February 28, 2007
2007 "Frontiers in Credit Forum" Report: Bubble Mania Redux?
by Janet Basilone, special to PRMIA
February 28, 2007 - New York, NY - Highlighted with keynote presentations from industry leaders like John Hull, Ed Altman and Don van Deventer, PRMIA New York's 2007 "Frontiers in Credit Forum" raised issues of high importance for the risk profession. The general consensus among participating experts was a mixture of enthusiasm about the point to which the industry has evolved tempered with concerns about trends that, if not properly managed, portend trouble on the horizon.
After a welcome from PRMIA New York Regional Director James Tunkey, the morning kicked off with a panel on Frontiers in Credit Research moderated by Peter Davis, Director of Credit Risk Services in Ernst & Young's Global Financial Services Advisory Practice. Co-panelists James Batterman, Senior Director in the Credit Policy Group at Fitch Ratings, and David Hamilton, Senior Vice President of Credit Policy Research at Moody's Investors Service, addressed a rapt audience on the topics of credit derivatives product news and near-term expectations for default experience, respectively.
Mr. Batterman reviewed highlights of Fitch's 2006 Global Credit Derivatives Survey, subtitled: "Indices Dominate Growth as Banks' Risk Position Shifts." The survey found that the notional amount of outstanding credit derivatives contracts sold rose from US$5.3 trillion at year-end 2004 to nearly US$12.0 trillion at year-end 2005 - an increase of 122%; by year-end 2006 this number had more than doubled to over $25 trillion. Indices and index-related products (CDX, iTraxx, ABX.HE) continue to drive the growth in the synthetic CDS market: the segment grew by an astounding 900% and, at US$3.7 trillion, now constitutes 31% of gross sold positions.
Of course, a key theme throughout the day was the strong appetite in the market for corporate leveraged loans, an asset class within one of the most innovative and fastest growing sectors of the U.S. capital markets in 20 years. Mr. Batterman noted how the growing secondary market for leveraged loans is driving the market in credit derivatives for these loans. Europe has taken the lead with LevX; dealers in the U.S. continue to work toward the introduction of the U.S. loan CDS index, LCDX.
Mr. Hamilton of Moody's pointed out that the prevalence of corporate leveraged loans prompted Moody’s to update its model for assessing the speculative grade default rate and introduce an LGD scale. The addition of corporate loan issuers to the bond universe, especially in the high-yield sector, will allow for a more representative indicator of corporate defaults.
Mr. Hamilton noted that the default rate on speculative grade instruments has been low - at or below 2% - for a "long" time. (He was referring to the period from mid-2005 to February 2007.) For 2007, he forecasts a default rate of 3.1%, still well below the historical average of 4.9%. Mr. Hamilton pointed out that the proportion of high-yield ratings categories (B2 to Caa) in Moody's portfolio has increased significantly. Like the morning's keynote speaker, Edward I. Altman, Mr. Hamilton projects a negative turn in the cycle by 2008 due to weak fundamentals.
Throughout the day, speakers discussed their views on the state of the market in high yield bonds, loans and distressed debt. Since 2003, there has been a steady climb in the issuance of speculative-grade bonds and loans. Corporate loans - in particular second lien loans - have become an important substitute asset class for highly leveraged issuers, and 2006 saw a pronounced rise in the number of loan-only issuers.
Compounding concerns is the expectation, based on historical data, that deterioration in the credit quality of loan-only issuers will coincide with deterioration in loan-only recovery rates. (Many panelists commented on the current abnormally low default/ high recovery rate state of the market versus the historical rate.) It was noted that the rise of loans as a substitute asset class, as well as the presence of new institutional investors with distinct strategic objectives and tactics, are wildcards for the direction of the expected default and recovery rates.
The dramatic increase in liquidity resulting from the presence of aggressive investors (e.g., hedge funds, private equity firms) in search of yield, however little, has given rise to an imbalance in supply and demand. And these aggressive investors, who lend directly to troubled issuers, can act as a lifeline or precipitate their default.
