Resolving The Credit Risk Conundrum

Resolving the Credit Risk Conundrum:
Fundamental Analysis vs. Market Signals

Marcel Heinrichs Co-Speaker
Director, Business Development, S&P Credit Solutions
S&P Capital IQ
Mark Williams Co-Speaker
Executive-in-Residence/Master Lecturer, Finance Department
Boston University School of Management
Alma Chen - Moderator
Regional Head Americas, Analytic Development Group
S&P Capital IQ
October 28, 2014
Permission to reprint or distribute any content from this presentation requires the prior written approval of S&P Capital IQ.
Not for distribution to the public. Copyright 2014 by Standard & Poors Financial Services LLC (S&P). All rights reserved.
Todays Speakers
Marcel Heinrichs
Director, Business Development
S&P Credit Solutions
S&P Capital IQ
Mark Williams
Executive-in-Residence/Master Lecturer
Finance Department
Alma Chen
Associate Director
Analytics Development
S&P Capital IQ
(Moderator)
Pleaseornote:
The views
and opinions
expressed
by Mr.requires
Williamsthedoprior
not necessarily
reflect
S&P
IQ and itstoaffiliates.
Permission to reprint
distribute
any content
from this
presentation
written approval
of the
S&Popinion
CapitalofIQ.
NotCapital
for distribution
the public.
Topics Of Discussion
Introduction: Where credit risk matters
II
Current challenges in credit risk management and surveillance
III
Navigating the credit landscape via the spectrum of credit measures

Introducing the spectrum of credit measures
Key differentiating factors between the metrics within the spectrum
Market signals of credit risk
Fundamental measures of credit risk
IV
The case for utilizing both market signals and fundamental measures of
credit risk
Case study and Summary
VI
Collaboration of S&P Capital IQ with the academic sector
Permission to reprint or distribute any content from this presentation requires the prior written approval of S&P Capital IQ. Not for distribution to the public.
What Is Credit Risk?
Narrow definition: risk that a borrower will default on its issued debt
Wider definition: risk that a business partner cannot fulfil financial obligations
Examples:
Loss of interest payments and principal
Loss in investment
Disruption to cash flows
Increased collection costs
Potential bankruptcy
Need for Regulatory Reporting
Business disruption
Who Needs Credit Risk Solutions?

NON-FINANCIAL CORPORATIONS
(INVESTMENT) BANK
CORPORATE
A
INSURER
Underwriting
Credit Analysis
Risk Management
Commercial/Trade Credit CORPORATE

B
Supply Chain
Transfer Pricing
Captive Finance
COMMERCIAL
LENDER
Loan Origination
Credit Department
Risk Management
Debt Capital Markets

Structured Finance
Loan Syndication
Ratings Advisory
Leveraged Finance
Restructuring
ASSET /INVESTMENT
MANAGER
Idea Generation Pre-Trade
Credit Analysis Pre- and Post-Trade
Portfolio and Performance Risk
Management
Different Indicators Different Perspectives
Period of 2001-2013; entire universe of publicly rated companies by Standard & Poors Ratings Services,
that are also listed at a stock market
7316 companies, of which 200 defaulted on their issued debt
Assess all companies with two different kind of models; for defaulters exactly one year prior the actual default.
One model is based on fundamental data, the other is based on stock price volatility as a market signal
generate the following matrix of observed default rates per bucket;
observed default rate = number of defaulters / total number of entities
aaa
aa+ to aaa+ to abbb+ to bbbbb+ to bbb+ to bccc+ or worse
0.00 to
0.01%
(aaa to aa-)
0.00
0.00
0.00
0.00
0.00
0.00
N/A
Market Signals-Based Model (Merton-Type Approach)

0.01 to
0.04 to
0.63 to
0.03%
0.13%
0.13 - 0.63%
2.27%
2.27 to 9.64% >9.64%
(aa+ to aa-) (a+ to a-)
(bbb+ to bbb-) (bb+ to bb-) (b+ to b-)
(ccc+ or worse)
0.00
0.00
0.00
0.00 N/A
N/A
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.03
0.15
0.18
0.75
1.19
0.00
0.15
0.22
0.62
1.44
4.78
0.28
0.46
1.15
3.35
6.07
10.89
0.00
0.00
6.19
11.43
20.00
28.53
Higher credit risk,

as indicated by market signals
Source: S&P Capital IQ.

