Paraphrasing an emailed question from Dominik (who IIUC is not from Australia): is there information out there about the credit risks associated with different categories of business? This is outside my zone (mostly retail, i.e. individuals).
Dominik asks: “I need to set up (for a loan granting purposes) a kind of a rating matrix for different unconnected types of business such as a poultry business or shipyard.”
IIRC in Australia there exists a well codified hierarchical classification of business types, starting at super categories (like agriculture, mining, ..) and moving through a couple of layers down to very specific categories (like “coffin maker”). Analysts concerned with non-retail credit risk would probably have some experience or information about the credit risk characteristics of these hierarchies, but, as Andrew has commented elsewhere, they would be reluctant to share this knowledge as it would be part of the bank’s competitive advantage. However, without sharing the content, perhaps some readers would share some analytical or modelling tips?
From very slight involvement I seem to recall that factors like size of the business, turnover, nature of assets, and (especially) recent financial performance could be more important than fine classifications of business type. Some of these in turn (like the assets) may be more relevant to LGD than to PD.
Dominik further: “I thought about comparing data from different stock exchanges considering some parameters like a market cycle etc”
This wouldn’t be an easy route, given that listed companies are a very select sample of all the medium to large businesses out there. However, there is plenty of received wisdom (and analysis) about cyclical versus non-cyclical sectors of any stock exchange and/or country. Poultry, and coffin makers: non-cyclical! But credit risk – as some recent ASX cases illustrate – will depend heavily on capital structure (gearing) and the management of that company.
Even with a poultry business, if the management borrows to the hilt and pursues an aggressive acquisition strategy, at the same time trying to challenge the purchasing power of the big retailers – they could easily end up with egg on their faces (sorry).
Any advices from those who work in the non-retail area would be a significant improvement on the above and would be appreciated.
5 September, 2008 at 13:02
This is the heart of an expert credit risk system, being able to profile a set of customers within a portfolio to understand the contribution of default to the portfolio part 1. Part 2 would be able to understand what factors have driven default in those sub set of customers, separate out the factors and assign specific ratings so that a score can be generated and used at origination. One important point to note is that such dynamics are not static even throughout a month of a year. Then of course we are only talking about Probability of Default here not LGD/LGE, those would require duration analysis to be carried out, a model of term structure in reality that might be achieved by a polynomial regression process.
Obviously people have written books on the above paragraph and not talking about data, matrix regression can be achieved using Gibbs Sampling but the data needs to be filtered using a process such as Multivariate Discriminant Analysis. After this, logical ordering can occur and the final decision tree built up.
I have a presentation on the above which is quite basic but eludes to how this can be achieved so please do email me or Clive and I can provide further details.
Now back to our matrix:
The matrix needs to be multi period which gives it several dimensions but before default adjusted returns can be understood the overall duration of the matrix needs to be dimensioned. After this a Markov Chain process is established which can be used to identify propagation values across the transition matrix. Amazing as it may sound I have a basic example in Microsoft Excel for fixed term notes that also shows recovery percentages across the matrix. Again I can email this to you or please contact Clive but it allows the foundation part of the framework to be built up. It is a starting place which you can build on.
Have a pleasant day.