Matthieu Royer, Director in the Portfolio & Balance Sheet Management Group at CALYON (a division of Credit Agricole Group), moderated a panel on The Credit Model Spectrum. This group included Stephen Figlewski, Professor of Finance at New York University, who presented recent research and findings on the macro-economic aspects of default likelihood and migration forecasts; Bjorn Flesaker of Bloomberg who spoke about the use of CDS to replicate or price other default contingent claims; and Sivan Mahadevan of Morgan Stanley who provided a market perspective on default correlation.
In the afternoon Practitioners Forum, Martin Fridson, CEO of FridsonVision, LLC, spoke abut the benefits, and costs, of liquidity. He referred to a "credit spiral" that lets companies borrow their way out of trouble. Indeed, fewer troubled companies are filing for Chapter 11 because hedge funds are eager to step in with financing in the current market environment. Mr. Fridson spoke of the power of liquidity to keep the default rate low (at least temporarily). And he raised concern about the quality of new issuances that he speculated could lead to a peak in the default rate in 2009. This idea was broached by an earlier presenter who indicated that the rating distribution of first-time issuers since 2004 leads many to think the default rate is primed for a rise: 30% of issuers are rated "Caa" out of the gate.
Curt Deane, principal of the Deane Group, pointed out that there is no apparent reward for the level of risk in this market, and questions how the liquidity can justify the homes it is seeking. Mr. Deane worries that you don't know who the ultimate counterparty is. He wonders why nobody kicks tires anymore and asks: are we too complacent about the concept of credit protection?
Chris Whalen, Managing Director of Institutional Risk Analysis, reiterated many of Mr. Deane's concerns. He asserts that we need a more critical view and must look at deeper default experience. He'd like answers to questions such as "When do you normalize a data series?" and "How does a company compare to its peers?" He, too, notes that there is no compensation for risk today, and that a hedge fund manager has zero incentive to enter into a restructuring driven by a bank workout department; the incentive is to liquidate.
The size of the distressed debt market and performance are what continue to drive investment in this asset class. Assets under management at distressed debt hedge funds range from $5 billion to $20 billion. In 2006, BB-rated bonds yielded 10%; CCCs yielded 20%; distressed CCCs yielded 40%; and the average return on defaulted bonds was 40% to 60%. Although more and more players see assets in bankruptcy as an exciting asset class, the big unknown is whether these investors will be capable of withstanding defaults and write-offs during a downturn.
Indeed Edward Altman, Max L. Heine Professor of Finance at New York University's Stern School of Business, sounded a note of caution for risk professionals. At 2.5% in 2007 and 3.7% in 2008, his default rate forecast for corporate high-yield non-investment grade bonds is higher than the current rate of 0.76%, but well below the historical average of 4.2%. While Professor Altman is not necessarily forecasting a drying up of liquidity, he does caution that corporate fundamentals and poor new bond and loan quality point toward significantly higher default rates in the future.
The issue for Professor Altman is: are historical default/recovery models still relevant or is there a new paradigm? He questions the conventional wisdom that recession paves the way for defaults. As he points out, this was not the case in the last two recessions. In his view, new models are needed.
Today's average loan in default sells at $0.93 on the dollar, an amount very close to that of the average on new defaults. Ed Altman wonders if these companies are really worth that much in asset value? And he poses this important question: will excess liquidity continue to dominate the market or will we observe a regression to the long-term mean and where defaults and recoveries are once again based on firm-fundamental and more traditional supply/demand risk patterns?
Sound familiar?
If PRMIA's 2007 Frontiers in Credit Forum is used to gauge quality for future programs, members will want to make a point of reserving a slot for upcoming events. Matthieu Royer summed it up by saying that he had never seen such a high caliber of panelists in a one-day event. This forum is just one example of PRMIA's level of commitment to delivering high-value programs to its membership.
Posted by dkoenig at 04:07 AM
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Robert C. Merton Selects Graduate Student To Receive PRMIA Institute Grant
Professor Robert C. Merton, the John and Natty McArthur University Professor at the Harvard Business School, and recipient of the 2006 PRMIA Higher Standard Award, has named Doriana Ruffino, a PhD student at Boston University, as the recipient of the PRMIA Institute academic grant associated with his Higher Standard Award.