6
Higher credit risk,

as indicated by fundamentals
FundamentalsBased Scoring
Model
II
Problem I: Large Unrated Counterparty Universe

Banks and corporations engage in business transactions with counterparties that
present: limited or unavailable information, and/or unreliable credit assessments
Rated: Wealth of Information
Banks ~6,500 &
Corporations ~3,500
Publicly Listed Companies
~60,000 Banks &
Corporations (Active)
Private: Information Scarcity

Banks (Est.) ~50,000 &
Corporations (Est.), Millions
Source: S&P Capital IQ. Data as of June 10, 2014.

7
II
Problem II: Complex Global Credit Matters And Different Credit Signals
Investing in
emerging markets
Ratings stable but

stock price down
and CDS spread up
14,000
Suppliers
from around
the world
Poor You
Source: The Economist, April 21, 2012.
Source: S&P Capital IQ, May 14, 2014.
III
Convention I Type Of Model Output
Scoring Models
Scoring models produce a credit score (lower case letter grade such as bbb-), which is then also
mapped to a Probability of Default (PD). However, the primary output and main interest of its users is
the credit score as a qualitative measure of credit risk
Developed on ratings (full scale from AAA to D = default) or similar assessments such as shadow
ratings, credit estimates etc.
Favored by clients with an affinity to ratings, usually with a background as a fundamental credit
risk analyst
Input Data
Ratings and
explanatory factors
State-of-the-art
Modeling Recipe
Output Data
Credit scores in
lower case letters
Lower case letters indicate that these credit risk

assessments are derived quantitatively by S&P
Capital IQ and NOT by rating analysts from
Standard & Poors Ratings Services
Cash
EBITDA
Total Assets
Debt/Capital
AA+ BBB- CCC BB

AA- A- B CCC+
Proprietary
Algorithm
a- bbb+ ccc bb+

b- aaa aa-
Convention I Type Of Model Output
III
PD Models
PD models produce a PD in the first place, which is then also mapped to a credit score. The primary
output and main interest of its users is the PD as a quantitative measure of credit risk
Developed on default data (binary decision: either a company defaulted on its debt repayments in a
particular year or not)
Favored by clients who are not used to ratings as a rank measure or who do not believe in the
relevance of ratings, and often have a quantitative background
Input Data
Default flags and
explanatory factors
State-of-the-art
Modeling Recipe
Output Data
Default probabilities
Cash
EBITDA
Total Assets
Debt/Capital
0 010
Proprietary
Algorithm
0.26% 1.59%
29.64% 0.05%
0.46%
0 0 1 0 1 0 0
10 1 1 0 0
10
1.21%
III
Convention II Type Of Explanatory Factors
Fundamental Data: Any data that is usually collected at periodically, often annually or
quarterly (in rare cases monthly)
Firm-specific financials (Annual report, quarterly financial statements)
Systemic Risk factors such as
Macroeconomic factors (such as GDP growth, inflation rates)
(other) Factors that reflect the environment that a company operates in vis-a-vis country risk, industry risk or
sovereign risk
Market Signals: Any data that is usually collected at high frequency, most often daily or even
intra-daily
CDS spreads of companies whose credit risk is traded in the CDS market
Fixed Income spreads of companies that issue debt via bonds or similar instruments
Stock market volatility of public companies
Since ratings are based on fundamental data, anyone with an affinity to ratings tend to
favor models that are based on fundamental data
Anyone that find ratings less relevant tend to favor models that rely heavily (or solely)
on market signals
11
Longer/Less
volatile
Time Horizon
Shorter/more
volatile
III
12
Convention III Time Horizon
Point in Time (PIT)

