Magazine article Business Credit

Risk Rating an International Corporate Risk Portfolio

Magazine article Business Credit

Risk Rating an International Corporate Risk Portfolio

Article excerpt

Portfolio risk-rating models for corporate credit have been in popular use for several years. Organizations that have large numbers of corporate credits have found that the development and use of a rating, or credit scoring model, provide many valuable risk management advantages. Pricing, loss reserving, marketing and financing strategies, including securitizations, can all benefit from the enhanced risk management knowledge that credit and portfolio risk rating brings.

Organizations typically will draw on outside credit information and rating sources and then use these assets in conjunction with their internal credit expertise to develop a risk-rating system that meets their needs. Typically, the scale used is "1-10" with "1" being the best-rated credit and "10" being the worst.A credit rated" would be a large multi-national company with significant size and if rated by S&P carry an AA rating or better. At the other end of the scale, the "9" and "10"credits are generally rated either "doubtful" or "loss". Rating credits at either end of the spectrum is relatively simple compared to those credits in the "5" through "7" range where there will tend to be more difference of professional opinion. Bell curve results for the population of individual credits should be generated after the entire portfolio is rated. However, it is likely that the amount of dollar risk exposure will be skewed toward the better quality risks. Balance sheet, liquidity and earnings ratios are often introduced as a means to assist the placement of a credit in a certain rating. Current and complete credit information is also important in developing the criteria for the model. It is possible for the rating of quality credits to slip one or two grades because of the lack of proper credit information on which to base an evaluation.

Though there will most certainly be distinctions between the risk rating parameters of individual models, similar results are normally generated. It would be unusual for a given credit to be rated a "Y under one model and a "6" or "7" under another. If the risk rating system is to provide value as a risk management tool, the actual grading of risk must be done in a uniform fashion.This would be fairly simple to accomplish if only one person was establishing the credit rating; this is normally not the case. Large credit staffs, often located in different geographic regions, must be trained property to ensure that uniform results are achieved. If the time is invested in establishing relevant criteria and in staff training, the probability of seeing positive results will be greatly enhanced.The instances of a difference of opinion on rating a credit will be surprisingly small.This is, of course, critical to the integrity of the data and its ultimate value.

It is also clear that the introduction of any risk rating system must be cost effective.The value derived must be greater than its cost. Large and diverse portfolios can have models that are very complex while smaller ones need less sophistication. Although a great deal of seed work will be needed to get it right at the outset, once established and introduced, the ongoing costs should be small. Programming changes to the credit database must be identified and introduced to assure that the proper data is captured and meaningful analysis is possible. It is important to be able to capture and retain historical data to analyze how both an individual risk and also the portfolio performed over an extended period of time.

Portfolio risk rating is commonplace for domestic risk but not as commonplace for international risks.Those organizations that have significant credit exposures overseas must grapple with the uncertainty of country risk, defined in terms of both political and economic, in addition to the commercial risk of the specific credit. The process is further complicated in one other important way, current and accurate credit information on specific overseas risks is often more difficult to obtain. …

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