Managing Credit Risk

Managing Credit Risk, Second Edition opens with a detailed discussion of today’s global credit markets—touching on everything from the emergence of hedge funds as major players to the growing influence of rating agencies. After gaining a firm understanding of these issues, you’ll be introduced to some of the most effective credit risk management tools, techniques, and vehicles currently available. If you need to keep up with the constant changes in the world of credit risk management, this book will show you how.

About the Authors xi

Introduction xv

Chapter 1 Credit Risk: The Great Challenge For The Global Economy 1

Chapter 2 Credit Culture 23

Chapter 3 Classic Industry Players: Banks, Savings Institutions, Insurance: Companies, Finance Companies, and Special Purpose Entities 41

Chapter 4 The Portfolio Managers: Investment Managers, Mutual Funds, Pension Funds, and Hedge Funds 59

Chapter 5 Structural Hubs: Clearinghouses, Derivative Product Companies, and Exchanges 69

Chapter 6 The Rating Agencies 81

Chapter 7 Classic Credit Analysis 103

Chapter 8 Asset-Based Lending and Lease Finance 117

Chapter 9 Introduction to Credit Risk Models 127

Chapter 10 Credit Risk Models Based upon Accounting Data and Market Values 139

Chapter 11 Corporate Credit Risk Models Based on Stock Price 181

Chapter 12 Consumer Finance Models 201

Chapter 13 Credit Models for Small Business, Real Estate, and Financial Institutions 223

Chapter 14 Testing and Implementation of Credit Risk Models 237

Chapter 15 About Corporate Default Rates 251

Chapter 16 Default Recovery Rates and LGD in Credit Risk Modeling and Practice 277

Chapter 17 Credit Risk Migration 311

Chapter 18 Introduction to Portfolio Approaches 325

Chapter 19 Economic Capital and Capital Allocation 349

Chapter 20 Application of Portfolio Approaches 367

Chapter 21 Credit Derivatives 411

Chapter 22 Counterparty Risk 437

Chapter 23 Country Risk Models 455

Chapter 24 Structured Finance 475

Chapter 25 New Markets, New Players, New Ways to Play 509

Chapter 26 Market Chaos and a Reversion to the Mean: The Rediscovery of Culture as a Critical Risk Management Tool 539

Notes 553

Appendix 569

Index 607

JOHN B. CAOUETTE is the former vice chairman of MBIA Insurance Corporation and is currently Chairman of Channel Capital Group, a European-based credit derivative products company.

EDWARD I. ALTMAN, PHD, MBA, is the Max L. Heine Professor of Finance at the Stern School of Business, New York University. Previously, he chaired the Stern School's MBA Program for twelve years. He has been acclaimed as the world's leading academic on credit risk and distressed and high-yield debt for most of his forty-year career.

PAUL NARAYANAN is Director of Credit Portfolio Analytics at American International Group, Inc. He has been involved with credit risk management for more than two decades and in the development and deployment of analytical solutions for credit issues.

ROBERT W. J. NIMMO is the former group risk director of Barclays PLC, where he was responsible for all the risk management activities of the group covering credit, market, operational risk, and compliance. He was also the chief risk officer for Wachovia Corporation (2000–2001) and for Westpac Banking Corporation (1993–2000).

It would be an understatement to say that the field of finance—specifically the credit arena—has changed in the decade since the first edition of Managing Credit Risk was published. Ten years later, things look a lot different. Credit risk has grown in scope and complexity against the backdrop of global economic, political, and technological change, and there are also many more tools, much more information, and some important new players to deal with.

That's why John Caouette, Edward Altman, Paul Narayanan, and Robert Nimmo have created Managing Credit Risk, Second Edition. Fully revised and updated to reflect the numerous developments within the discipline, this timely title combines state-of-the-art credit risk solutions with the practical perspectives of leading experts who have successfully implemented them.

Written with the serious financial professional in mind, Managing Credit Risk, Second Edition opens with a detailed discussion of today's global credit markets—touching on everything from the emergence of hedge funds as major players to the growing influence of rating agencies. After gaining a firm understanding of these issues, you'll be introduced to some of the most effective credit risk management tools, techniques, and vehicles currently available, including:

• Credit models for small business, real estate, and emerging market companies
• Default recovery rates and "loss given default" in credit risk modeling and practice
• Credit risk models based on accounting data and market values
• Testing and implementation of credit risk models
• The most popular forms of credit derivatives and approaches that can be used to analyze counterparty credit risk and much more

Rounding out this discussion of credit risk management, the authors skillfully integrate emerging trends in the financial markets with the new methods mentioned. This will allow you to quickly

apply the lessons outlined throughout these pages to today's dynamic credit environment.

In recent years, credit risk has become pervasive throughout the world. The dramatic growth in borrowing by all segments of society—from corporations and consumers to governments—clearly illustrates the scale of this credit explosion. If you need to keep up with the constant changes in the world of credit risk management, and want to improve your overall understanding of this field, then look no further than Managing Credit Risk, Second Edition.

It would be an understatement to say that the field of finance—specifically the credit arena—has changed in the decade since the first edition of Managing Credit Risk was published. Ten years later, things look a lot different. Credit risk has grown in scope and complexity against the backdrop of global economic, political, and technological change, and there are also many more tools, much more information, and some important new players to deal with.

That's why John Caouette, Edward Altman, Paul Narayanan, and Robert Nimmo have created Managing Credit Risk, Second Edition. Fully revised and updated to reflect the numerous developments within the discipline, this timely title combines state-of-the-art credit risk solutions with the practical perspectives of leading experts who have successfully implemented them.

Written with the serious financial professional in mind, Managing Credit Risk, Second Edition opens with a detailed discussion of today's global credit markets—touching on everything from the emergence of hedge funds as major players to the growing influence of rating agencies. After gaining a firm understanding of these issues, you'll be introduced to some of the most effective credit risk management tools, techniques, and vehicles currently available, including:

• Credit models for small business, real estate, and emerging market companies
• Default recovery rates and "loss given default" in credit risk modeling and practice
• Credit risk models based on accounting data and market values
• Testing and implementation of credit risk models
• The most popular forms of credit derivatives and approaches that can be used to analyze counterparty credit risk and much more

Rounding out this discussion of credit risk management, the authors skillfully integrate emerging trends in the financial markets with the new methods mentioned. This will allow you to quickly apply the lessons outlined throughout these pages to today's dynamic credit environment.

In recent years, credit risk has become pervasive throughout the world. The dramatic growth in borrowing by all segments of society—from corporations and consumers to governments—clearly illustrates the scale of this credit explosion. If you need to keep up with the constant changes in the world of credit risk management, and want to improve your overall understanding of this field, then look no further than Managing Credit Risk, Second Edition.