CDS
spreads
Bond
spreads
Stock
Price
Volatility
Snapshot of the current market opinion: Used as a means

to screen out potential defaulters. These can include false
positives, but are unlikely to omit companies that can
potentially default
Short- to Mid-Term
Useful for someone who wants something less volatile than

PD market signals, but more volatile than Ratings
Hybrid Models (out

of scope for this
presentation)
Such models are favored by users with an affinity to pure

quantitative risk measures for pricing, reserve
calculation, Credit VaR etc
Mid- to Long-Term
Public
Ratings
Many
FundamentalsBased Models
For ratings, these are expected to be stable for 3-5 years for
investment grade (IG) and 2-3 years for non-IG companies
Much less volatile results
III
The Complete Picture: The Credit Spectrum
Time Horizon
Coverage
Usual
Primary
Measure
Issuer Credit Ratings

Daily Monitored
Quantitative Fundamentals-Based Models

Quarterly Updates
Quantitative Market Signals Models

Daily Updates
Qualitative Judgment
Peer Group Analysis
Fundamentals
Scoring or PD Model
Credit ratings (BBB-)*
Rank Peers from

Top to Bottom
Credit Score (bbb-)

Then mapped to PD in %
OR vice versa
PD in %
Then mapped to
credit score
PD in %
Then mapped to
credit score
PD in %
Then mapped to
credit score
Global Coverage
~9k companies
Global Coverage
Unlimited applicability
Global Coverage
Unlimited applicability
Publicly listed
Companies
38k companies
Companies w/
liquid bond market
~6k companies
Companies w/
liquid CDS market
>1k companies
Medium to
long- term metric
Medium to
long-term metric
Medium to
long- term metric
Point-in-Time
metric
Point-in-Time
metric
Point-in-Time
metric
78% of companies stay at

same level after 1 year
76% of companies stay at same level after 1 year
Fundamentals-based quantitative
models expand the rated
universe to any public or private
company around the globe for a
medium- to long-term view of
credit risk
Stock Price
Volatility
Bond Spread
32% of companies stay at same level after 1 year
Market signals models

provide additional shortterm (point-in-time) credit
risk indicators
*From Standard & Poors Ratings Services. S&P Capital IQ, as well as its products and services are analytically and editorially separate and independent from other analytical
areas at S&P, including S&P Credit Ratings.
13
CDS Spread
IV
Why Use Multiple Indicators Of Credit Risk?
Frequency Distribution Of Defaulters

70.0%
60.0%
50.0%
40.0%
Smaller area below the blue

line than the red line in the
shaded area
30.0%
20.0%
10.0%
0.0%
aaa
aa
CreditModel Score
bbb
bb
ccc &
below
PD Market Signals
In this example, we classified all companies with a Market Signal PD < 9.64%,
or a CreditModel score of b- and above, as healthy companies.
Type I Error:
Number of
defaults in
healthy group /
Total Number of
Defaults
Detected too late:
lose money
because of wrong
acceptance of
business
engagement
Source: Bankruptcy and default data from SP
CreditPro, CreditModel Scores from S&P
Credit Analytics, Market Signals PD from S&P
Capital IQ, from 2001 to 2013.
For illustrative purposes only.
Conclusion:
Market Signals PD Have Lower Type I Errors in the short-term
We can use these as a first cut to shortlist potential defaulters
14
IV
Why Use Multiple Indicators Of Credit Risk?
Frequency Distribution Of Non-defaulters

