Basel III Credit Rating Systems An Applied

The market turmoil and the new Basel III capital requirements are re-shaping the financial competitive landscape. More than ever, banking competition is based on the ability to assess, to price and to manage the cost of credit risk. Bankers are increasingly called to manage a process of analysis of the customer in a more structured way. This book is a comprehensive guide to quantitative and qualitative credit rating models and covers all loan portfolios (Corporate, Retail, Banks, Sovereign and Specialized Lending).The credit rating models are illustrated in great detail and are based on the best practices currently in use in large international banking groups. The book also contains pricing tools for liquid and non-liquid markets and is one of the first books on credit risk management published since the crisis.

Luisa Izzi, PhD in Economics and Financial Decisions, is Head of Model Validation, BNL-BNP Paribas Group, Italy. She has worked in different areas of risk management in international banking groups, supporting the group-wide Basel implementation and validation processes. She is author of a number of scientific publications and articles in mathematical finance and economics. Gianluca Oricchio is Professor of Finance and Capital Markets, CBM University, Italy. He has held senior capital and risk management positions at several global financial institutions. He has been Head of ACPM at Capitalia Banking Group and Head of Group Credit Treasury at UniCredit Group and has written several books on financial markets, corporate finance and risk management. Laura Vitale is Head of Judgmental Rating, BNL-BNP Paribas Group, Italy. She has worked for major Italian banks in the areas of investment banking and mergers and acquisitions. She has also been Head of Business Development in the Public Administration Sector, BNL-BNP Paribas Group, Italy, and has written many articles appearing in academic journals.

List of Figures	p. viii
List of Tables	p. xii
List of Abbreviations	p. xv
Acknowledgements	p. xviii
Foreword	p. xix
Introduction: The Efficient Market Hypothesis and Basel III New Banking Regulations	p. 1
The Quantitative Approach to Credit Rating Models
Corporate SME and Retail PD models	p. 11
PD corporate SME model development	p. 11
PD corporate SME sub-segment models	p. 43
PD retail models development	p. 60
Sovereign and Banks' Rating Models	p. 68
Country rating model	p. 71
Bank rating model	p. 77
Exposure at Default Valuation	p. 89
Calculating EAD components	p. 92
Granularity of CCF	p. 95
Application of average values to the current portfolio	p. 96
From historical medium value to an ex ante EAD model	p. 97
Loss Given Default Estimation	p. 102
Structure of the LGD workout calculation	p. 102
Downturn LGD	p. 110
From workout to an ex ante LGD model	p. 111
Validation of Internal Credit Models	p. 114
Validation of the PD model	p. 116
LGD model validation	p. 121
EAD model's validation	p. 125
PD validation statistical test	p. 133
The Qualitative Approach to Credit Rating Models
The Internal Rating Agency: Organization and Scope	p. 147
Expert Judgment-based Rating Assignment Process	p. 155
Introduction	p. 155
Obligor 'corporate' definition	p. 156
Rating horizon	p. 157
High-level step-by-step guide to final rating	p. 158
Key drivers of the stand-alone rating	p. 161
Definition of support	p. 171
Identification of the support entity	p. 172
Nature of support	p. 173
Final rating	p. 177
Rating assignment on investment holding companies	p. 178
Implication of convertibility risk	p. 180
Slotting Criteria Credit Rating Models	p. 182
From risk factors to maturity profiles	p. 182
Maturity profiles and the slotting process	p. 186
Putting it all together: the importance of slotting	p. 188
Global Recovery Rate	p. 194
Introduction	p. 194
Unsecured global recovery rate: definition and drivers	p. 196
Secured global recovery rate	p. 198
Particular cases of global recovery rate	p. 203
Exposure at default valuation	p. 204
Rating Assignment on Specialized Lending
Rating Assignment on Project Finance	p. 209
Project phase rating	p. 209
Project's stand-alone rating	p. 211
Support and final rating	p. 211
Senior unsecured GRR	p. 211
GRR secured at the facility level	p. 212
Rating Assignment on Object Finance	p. 215
Rating assignment on LBOs	p. 215
Rating assignment on shipping finance	p. 220
Rating assignment on airlines and operating lessors	p. 225
Rating Assignment on Telecom Operators	p. 232
Stand-alone rating	p. 233
Risk-Adjusted Credit Pricing Models
Pricing in Liquid Markets	p. 243
Introduction	p. 243
The Merton structural default model©¹	p. 243
The mathematical model	p. 250
Nelson-Siegel: a parametric approach	p. 251
The credit default swap⁵	p. 251
Liquid curves	p. 254
Non-liquid curves	p. 255
CDS-implied EDF Credit Measures and Fair-value Spreads¹	p. 257
Introduction	p. 257
Overview	p. 258
Practical applications of CDS-implied EDF measures and fair-value spreads	p. 260
CDS-implied EDF model and fair-value spread model	p. 272
Applying the framework to sovereigns	p. 284
Summary	p. 293
Frequently asked questions	p. 294
Pricing in Nonliquid Markets	p. 302
Introduction	p. 302
Transition matrix state: dependent pricing model	p. 311
Analytics of pricing models	p. 323
Pricing of a pre-payment option	p. 330
Notes	p. 334
References	p. 339
Index	p. 343
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Basel III Credit Rating Systems An Applied Guide to Quantitative and Qualitative Models

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