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October 2012

CCAR Stress Testing and Its Implications for Risk Modeling

Related Insights

Introduction to CECL Quantification Webinar Slides

In this presentation, our experts Emil Lopez and Jing Zhang, introduce some key CECL quantification methodologies and enhancements that can be made to existing approaches to make them CECL compliant.

February 2017 Pdf Emil LopezDr. Jing Zhang

CECL Webinar Series: Introduction to CECL Quantification

In this presentation, our experts Emil Lopez and Jing Zhang, introduce some key CECL quantification methodologies and enhancements that can be made to existing approaches to make them CECL-compliant.

February 2017 WebPage Emil LopezDr. Jing Zhang

Measuring and Managing Credit Earnings Volatility of a Loan Portfolio Under IFRS 9

IFRS 9 materially changes how institutions set aside loss allowance. With allowances flowing into earnings, the new rules can have dramatic effects on earnings volatility. In this paper, we propose general methodologies to measure and manage credit earnings volatility of a loan portfolio under IFRS 9. We walk through IFRS 9 rules and the different mechanisms that it interacts with which flow into earnings dynamics. We demonstrate that earnings will be impacted significantly by credit migration under IFRS 9. In addition, the increased sensitivity to migration will be further compounded by the impact of correlation and concentration. We propose a modeling framework that measures portfolio credit earnings volatility and discuss several metrics that can be used to better manage earnings risk.

January 2017 Pdf Dr. Amnon LevyDr. Yanping PanDr. Yashan Wang, Dr. Pierre Xu, Dr. Jing Zhang, Xuan Liang

Managing Earnings Volatility and Uncertainty in the Supply and Demand for Regulatory Capital: The Impact of IFRS 9

This paper presents a novel modeling approach that allows for better management of the interplay between supply and demand dynamics for regulatory capital, combining an economic framework with regulatory capital and new loss recognition rules. The framework is particularly relevant in understanding the extent to which IFRS 9 can lead to more aggressive provisioning, which feeds into earnings volatility. Our approach provides guidance on how organizations can better manage their capital buffer, considering investment concentration, its impact on earnings volatility, and the relationship with regulatory capital requirements. Imperative to portfolio management, the framework recognizes the likelihood of a capital shortfall being significantly impacted by portfolio asset class, geography, industry, and name concentration, as extreme fluctuations in capital supply and demand occur more often for institutions holding more concentrated portfolios. Finally, we discuss integrated investment and strategic decision measures that account for the full spectrum of economic risks and interactions with regulatory and accounting rules, as well as instruments' contribution to earnings volatility and capital surplus dynamics.

September 2016 Pdf Dr. Amnon Levy, Dr. Pierre Xu, Dr. Jing Zhang, Andriy Protsyk

Long-Range Economic Growth: Does Project Finance Matter?

The answer is a definitive “Yes,” suggesting increased project finance investment could become an important tool for addressing sluggish growth concerns brought about by the Great Recession. Empirical results, based on a comprehensive and unique project finance loan database not previously available, show that increasing project finance by one percentage point of GDP could increase real GDP growth per capita by 6 to 10 percent, with growth effects higher for upper-middle income and advanced economies. In other words, in these countries, if GDP per capita is growing at three percent annually, the boost provided by project finance could deliver cumulative, additional growth as high as two percent during the next five years. These results suggest that proposals for stimulating economic growth and productivity via increased project finance merit careful consideration. In contrast, in low-income countries, project finance appears to have less of an impact, possibly owing to deficiencies and weaknesses in financial systems and regulatory frameworks. By addressing these deficiencies, less developed countries could unleash increased growth and productivity.

July 2016 Pdf Dr. Jing Zhang, Kevin Kelhoffer, Jorge A. Chan-Lau

Credit Risk Management Under Regulatory Capital Constraints

This article outlines recent approaches to managing credit risk when facing regulatory capital requirements. We explore how institutions should best allocate capital and make economically-optimized investment decisions under regulatory capital constraints, such as those imposed by Basel or CCAR-style rules.

December 2015 WebPage Dr. Amnon Levy, Dr. Pierre Xu, Dr. Jing Zhang

RiskCalc Plus C&I Stress Testing PD & LGD Model (granular approach) Overview

To help our clients build benchmark commercial and industrial (C&I) loss models for the Federal Reserve's Comprehensive Capital Analysis and Review (“CCAR”)/DFAST exercises, we have developed an approach designed specifically to calculate provisions for losses of C&I portfolios. Our approach utilizes Moody's Analytics probability of default (PD), loss given default (LGD), and exposure at default (EAD) econometric models, which are intuitive, parsimonious, make economic sense, and have good statistical fit. We construct these models using our public EDF credit measures, RiskCalc™ private firm EDF credit measures, and Moody's Default & Recovery Database and Credit Research Database.

July 2014 Pdf Nan Chen, Jian Du, Heather Russell, Dr. Douglas DwyerDr. Jing Zhang, Zhong Zhuang

Usage and Exposures at Default of Corporate Credit Lines: An Empirical Study

A major source of firm funding and liquidity, credit lines can pose significant credit risk to the underwriting banks. Using a unique dataset pooled from multiple U.S. financial institutions, we empirically study the credit line usage of middle market corporate borrowers. We examine to what extent borrowers draw down their credit lines and the characteristics of those firms with high usage. We study how line usage changes with banks' internal ratings, collateral, and commitment size and through various economic cycles. We find that defaulted borrowers draw down more of their lines than non-defaulted borrowers. They also increase their usage when approaching default. Risky borrowers tend to utilize a higher percentage of their credit lines as well.

