENDIX 13.1 LOAN RATING SYSTEMS

Notes

Bibliography

Index

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Copyright © 2010 by Anthony Saunders and Linda Allen. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Saunders, Anthony, 1949-

p. cm.—(Wiley finance series)

Includes bibliographical references and index.

eISBN : 978-0-470-62238-4

1. Bank loans. 2. Bank management. 3. Credit—Management. 4. Risk management.

I. Allen, Linda, 1954- II. Saunders, Anthony, 1949- Credit risk measurement. III. Title.

HG1641.S33 2010

332.1′ 20684—dc22

2009044765

List of Abbreviations

ABCPasset-backed commercial paperABSasset-backed securityAEaverage exposureAMAadvanced measurement approachARMadjustable rate mortgageARSadjusted relative spreadABXindex of mortgage-backed security valuesBHCbank holding companyBISBank for International SettlementsBISTROBroad Index Secured Trust OfferingBRWbenchmark risk weightBSMBlack-Scholes-Merton ModelCAPMcapital asset pricing modelCBOEChicago Board Options ExchangeCDOcollateralized debt obligationCDScredit default swapCFTCCommodity Futures Trading CommissionCIOcollateralized insurance obligationCLNcredit-linked noteCLOcollateralized loan obligationCMOcollateralized mortgage obligationCMRcumulative mortality rateCREcommercial real estateCScredit spreadCSFPCrédit Suisse Financial ProductsCVRcontingent value rightsCWIcreditworthiness indexCYCcurrent yield curveDDdistance to defaultDMdefault mode modelEADexposure at defaultEBITDAearnings before interest, taxes, depreciation, and amortizationECEuropean CommunityECAExport Credit AgencyEDFexpected default frequencyEDPestimated default probabilityEEexpected exposureELexpected lossesEVAeconomic value addedEVTextreme value theoryFAfoundation approachFASFinancial Accounting StandardFASBFinancial Accounting Standards BoardFDfair disclosureFDICFederal Deposit Insurance CorporationFNMAFederal National Mortgage AssociationFHFAFederal Housing Finance AgencyFIsfinancial institutionsFSHCfinancial service holding companyFSAFinancial Services AuthorityFSLICFederal Savings and Loan Insurance CorporationFSOfinancial statement onlyFVfuture valueFXforeign exchangeFYCforward yield curveGEVgeneralized extreme valueGDPgross domestic productGLBGraham-Leach-Bliley (author discretion)GPDGeneralized Pareto DistributionGNMAGovernment National Mortgage AssociationGSEgovernment sponsored enterpriseGSFgranularity scaling factorIDRimplied debenture ratingIIFInstitute of International FinanceIMFInternational Monetary FundIRBinternal ratings-based modelISDAInternational Swaps and Derivatives AssociationIQRinterquartile rangeLASLoan Analysis System (KPMG)LBOleveraged buyoutLDCless developed countryLDCsless developed countriesLGDloss given defaultLPCLoan Pricing CorporationLTVloan to valueMmaturityLIBORLondon Inter-Bank Offered RateMBSmortgage-backed securityMDmodified durationMMRmarginal mortality rateMPTmodern portfolio theoryMRCmarginal risk contributionMTMmark-to-market modelNAICNational Association of Insurance CommissionersNASDNational Association of Securities DealersNGRnet to gross (current exposure) ratioNPVnet present valueNRSROnationally recognized statistical rating organizationOAEMother assets especially mentionedOBSoff-balance-sheetOCCOffice of the Comptroller of the CurrencyOECDOrganization for Economic Cooperation and DevelopmentOFHEOOffice of Federal Housing Enterprise OversightOISovernight index swapONIOffice of National InsuranceOPMoption-pricing modelOTCover-the-counterOTSOffice of Thrift SupervisionPDprobability of defaultQDFquasi default frequencyQISQuantitative Impact StudyRAROCrisk-adjusted return on capitalRBCrisk-based capitalREITreal estate investment trustReporepurchase agreementRNrisk-neutralROAreturn on assetsROCreceiver operating characteristicROEreturn on equityRORACreturn on risk-adjusted capitalRMBSresidential mortgage-backed securityRTCresolution trust corporationRWrisk weightRWArisk-weighted assetsSBCSwiss Bank CorporationSECSecurities and Exchange CommissionSIVstructured investment vehicleSMstandardized modelSMEsmall and medium enterpriseSPEspecial-purpose entitySPVspecial-purpose vehicleTBTFtoo big to failTRACETrade Reporting and Compliance EngineULunexpected lossesVARvalue at riskVIXvolatility indexWACCweighted-average cost of capitalWALweighted-average lifeWARRweighted-average risk ratioZYCzero yield curve

Preface

It might seem the height of hubris to write a book on quantitative models measuring credit risk exposure while the wreckage of the credit crisis of 2007 is still all around us. However, in our view, it is just at this time that books like this one are needed. While credit risk measurement models are always in need of improvement, we cannot place all of the blame for the crisis on their failure to detect risk and accurately value credit instruments. Models are only as good as their assumptions, and assumptions are driven by market conditions and incentives. The first three chapters of this book are devoted to a detailed analysis of the before, during, and aftereffects of the global financial crisis of 2007-2009.

