Credit Portfolio Management: Key Concepts

Content
CREDIT RISK OVERVIEW
The goal of this section is to teach the fundamental concepts of credit risk

Traditional and current definitions of credit risk: default and credit migration
Credit risk for different market participants e.g. bank lender, fixed income investors, CDS counterparty, credit insurer
Categories of credit risk: lending, issuer, contingent, pre-settlement, settlement, country / transfer, other
Key concepts of credit risk: default, recovery and exposure
Differing approaches under Basel II, US GAAP, IFRS, internal models and market practices (e.g. ISDA agreements).
PORTFOLIO RISK MANAGEMENT
The goal of this section is to review the various techniques used to manage and measure credit risk within a portfolio and to understand the key drivers of credit risk.

Risk management strategy
Portfolio management objectives: balancing risk appetite and diversification to maximise risk adjusted returns
Diversification, granularity and correlation concepts
Contagion risk – lessons learned in mature and emerging markets
Techniques to spread risk: syndication, sub-participation, whole loan sales, credit derivatives, securitisation
Liquidity: assumptions re: liquidity of credit market
Focus on credit default swaps: basic structure, uses, variants, issues and uncertainties to consider as a hedging tool.
Measuring portfolio risk
Portfolio credit risk versus single credit risk
Credit risk loss distributions: quantifying expected and unexpected losses
Contrasting credit and market risk measurement
Key drivers of credit risk:
Probability of default: using rating models and rating migration
Correlations: importance and issues with estimation
Loss given default: recognition, calculation issues
Exposure at default: estimation issues for different risk types
Maturity and time horizon.
CREDIT RISK MODELS
The goal of this section is to review the key types and approaches of credit portfolio models.

Introduction to credit portfolio models
Basic statistics for risk management: volatility, correlation, VaR, Monte Carlo simulation
Alternative modelling approaches
Default models and mark to market / multi-state models
Structural and reduced form models
Conditional and unconditional models
Widely used models: KMV, Credit Risk+, CreditMetrics, Credit Explorer
Key features and advantages and disadvantages of each model
Who uses what model?
Scenario and sensitivity analysis
Why scenario analysis is necessary and different methodologies
Role of scenario analysis within the stress testing framework
Sensitivity of key inputs: probability of default, loss given default, number of rating scales etc.
CAPITAL ALLOCATION

Regulatory framework
Basel capital adequacy model and comparison with other models
Single credit risk concepts: Basel I and Basel II standardised approach
Basel II internal ratings based methodologies
Capital requirements for a simple portfolio under Basel I, Basel II standardised and Basel II internal rating methodology.
Economic capital:
Key differences between regulatory (Basel II) and economic capital
Comparison of models
Relationship between shareholder, regulatory and economic capital
Different types of capital: credit risk capital, market risk capital, etc.
Credit VaR: VaR and Credit VaR disclosure for a leading institution.
CONCLUSION
Role of credit portfolio management: veto rights, advisory or profit centre
Within credit department: controller or adviser
Decisions makers: front office portfolio optimisers
Lessons learned from and impact of sub-prime crisis and credit crunch.