- 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
- 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 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)
- 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
- 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
- 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