70.0%
Smaller
area below
the red line
than the
blue line in
the shaded
area
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
aaa
aa
CreditModel Score
bbb
bb
ccc &
below
PD Market Signals
In this example, we classified all companies with a Market Signal PD > 9.64%,
or a CreditModel score of ccc+ and below, as unhealthy companies.
Type II Error:
Number of nondefaulters in badcompanies group
/ total number of
healthy
companies;
False alarms: lose
money because of
wrong rejection of
business
engagement
Source: Bankruptcy and default data from SP
CreditPro, CreditModel Scores from S&P Credit
Analytics, Market Signals PD from S&P Capital
IQ, from 2001 to 2013.
For illustrative purposes only.
Conclusion:
CreditModel scores have lower type II errors in the medium- to long-term
First, shortlist potential defaulters using PD Market Signals, then use CreditModel
scores to narrow down the list of potential defaulters
15
Case Study Will This Company Default On Its Debt?
The Credit Surveillance Conundrum

Credit risk of company as indicated by different credit signals
AAA / aaa
25
AAA+ / aa+
24
23
AA / aa
22
AA- / aa21
A+ / a+
A / 20
a
19
A- / a18
BBB+ /
17
bbb+
16
BBB / bbb
15
BBB- / bbb14
BB+ / bb+
13
BB / bb
12
BB- / bb11
B+ / b+
10
B / b9
B- / b-8
CCC+ / ccc+7
CCC / ccc6
CCC- / ccc-5
CC / cc4
3
C/c
2
SD/D/NR
1
/sd/d/nr0
PD Model Fundamentals
Standard & Poors Ratings
British Petroleum (LSE:BP.)s
share price fell and its CDS spiked
during the oil spill in year 2010
MDS CDS
Scores
Volatile equity or CDS based

market signals would have
indicated a need to place BP on a
watch list.
Company did not default on its
debt, but contemplated filing for
bankruptcy/reorganization in
August 1, 2012
Source: S&P Ratings, S&P CreditModel Scores, and PD Market Signals from S&P Capital IQ RatingsDirect, October 2008 October 2013.
Key Developments news from S&P Capital IQs news sources.
16
Which Companies Are To Be Watched Now?

PD Model Market Signals (%)
0.63 to
CreditModel Score
0.00 to 0.01% 0.01 to 0.03% 0.04 to 0.13% 0.13 - 0.63%
2.27%
(aaa to aa-) (aa+ to aa-) (a+ to a-)
(bbb+ to bbb-) (bb+ to bb-)
2.27 to 9.64%
(b+ to b-)
>9.64%
(ccc+ or worse)
aaa
0.00
0.00
0.00
0.00
0.00 N/A
aa+ to aa-
0.00
0.00
0.00
0.00
0.00
0.00
0.00
a+ to a-
0.00
0.00
0.00
0.00
0.00
0.00
0.00
bbb+ to bbb-
0.00
0.00
0.03
0.15
0.18
0.75
1.19
bb+ to bb-
0.00
0.00
0.15
0.22
0.62
1.44
4.78
b+ to b-
0.00
0.28
0.46
1.15
3.35
6.07
10.89
0.00
0.00
6.19
11.43
20.00
28.53
ccc+ or worse
N/A
N/A
Double-Red Flag Candidates Around the Globe from Various Sectors as of Sep 30, 2014 (Excerpt)
Company
Industry
Country
CreditModel Score
PD Market Signals
OSX Brasil S.A.
O&G Equipment and Services
Brazil
cc
53.90% (cc)
Doral Financial Corp
Mortgage Finance
Puerto Rico
cc
40.89% (cc)
Air Berlin PLC
Airlines
Germany
ccc
22.46% (ccc-)
PT Bumi Resources Tbk
Coal and Consumable Fuels
Indonesia
cc
20.42% (ccc-)
Caesars Entertainment Corp
Casinos and Gaming
US
ccc-
16.15% (ccc)
Petrobras Argentina SA
Integrated Oil & Gas
Argentina
ccc-
16.02% (ccc)
Source: S&P Capital IQ.

