chap11_12 - A bank is a place that will lend you money if...

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1 “A bank is a place that will lend you money if you can prove that you don’t need it.” Bob Hope
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2 Why New Approaches to Credit Risk Measurement and Management? Why Now?
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3 Structural Increase in Bankruptcy Increase in probability of default High yield default rates: 5.1% (2000), 4.3% (1999, 1.9% (1998). Source: Fitch 3/19/01 Historical Default Rates: 6.92% (3Q2001), 5.065% (2000), 4.147% (1999), 1998 (1.603%), 1997 (1.252%), 10.273% (1991), 10.14% (1990). Source: Altman Increase in Loss Given Default (LGD) First half of 2001 defaulted telecom junk bonds recovered average 12 cents per $1 ($0.25 in 1999-2000) Only 9 AAA Firms in US: Merck, Bristol-Myers, Squibb, GE, Exxon Mobil, Berkshire Hathaway, AIG, J&J, Pfizer, UPS. Late 70s: 58 firms. Early 90s: 22 firms.
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4 Disintermediation Direct Access to Credit Markets 20,000 US companies have access to US commercial paper market. Junk Bonds, Private Placements. “Winner’s Curse” – Banks make loans to borrowers without access to credit markets.
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5 More Competitive Margins Worsening of the risk-return tradeoff Interest Margins (Spreads) have declined Ex: Secondary Loan Market: Largest mutual funds investing in bank loans (Eaton Vance Prime Rate Reserves, Van Kampen Prime Rate Income, Franklin Floating Rate, MSDW Prime Income Trust): 5-year average returns 5.45% and 6/30/00- 6/30/01 returns of only 2.67% Average Quality of Loans have deteriorated The loan mutual funds have written down loan value
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6 The Growth of Off-Balance Sheet Derivatives Total on-balance sheet assets for all US banks = $5 trillion (Dec. 2000) and for all Euro banks = $13 trillion. Value of non-government debt & bond markets worldwide = $12 trillion. Global Derivatives Markets > $84 trillion. All derivatives have credit exposure. Credit Derivatives.
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7 Declining and Volatile Values of Collateral Worldwide deflation in real asset prices. Ex: Japan and Switzerland Lending based on intangibles – ex. Enron.
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8 Technology Computer Information Technology Models use Monte Carlo Simulations that are computationally intensive Databases Commercial Databases such as Loan Pricing Corporation ISDA/IIF Survey: internal databases exist to measure credit risk on commercial, retail, mortgage loans. Not emerging market debt.
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9 BIS Risk-Based Capital Requirements BIS I: Introduced risk-based capital using 8% “one size fits all” capital charge. Market Risk Amendment: Allowed internal
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This note was uploaded on 08/27/2011 for the course FINANCE Fixed Inco taught by Professor Proflim during the Three '09 term at University of Adelaide.

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chap11_12 - A bank is a place that will lend you money if...

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