In this edition, we build on the first two editions’ approach of explaining the economic underpinnings behind the mathematical modeling, so as to make the concepts accessible to bankers and finance professionals as well as students. We also compare the various models, explaining their strengths and their shortcomings, and describe and critique proprietary services available.

The first section (Chapters 1-3) describes bubbles and crises in order to understand the global financial crisis of 2007-2009. The second section presents several quantitative models used to estimate the probability of default (PD). The two major modeling approaches are the options-theoretic structural models (Chapter 4) and the reduced form models (Chapter 5). The options-theoretic approach explains default in structural terms related to the market value of the firm’s assets as compared to the firm’s liabilities. The reduced form approach statistically decomposes observed risky debt prices into default risk premiums that price credit risk events without necessarily examining their underlying causality. In Chapter 6, we compare and contrast these and other more traditional models (for example, Altman’s Z score and mortality models) in order to assess their forecasting accuracy.

Estimation of the expected probability of default is only one, albeit important, parameter required to compute credit risk exposure. In Chapter 7, we discuss approaches used to estimate another critical parameter: the loss given default (LGD). We also describe how the credit risk of a portfolio is determined in Chapter 8. In the subsequent three chapters, we combine these parameters in order to demonstrate their use in credit risk assessment. Value at risk (VAR) models are discussed in Chapter 9; stress test (including a description of the U.S. government stress testing of 19 systemically important financial firms, released in March 2009) is discussed in Chapter 10; and Chapter 11 describes risk-adjusted return on capital (RAROC) models that are used to allocate capital and even compensation levels within the firm.

The final section deals with credit risk transfer mechanisms. In Chapter 12, we describe and analyze credit default swaps (CDS) and asset-backed securities (ABS). Chapter 13 discusses capital regulation, focusing on Basel II risk-based capital requirements and proposed reforms.

We have many people to thank, but in particular, we would like to thank Anjolein Schmeits for her insightful comments and careful reading of the manuscript.

PART One

Bubbles and Crises: The Global Financial Crisis of 2007-2009

CHAPTER 1

Setting the Stage for Financial Meltdown

INTRODUCTION

In this first chapter we outline in basic terms the underlying mechanics of the ongoing financial crisis facing the financial services industry, and the challenges this creates for future credit risk models and modelers.

Rather than one crisis, the current financial crisis actually comprises three separate but related phases. The first phase hit the national housing market in the United States in late 2006 through early 2007, resulting in an increase in delinquencies on residential mortgages. The second phase was a global liquidity crisis in which overnight interbank markets froze. The third phase has proved to be the most serious and difficult to remedy and was initiated by the failure of Lehman Brothers in September 2008. The lessons to be learned for credit risk models are different for each of these phases. Consequently, we describe first how we entered the initial phase of the current crisis. In the upcoming chapters, we discuss the different phases and implications of the global financial crisis that resulted from the features that characterized the run-up to the crisis.

THE CHANGING NATURE OF BANKING

The traditional view of a bank is that of an institution that issues short-term deposits (e.g., checking accounts and certificates of deposit) that are used to finance the bank’s extension of longer-term loans (e.g., commercial loans to firms and mortgages to households). Since the traditional bank holds the loan until maturity, it is responsible for analyzing the riskiness of the borrower’s activities, both before and after the loan is made. That is, depositors delegate the bank as its monitor to screen which borrowers should receive loans and to oversee whether risky borrowers invest loan proceeds in economically viable (although not risk-free) projects see Diamond [1984].

In this setting, the balance sheet of a bank fully reflects the bank’s activities. The bank’s deposits show up on its balance sheet as liabilities, whereas the bank’s assets include loans that were originated by the bank and are held to maturity. Despite the simplicity of this structure, traditional banking is not free of risk. Indeed, the traditional model tended to expose the bank to considerable liquidity risk, interest rate risk, and credit risk. For example, suppose a number of depositors sought to withdraw their deposits simultaneously. In order to meet depositors’ withdrawals the bank would be forced to raise cash, perhaps by liquidating some assets. This might entail the selling of illiquid, long-term loans at less than par value. Thus, the bank might experience a market value loss because of the liquidity risk associated with financing long-term, illiquid assets (loans) with short-term, readily withdrawable liabilities (deposits).

With respect to interest rate risk in the traditional banking model, a good example occurred in the early 1980s when interest rates increased dramatically. Banks and thrift institutions found that their long-term fixed-rate loans (such as 30 year fixed-rate mortgages) became unprofitable as deposit rates rose above mortgage rates and banks earned a negative return or spread on those loans.