17
Summary I
1. Always remember:
Essentially all models are wrong, but some are useful

[George E.P. Box]
2. On a standalone basis, no single credit risk model is superior to another

across the entire range of performance measures or criteria.
3. In particular, between fundamentals-based and market signals-based models
there is a trade-off between
Type 1 errors (accepting bad customers): market signals-based models are superior in
detecting (rapid) credit deterioration &
Type 2 errors (rejecting good customers) : fundamentals-based models are superior in

avoiding more false alarms
It is critical to know the type 1 and type 2 % of your model

Investors need to decide which error they deem more important
Issuer Credit
Ratings
18
FundamentalsBased
Credit Scoring
or PD Model
Market SignalsBased PD
Models
Summary II
4. Superior performance can be achieved by leveraging two independently derived

signals - one being fundamental and one being market-driven - and focusing on
companies that give double confidence:
CreditModel Score
Safe
Haven
PD Model Market Signals (%)

0.63 to
0.00 to 0.01% 0.01 to 0.03% 0.04 to 0.13% 0.13 - 0.63%
2.27%
(aaa to aa-) (aa+ to aa-) (a+ to a-)
(bbb+ to bbb-) (bb+ to bb-)
2.27 to 9.64%
(b+ to b-)
>9.64%
(ccc+ or worse)
aaa
0.00
0.00
0.00
0.00
0.00 N/A
aa+ to aa-
0.00
0.00
0.00
0.00
0.00
0.00
0.00
a+ to a-
0.00
0.00
0.00
0.00
0.00
0.00
0.00
bbb+ to bbb-
0.00
0.00
0.03
0.15
0.18
0.75
1.19
bb+ to bb-
0.00
0.00
0.15
0.22
0.62
1.44
4.78
b+ to b-
0.00
0.28
0.46
1.15
3.35
6.07
10.89
0.00
0.00
6.19
11.43
20.00
28.53
ccc+ or worse
N/A
N/A
Stay
Away
5. For companies with mixed signals, follow the suggested approach in our paper:
http://bit.ly/1zelpbO
19
VI
Current Projects with Academics
Standard & Poors Ratings Services, S&P Dow Jones Indices and S&P Capital IQ are
engaged with the academic sector in order to continuously provide best-in class data
and analytics both for research and for any of our customers immediate workflows.
Examples of current credit risk projects include:
Analysis of discriminatory power of behavioral data in credit risk with MSc students from Columbia
University; students get credit for this project as part of their curriculum
Project with world-renowned professor of economics from NYU on analysis of ratings momentum
Speaking engagements in credit risk to academics and/or (financial engineering) students from various
universities in the U.S. and the UK
Independent review of our suite of credit risk models by academics from top university in Far East
Well established program of internships in fall with MSc students in financial engineering from University
of Berkeley
Distribution of our data and research articles via WRDS (Wharton Research Data Services)
WE HAVE PLENTY OF IDEAS FOR

RESEARCH IN CREDIT RISK AND ARE
LOOKING FORWARD TO HEARING FROM
YOU ON ANY SUGGESTIONS FOR
FUTURE COLLABORATIONS
20
What Else Matters