"Doriana is absolutely first-rate in quality of mind, dedication to the subject, and delivering on performance," said Dr. Merton. "She exemplifies well the quality expected of someone receiving a grant as a consequence of the PRMIA Higher Standard Award."
Ms. Ruffino's research employs continuous-time finance theory in the study of optimal risk management, both at the level of financial firms and at the level of households finance. In the context of the risk management techniques utilized by financial firms, she has authored an article that responds to recent commentaries suggesting that dynamic hedging is an inadequate description of real-world practices.
Her most current research is on optimal household decisions over the life-cycle. The model that she has been developing over the past few months will be part of her dissertation proposal and it is entitled "Career Risk Management: The Optimal Exercise of Life-Cycle Options (with Jonathan Treussard)."
"I am truly honored to have received this award and to have the opportunity to conduct academic research in line with PRMIA's primary objectives," said Ms. Ruffino. "Needless to say, this does and will motivate me even further to pursue higher standards in my research."
The PRMIA Higher Standard award is granted to individuals who have significantly impacted the global practice of risk management, provided a substantial contribution to the Mission of PRMIA and its members, and who show an ongoing commitment to the highest standards of the profession.
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February 16, 2007
Frontiers in Credit Forum: Professor Edward I. Altman Issues Caution on Credit
February 16, 2007 – New York, NY – Edward I. Altman, Max L. Heine Professor of Finance at New York University’s Stern School of Business, today presented at PRMIA’s Frontiers in Credit Forum his latest forecasts on default rates for corporate high-yield non-investment grade bonds.
Using his model based on mortality rates, Professor Altman forecasts a default rate of 2.5% in 2007 and 3.7% in 2008. While higher than the current rate of 0.76%, these default forecasts are well below the historical average of 4.2%. Leveraged loans are also currently exhibiting similarly low historic rates of default.
Professor Altman points out that this is the lowest default rate in 25 years on corporate high-yield non-investment grade bonds, and the highest recovery rate ever. He attributes this to the unusually high volume of liquidity chasing few defaults.
Today’s average loan in default sells at $0.93 on the dollar, an amount very close to that of the average on new defaults. Driving these trends are an estimated 170 managers of distressed debt in the U.S. alone.
While Professor Altman is not necessarily forecasting a drying up of liquidity, he does caution that corporate fundamentals and poor new bond and loan quality point toward significantly higher default rates in the future.
The PRMIA Frontiers in Credit Forum is the first of four events in this year’s PRMIA New York Conference Series.
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February 13, 2007
The PRMIA Institute Announces the Formation of the PRMIA Institute - China
The PRMIA Institute has formed a partnership with the RiskChina Research Center and several university programs in China to launch the PRMIA Institute – China.
The focus of this partnership will be the provision of training programs in China that feature leading international faculty as well as the top faculty from Chinese universities, the support of academic work at these institutions and the enhanced availability of publications and research serving Chinese risk management professionals.
The RiskChina Research Center is an institution affiliated with RiskLab from University of Toronto and jointly sponsored by Shanghai University of Finance and Economics. In addition to the RiskChina Research Center, the PRMIA Institute – China will work with the Shenzhen Institute of Advanced Technology, Chinese Academy of Sciences, the International School of Software Engineering Wuhan University and Shanghai University of Finance and Economics.
“We are thrilled to see the growth of the PRMIA Institute partnerships to mainland China and are especially pleased that Prof. Dash Wu will bring his leadership and academic expertise to the PRMIA Institute – China,” said David R. Koenig, President of the PRMIA Institute. “There is a vast demand for professional development programs for risk managers and the PRMIA Institute – China looks forward to serving the local needs.”
“There is no security on this earth, only opportunity,” said Prof. Dash Wu, Director of RiskChina Research Center and Adjunct Professor of Shanghai University of Finance and Economics “Joining the PRMIA Institute partnership, we are winning these opportunities.”
