SettingCreditRiskLimits-ColumbiaUniversity.ppt

Credit Risk, Diversification and Setting Limits Outline Overview Market Concerns Credit Risk Limits Credit Risk Models Credit Risk Diversification Credit Risk Management Process Overview:Current State of the Credit Market Although Fixed Income has recently outperformed equity, the Corporate Bond market has severely underperformed Treasuries The market has experienced rising defaults, downgrades, and an unprecedented number of Investment Grade credits falling into High Yield (a.k.a. “Fallen Angels”) “Fallen Angels” are overwhelming the High Yield market as they number 14 of the top 25 issuers and comprise 20% of the total amount outstanding in High Yield Telecom/Energy have been at the core of the fundamental deterioration in credit with outsized spending to meet unrealistic demand expectations and aggressive expansions into energy trading in utilities Extreme market volatility and limited liquidity best characterizes the current state of the corporate bond market Banks are restricting access to liquidity and the resulting illiquidity is contributing to the credit market’s volatility Portfolio diversification is difficult to achieve given that 33% of amount outstanding and 42% of new issue volume are in the the top 25 names Survival depends on minimizing the occurrence and magnitude of distressed credits Market Concerns What is contributing to the current credit volatility? Bear equity market and corporate scandals Credit recession (stressed credit market) Liquidity crisis Historically low rates Economic recovery unclear A Bear Market in Equity Volatility at historic highs since 1997 3+ years upside of technology bubble 2.5 years of bubble bursting and corporate scandals Volatility measure of “% days per year SP 500 Index moved greater than +/- 1%” in August 2002 was 43% versus 22% historic average since 1925 Current downturn deepest since 1973-74 and longest since 1929-32 or 1946-49 At its July 2002 low, the SP 500 was 48% below its March 2000 peak and the declin