1. Parental Support for Subsidiaries or Governmental Support for
Government-Related Entities (GREs)
Frances national railway service SNCF is a GRE and has a standalone rating of BBB-,
but its final rating is AA- (6 notches up!) because of its criticality to Frances
infrastructure system. Frances sovereign rating is AA
Petrobras Argentina gets one notch uplift for assumed support from its parent company
in Brazil
2. Systemic Risk Factors
Country Risk
Sovereign Risk
Industry Risk
Economic Risk
3. Recovery Risk (when a default occurs)
Distinguishes risk at issuance (or facility) level, while default risk is assessed at
company-level
4. So much more
21
Q&A
Marcel Heinrichs
S&P Capital IQ
22
Mark Williams
Alma Chen
S&P Capital IQ
(Moderator)
Pleaseornote:
The views
and opinions
expressed
by Mr.requires
Williamsthedoprior
not necessarily
reflect
S&P
IQ and itstoaffiliates.
Permission to reprint
distribute
any content
from this
presentation
written approval
of the
S&Popinion
CapitalofIQ.
NotCapital
for distribution
the public.
Biographies
Marcel Heinrichs, CFA
Director, Business Development, S&P Credit Solutions, S&P Capital IQ
Marcel is responsible for the market development of credit risk offerings to financial institutions and non-financial corporations in the Americas. In this role, Marcel defines
the roadmap for new offerings of content, tools and analytics, works with marketing and sales teams on activities for branding and sales generation, oversees thought
leadership and interaction with key market influencers including top clients, regulators or associations and paves the path for new markets and client segments. Prior to his
current role, Marcel was global head of the Analytic Development Group (ADG) of S&P Capital IQ, responsible for the analytical innovation, development, maintenance and
ongoing validation of all credit risk models and products. Until 2010, Marcel was based in London and co-leading the services team of S&P Risk Solutions EMEA, the
consultancy business of S&P Capital IQ. Before joining S&P Risk Solutions in 2004, Marcel taught courses in econometrics, financial econometrics, mathematical
economics and macroeconomics at the London School of Economics and consulted various financial institutions on a variety of modeling problems. Marcel is also a
member of the Financial Markets Group, the Research Center in Finance of the London School of Economics. He has a Master degree in economics from the University of
Bonn, Germany and Ecole Nationale de la Statistique et de lAdministration Economique (ENSAE), France.
Mark Williams
Executive-in-Residence/Master Lecturer, Finance Department, Boston University School of Management
Mark is an academic, author, columnist and risk management expert. Prior to joining Boston University he worked as a trust banker, senior trading floor executive and as a
Federal Reserve Bank examiner. Since 2002, he has been on the finance faculty at Boston University specializing in banking, energy and capital markets related matters.
He teaches at the graduate and undergraduate levels. In 2008 he was awarded the Boston University Beckwith Prize for excellence in teaching. Mark frequently appears in
the national media and has been a guest columnist for the Financial Times, New York Times, Reuters.com, Forbes.com, Business Insider, Boston Globe and Foreign Policy
Magazine. In 2010, his book Uncontrolled Risk, detailing the rise and fall of Lehman Brothers and root causes of the financial crisis was published by McGraw Hill.
www.uncontrolledrisk.com. In 2013 he coauthored Longwood Covered Courts and the Rise of American Tennis. This work won a best book award at the New England
Book Show. In 2014 he provided Congressional testimony relating to the risks associated with virtual currencies. In addition to teaching and expert witness work, he
services on several boards including Appleton Partners LLC, a Boston-based, wealth-management company and Standard & Poors Academic Advisory Council. Mark
holds a BSBA in Finance from the University of Delaware and a MBA from Boston University. He is also a founding board member of the Boston Chapter of the Global
Association of Risk Professional, a member of the Boston Analyst Security Association and International Association of Financial Engineers.
Alma Chen
Associate Director, Analytics Development, S&P Capital IQ
Alma is Head of the Analytic Development Group (ADG), Americas, and is currently based in New York. (Formerly, Head of ADG APAC, based in Hong Kong.) Her team is
focusing on analytical development, maintenance and ongoing validation of credit risk models and products, which are used by financial institutions and other creditsensitive entities to measure and manage credit risk, also within regulatory frameworks such as Basel II/III or Solvency II. Her team provides analytical support to existing
clients and Sales during pre-sales support, as well as to Risk Solutions, for ad-hoc assignments in Americas Region and APAC respectively. She has more than 12 years of
experience in the risk analysis and financial modeling. Prior to joining S&P Capital IQ, Alma was a Lead Consultant, who has provided robust and accurate solutions on
credit risk quantitative & expert-judge hybrid models for key components of Expected Loss: Probability of Default, Loss Given Default & Exposure at Default, including
different stages of modeling cycle: development, calibration, performance monitoring, validation and optimization. Before moving to Asia in 2008, Alma worked as an
economist of a U.S.-based company engages in mortgage purchasing, credit guarantee, issuing guaranteed mortgage-related securities and portfolio investment activities,
where Alma accumulated seven years of extensive experience in financial model development, validation and calibration, Alma also conducted economic research and
analysis. Alma holds a Masters Degree in Statistics from Texas A&M University in the United States, and a Bachelors Degree from Tsinghua University in China.
23
Appendix
24
Fundamentals-Based Models Strengths And Weaknesses

