1. How frequently should counter party credit risks be reviewed?
Recent markets have shown that the financial strength of companies is usually not static and can in some instances change for the worse very rapidly. The frequency of review may depend on the relative strength of the counter parties and the current market conditions and level of economic uncertainty. Monitoring of credit exposure should be increased during volatile market conditions.
That said, key indicators should likely be reviewed weekly during normal conditions. Significant changes in indicators or negative news that suggest possible deterioration of financial health of a counter party would dictate vigilance and close watch of the counter party exposure.
2. Are there any recommended references on counter party credit risk management?
There are a host of books on credit risk, as a search of online booksellers like Amazon or B&N will show; however, many of these are not particularly helpful in term of assessment of counter party default probability. Risk Books in London (http://riskbooks.com) has an extensive catalog of credit risk management books that are useful, although some of the publications tend to be rather technical. Credit Risk edited by David Shimko and Credit Ratings by Michael K. Ong are highly recommended. Another strongly recommended standard reference is Credit Derivatives & The Management of Risk, by Dimitris N. Chorafas.
An extended list of suggested references on credit risk management is shown in the credit risk portal on the References page.
3. Why do the assessment methods differ for some of our counter parties?
Default indicators and weighting of factors such as financial ratios can differ substantially between sectors and industries. For example, counter parties that are primarily financial institutions will have very different values for their financial ratios relative to energy producers/generators, or marketers. Also, key risk factors to be considered in default probability assessments vary with a firm’s industry and domain of operation, so there is no standardized assessment method across all the industries.
4. Are credit rating agency ratings available for privately-held companies?
Credit rating agencies typically assign credit ratings for issuers of certain types of debt obligations, which may include some privately-held companies. Unfortunately, the recent financial crisis has raised concerns about the integrity and value of such agency ratings, whether for publicly-traded or privately-held companies.
Security & Exchange Commission Chairman Mary Schapiro noted that investors consider ratings for decisions and, “that reliance [on agency ratings] did not serve them well over the last several years.” In the current environment, if credit rating agency assigned ratings (and upgrades/downgrades) are available, then these should be checked, but certainly should not be solely relied upon for counter party default probability assessments. Further, the Risk Limited Corp default probability assessment of counter parties is focused on just that, default probability, not necessarily potential investment returns.
5. How are counter party credit risk assessments used?
That depends on the particular company, objectives and applications; however, typical uses include: - to determine if a transaction can or should be entered into with a particular counter party based on the assessment of their likely ability to perform, - to determine the level of acceptable credit risk exposure for the counter party and the corresponding credit line to be allocated for trading and transactions, - to establish the level of collateral and credit protection provisions in swap agreements and/or transaction provisions, - to determine when risk mitigation strategies should be applied to reduce exposures to existing counter parties, and - to aid in the assessment by independent auditors that a firm is an on-going concern.
6. What type of clients and markets does Risk Limited Corp serve?
We serve a wide range of clients, including major corporations, growth companies, privately-held firms, financial institutions & private equity investors, and start-up operations.