CCAR and Beyond: Capital Assessment, Stress Testing, and Applications – An Introduction

Comprehensive Capital Analysis and Review (CCAR) has quickly become one of the most dominant regulatory regimes for US banks in recent years. Of the new regulatory requirements BHCs must address, CCAR is widely considered to have the greatest influence on banks' risk management and business practices. Against the backdrop of CCAR's profound impact, there have been few, if any, systematic treatments of the subject. CCAR and Beyond: Capital Assessment, Stress Testing and Applications, a new book published by Risk Books, is designed as a unique source of information and insight from key figures involved in CCAR. This book, with fifteen contributed chapters, represents a timely, concerted and collective effort to provide comprehensive and authoritative coverage of CCAR and its implications.

February 2014 Pdf Dr. Jing Zhang

Joint Modeling of Conditional Credit Migration and Default: New Answers to Old Problems

In this presentation, Dr. Jing Zhang, Divisional Managing Director and Global Head of Quantitative Research at Moody's Analytics, shares new solutions to joint modeling of condition credit migration and default that are lightweight, simple to implement, and complementary to your bank's internal data and approach.

October 2013 Pdf Dr. Jing Zhang

A Unified Approach to Accounting for Regulatory and Economic Capital

In this paper, we introduce two new measures that incorporate both RegC and EC: return on risk-adjusted capital (RORAC) and economic value added (EVA™). These measures allow institutions to rank-order their portfolios and potential deals in a way that accounts for economic risk and regulatory charges.

August 2013 Pdf Dr. Amnon Levy, Andrew Kaplin, Qiang Meng, Dr. Jing Zhang

A Unified Decision Measure Incorporating Both Regulatory Capital and Economic Capital

Required economic capital (EC) and regulatory capital (RegC) are two measures frequently used in loan origination and other decisions related to portfolio construction. EC accounts for economic risks such as diversification and concentration effects. When used in measures such as return on risk-adjusted capital (RORAC) or Economic Value Added (EVA™), EC can provide useful insights that allow institutions to optimize risk-return profiles, facilitate strategic planning and limit setting, as well as quantify risk appetite. Meanwhile, when RegC is binding, an institution faces a tangible cost, in that additional capital is needed for new investments that face a positive risk weight. Given these observations, both EC and RegC should influence decision making. After all, a deal with lower RegC but the same EC is favorable, and a deal with lower EC but the same RegC is favorable. In this paper, we formalize RORAC and EVA measures that incorporate both RegC and EC. The new measures allow institutions to rank-order their portfolios and potential deals in a way that accounts for economic risks and regulatory charges.

January 2013 Pdf Dr. Amnon Levy, Andrew Kaplin, Qiang Meng, Dr. Jing Zhang

A Model-Based Approach to Constructing Corporate Bond Portfolios

In this whitepaper, we discuss our model-based approach for constructing investment grade and high yield corporate bond portfolios that consistently beat representative market benchmarks.

April 2012 Pdf Dr. Jing Zhang, Zan Li

Modeling Commercial Real Estate Loan Credit Risk: An Overview

In this paper, we present the Moody's Analytics framework for measuring commercial real estate loan credit risk, which is the model at the core of our Commercial Mortgage Metrics (CMM)™ product. We describe our modeling approaches for default probability, loss given default (LGD), Expected Loss (EL), and other related risk measures.

May 2011 Pdf Jun ChenDr. Jing Zhang

Quantifying the Value of Implicit Government Guarantees for Large Financial Institutions

This methodology takes a hard look at "too-big-to-fail" financials and the market value of the government's guarantee to them.

January 2011 Pdf Zan Li, Shisheng Qu, Dr. Jing Zhang

Investing in Corporate Credit Using Quantitative Tools

Corporate credit is an important investment class with potentially attractive returns. The asymmetric nature of corporate bond returns implies that investing in credit is not about picking “winners,” but rather about avoiding “losers” (i.e., defaults and spreads blow-ups). Investors can utilize quantitative measures of credit risk to minimize the risk of such events.

September 2010 Pdf Zan Li, Dr. Jing Zhang

Navigating Through Crisis: Validating RiskFrontier® Using Portfolio Selection

Assessing credit risk and ensuring the effectiveness and reliability of credit models are critically important to many risk managers and portfolio managers, especially during financial crises. This validation study examines the measurement accuracy of the portfolio credit risk models employed in Moody's Analytics RiskFrontier.

April 2010 Pdf Zhenya Hu, Dr. Amnon LevyDr. Jing Zhang

CDS-implied EDF™ Credit Measures and Fair-Value Spreads

In this paper, we present a framework that links two commonly used risk metrics: default probabilities and credit spreads. This framework provides credit default swap-implied (CDS-implied) EDF™ (Expected Default Frequency) credit measures that can be compared directly with equity-based EDF credit measures.

March 2010 Pdf Dr. Douglas Dwyer, Zan Li, Shisheng Qu, Heather Russell, Dr. Jing Zhang