Key Strengths:
Models which are validated on a regular basis can be calibrated to maintain high
forecasting accuracy
Ties in company fundamentals to business and financial risk
Can be used for private companies where there are no traded equities, bonds, or CDS
Hybrid qualitative + quantitative models* can include the impact of government / parent
company support and qualitative factors (e.g., management quality) on credit risk
Key Weaknesses:
Unable to detect changes in fundamentals between reporting periods
May react too slowly for equity investors and for fixed income investors with
short holding horizons
* Available for Risk Scorecards only.

25
Market Signals-Based Models Strengths And Weaknesses

Equity-driven
Bonds-driven
CDS- driven
Strengths
Covers all publicly listed
companies, including
emerging markets
Covers companies that

issue bonds
This is the market price of the

entitys credit risk where CDS
is traded
Research shows that CDS
provide additional information
on credit risk that is not
reflected in distance to default
Particularly suited for
sovereign credit risk
monitoring
Weaknesses
May be noisy
Equity prices can react to
non-credit related events
Equity prices can over-react
to news, and exhibit shortterm reversals
Not all companies covered (e.g., few companies have

actively traded CDS or listed debt)
Illiquidity in bond and CDS markets reduce price
informative-ness
Bond yields are affected by interest rate movements that
are not related to default risk
Emerging markets may not have actively traded bonds or CDS
Market Derived Signals are represented in lowercase nomenclature to differentiate them from S&P Credit Ratings.
26
When To Use Fundamental Measures Of Credit Risk

Fundamentally driven models offer a mid-term to long-term view of the
credit worthiness of entities.
They can be used for the following:
As inputs into longer-lasting strategic decision such as limit setting
For credit risk origination/underwriting policies

Counterparty credit risk management
For debt pricing (fixed income, syndicated loans, transfer pricing etc.)
Issuer Credit
Ratings
27
FundamentalsBased
Credit Scoring or
PD Model
Peer Group Model
When To Use Market Signals Of Credit Risk

Market signals of credit risk provide a short-term or point-in-time view
of the creditworthiness of entities.
They can be used for the following:
As inputs into early warning signals
As leading indicators of possible long-term credit quality shifts
To monitor counterparty credit risk
To inform tactical or short-term credit related and investment management
decisions
Market SignalsBased PD Models

CDS Spreads

Bond Spreads

Stock Price Vola
Global coverage includes 246 countries including emerging and frontier markets.
Market Derived Signals are represented in lowercase nomenclature to differentiate them from S&P Credit Ratings.
28
Different Types Of Credit Risk Workflows:

Origination/ Idea
Generation
Screening and simple risk
assessment
Benchmarking
Managing high-risk
entities:
Adjust exposure terms
(less amount/ higher rate)
Outsource the risk, e.g.
insurance cover
Terminate exposure
Credit Decision
Accept or reject
exposure
Surveillance and
Monitoring
Generating earlywarning indicators
Adjusting reserves
Calculating Value at
Risk (VaR)
29
In-Depth Analysis
Incorporating
entities into a
portfolio
Using models to score

