ABOUT THE AUTHOR

Donald R. Van Deventer, Ph.d.

Don founded Kamakura Corporation in April 1990 and currently serves as its chairman and chief executive officer where he focuses on enterprise wide risk management and modern credit risk technology. His primary financial consulting and research interests involve the practical application of leading edge financial theory to solve critical financial risk management problems. Don was elected to the 50 member RISK Magazine Hall of Fame in 2002 for his work at Kamakura.

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How Risky Is Your Employer?

07/20/2009 03:20 AM

One of the lessons of the credit crisis that started in 2007 is that even the largest public companies in the United States could not answer key questions about risk management like those posed in our blog of April 27, 2009.  In our post mortems on Countrywide Financial, Washington Mutual, and New Century Financial, we found that in many cases management ignored working level staff who were trying to alert management and the Board to the risks being taken.  This blog is devoted to how modern credit risk techniques can be used to send a wake-up call to senior management and directors who have not been paying attention to the risk of the firm. &l

We posed these four key risk management questions in the April 27 blog, which we labeled a 4 question pass/fail test in risk management for financial institution CEOs and Board of Directors:

Question 1: What happens to the market capitalization and net income of the firm if any of these risk factors change: home prices, foreign exchange rates, commercial real estate prices, stock index levels, interest rates, commodity prices?

Question 2: Using an insider’s knowledge of the assets and liabilities of the firm, both “on balance sheet” and “off balance sheet,” what is the best estimate, monthly for the next ten years, of the probability that the firm will fail in each of these 120 monthly periods?

Question 3: Using only information available to an outsider, what is the best estimate of the probability of the failure of the firm in both the short run and the long run?

Question 4: If the firm is able to answer Questions 1, 2, and 3, what hedging position is necessary to insure that the macro factor sensitivity of the firm and default probability of the firm reach the target levels set by the Board of Directors?

Today’s blog focuses on question 3. How can a dedicated risk manager or member of the management team show the CEO and board members what the probability of default of the firm is now, how it’s changed over time, and what the rating of the firm would like be today if the rating agencies have behaved “normally,” not using the inflated ratings like those for financial institutions leading into the current credit crisis?

Kamakura Corporation would like to help by sending a “one company” credit assessment from the Kamakura Risk Information Services default probability service. This one company credit assessment is specifically designed to answer these questions for publicly listed firms:

What is the company’s annualized default probability over the next

  • 1 month
  • 3 months
  • 6 months
  • 1 year
  • 2 years
  • 3 years
  • 5 years?

What is the company’s cumulative default probability over the next

  • 1 month
  • 3 months
  • 6 months
  • 1 year
  • 2 years
  • 3 years
  • 5 years?

If the company has a traditional debt rating, what would the rating be now if the rating agencies could instantly change the current rating to what it should be now?  For example, FNMA and FHLMC were rated AAA when they were nationalized, because the rating agencies were too intimated by the political consequences to assess their credit risk adequately.

If the company does not have a traditional debt rating, what is the best estimate of what rating would be awarded?

If debt markets returned to conditions that prevailed in 2003-2005, what is the best estimate of the credit default swap quotations for the company?

From a third party perspective, what macro factors are most significant in explaining movements of the company’s default probability over time?

How have default probabilities for the company moved over time?

Among the 27,000 companies on KRIS, how does the company rank in terms of riskiness?

In order to help management better inform senior management about how others perceive the risk of their firm, Kamakura would be pleased to provide this “one company” credit assessment” to our readers who request one using their corporate e-mail address. The credit risk assessment is only for one’s own firm and it is only available if the company is a publicly listed company in the 30 countries covered by KRIS. To request such a one company credit risk assessment, please contact any of these members of our world-wide Kamakura Risk Information Services team:

London: Julian Goodkin, jgoodkin@kamakuraco.com
Cambridge, MA: Sean Klein, sklein@kamakuraco.com
Honolulu: Mark Mesler, mmesler@kamakuraco.com
Tokyo: Toshio Murate, tmurate@kamakuraco.com

We hope we can be of help.

Donald R. van Deventer
Kamakura Corporation
Honolulu, July 20, 2009

ABOUT THE AUTHOR

Donald R. Van Deventer, Ph.d.

Don founded Kamakura Corporation in April 1990 and currently serves as its chairman and chief executive officer where he focuses on enterprise wide risk management and modern credit risk technology. His primary financial consulting and research interests involve the practical application of leading edge financial theory to solve critical financial risk management problems. Don was elected to the 50 member RISK Magazine Hall of Fame in 2002 for his work at Kamakura.

Read More