The PRMIA Institute is an international cooperative effort between the Professional Risk Managers’ International Association and leading university programs around the world. Current partners include the Columbia Business School, the Hong Kong University of Science and Technology Business School, the National University of Singapore Centre for Financial Engineering, the University of Toronto Risk Lab, the University of Reading ICMA Centre, Technical University of Munich - HVB-Institute for Mathematical Finance, the Macquarie University Applied Finance Center, Groupe HEC Business School, George Washington University’s MS in Finance program, the University of Michigan College of Engineering, the University of Cyprus Center for Banking and Financial Research. In addition, of the Masters in Financial Engineering Program, Haas School of Business, University of California at Berkeley is represented by Dr. Linda Kreitzmann, its Director.
About PRMIA and the PRMIA Institute
PRMIA is the Professional Risk Managers’ International Association. Formed in January of 2002, PRMIA is a higher standard for risk professionals with more than 60 chapters around the world and over 35,000 members from more than 170 countries. A Section 501(c)(6) non-profit, member-led association of professionals, PRMIA is dedicated to advancing the standards of the profession worldwide through the free exchange of ideas. PRMIA offers the only globally endorsed Professional Risk Manager (PRM) certification program, pursued by over 1,900 active candidates from more than 90 countries.
The PRMIA Institute is setting a higher standard in risk education. It is a non-profit Section 501(c)(3) corporation formed to serve the academic, scientific and charitable mission of PRMIA. The PRMIA Institute partners with leading university programs around the world to develop best-practice curricula for graduate studies in risk management and financial mathematics / engineering, provides classroom and online educational programs for working professionals, financial support of scholarly work, publications like the Professional Risk Managers' Handbook and scholarships to support the study of risk management among lower-income individuals.
You can learn more about both at www.prmia.org.
About the RiskChina Research Center
The RiskChina Research Center(RCRC, Chinese Domain: www.riskchina.org) at University of Toronto is an institution affiliated with RiskLab Toronto (part of the international network of RiskLabs sponsored by Algorithmics) which was founded in 1996 to conduct activities in financial risk management, often times in collaboration with industrial partners. RCRC aims to promote collaboration toward understanding greater China based on in-depth research and experience. The Center draws much if its expertise from the universities around the world, working collaboratively across institutions and jointly with the public and private sectors. The universities currently represented are University of Toronto, University of Chicago, University of Nebraska Lincoln (USA), Ryerson University (Toronto), Munich Institute of Technology (Germany), Universidad Autonoma de Madrid (Spain), the International Management Center in Nicosia (Cyprus), the Universidad del Pacifico in Lima (Peru) and many others in South America.
The researchers of the Center study various aspects of Chinese financial and enterprise risks and the economic and business environment. Our goal via the Center is to make our knowledge and expertise available to a wide variety of constituents beyond our academic community, as well as to enhance our academic work via cross-disciplinary and institutional collaboration.
To date the Center has sponsored and co-sponsored many events. We have organized major business and academic conferences such as ICMI, edit special issues for various journals such as IJTM, IJVCM, IJENM, IJECRM, and participate in on-going workshops, panels and presentations aimed at disseminating insights and information about developments in contemporary China. The Center publishes an online bulletin with research articles, current events and information about study, business training programs. We also publish a calendar of China related events, and supply information via resource links on the Center’s website.
The Center also sponsors the referred journal:
International Journal of Services Sciences (IJSSci)
International Journal of Chinese Culture and Management (IJCCM)
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February 12, 2007
The PRMIA Institute and the PRMIA Institute - China issue a Call for Papers
The PRMIA Institute and the PRMIA Institute - China, supporters of the 2007 International Conference on Management Innovation (ICMI 2007) in Shanghai, China, are issuing a call for papers for technical sessions/Focus Symposia related to the themes of the conference which include:
Quantitative Financial Management Theory and Applications
Credit Risk
Integrated Risk Management
Interest Rate Term Structure
Portfolio Optimisation
Business Data Mining Theory and Applications
Business Data Mining Risk Management in Supply Chain
Financial market analysis
Supply Chain and Financial Options
E-commerce and Web Services
Online filtering
Benchmarking and Evaluations
Business Outsourcing
Proposals can be submitted to dash@risklabchina.ca with a copy to ijssci@inderscience.com. Please use the standard form which can be found online at http://www.icmi2007.org/pages/cfp.html.
You can learn more about this conference at http://www.icmi2007.org/index.html.
Proposals must be submitted not later than March 15th, 2007.
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