companies
Stress-testing
Performing sensitivity
analysis
www.spcapitaliq.com
Copyright 2014 by Standard & Poors Financial Services LLC, a subsidiary of McGraw Hill Financial Inc. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model,
software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval
system, without the prior written permission of Standard & Poors Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and
any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively, S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content.
S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data
input by the user.
The Content is provided on an as is basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF
MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENTS FUNCTIONING WILL BE
UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect,
incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses
caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact or recommendations to purchase, hold,
or sell any securities or to make any investment decisions. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a
substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&Ps opinions and analyses do not
address the suitability of any security. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable,
S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have
information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each
analytical process.
S&P provides a wide range of services to, or relating to, many organizations, including issuers or underwriters of securities or obligors, investment advisers, broker-dealers, investment banks, other financial
institutions and financial intermediaries. As a result, S&P may receive fees or other economic benefits from organizations whose securities or services it may recommend, analyze, rate, include in model
portfolios, evaluate, price or otherwise address.
STANDARD & POORS, S&P, CREDITMODEL and GICS are registered trademarks of Standard & Poors Financial Services LLC. Capital IQ is a registered trademark of Capital IQ, Inc. S&P CAPITAL IQ is a
trademark of Standard & Poors Financial Services LLC. MICROSOFT, WORD, POWERPOINT, and EXCEL are registered trademarks or trademarks of Microsoft Corporation in the United States and/or other
30
Permission
to reprint
or may
distribute
contentoffrom
presentation
requires the prior written approval of S&P Capital IQ. Not for distribution to the public.
countries. All other product
or service
names
be theany
property
theirthis
respective
owners.

Resolving The Credit Risk Conundrum

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Resolving The Credit Risk Conundrum

Uploaded by

Copyright:

Available Formats

Resolving the Credit Risk Conundrum:

Fundamental Analysis vs. Market Signals

Introduction: Where credit risk matters

Current challenges in credit risk management and surveillance

Navigating the credit landscape via the spectrum of credit measures

Case study and Summary

Collaboration of S&P Capital IQ with the academic sector

What Is Credit Risk?

Who Needs Credit Risk Solutions?

Commercial/Trade Credit CORPORATE

Debt Capital Markets

Different Indicators Different Perspectives

Market Signals-Based Model (Merton-Type Approach)

Higher credit risk,

Source: S&P Capital IQ.

Higher credit risk,

Problem I: Large Unrated Counterparty Universe

Private: Information Scarcity

Source: S&P Capital IQ. Data as of June 10, 2014.

Ratings stable but

Source: The Economist, April 21, 2012.

Source: S&P Capital IQ, May 14, 2014.

Convention I Type Of Model Output

Lower case letters indicate that these credit risk

AA+ BBB- CCC BB

a- bbb+ ccc bb+

Convention I Type Of Model Output

Convention II Type Of Explanatory Factors

Macroeconomic factors (such as GDP growth, inflation rates)

Convention III Time Horizon

Point in Time (PIT)

Snapshot of the current market opinion: Used as a means

Useful for someone who wants something less volatile than

Hybrid Models (out

Such models are favored by users with an affinity to pure

The Complete Picture: The Credit Spectrum

Issuer Credit Ratings

Quantitative Fundamentals-Based Models

Quantitative Market Signals Models

Peer Group Analysis

Credit ratings (BBB-)*

Rank Peers from

Credit Score (bbb-)

78% of companies stay at

76% of companies stay at same level after 1 year

32% of companies stay at same level after 1 year

Market signals models

Why Use Multiple Indicators Of Credit Risk?

Frequency Distribution Of Defaulters

Smaller area below the blue

Why Use Multiple Indicators Of Credit Risk?

Frequency Distribution Of Non-defaulters

Case Study Will This Company Default On Its Debt?

The Credit Surveillance Conundrum

Volatile equity or CDS based

Which Companies Are To Be Watched Now?

OSX Brasil S.A.

O&G Equipment and Services

Doral Financial Corp

Air Berlin PLC

PT Bumi Resources Tbk

Coal and Consumable Fuels

Caesars Entertainment Corp