5 New Year’s Resolutions for Credit Analysts

1) I will think like an equity analyst.  In order to properly assess the credit risk of a company, you must understand what management is thinking.  Since management works for the owners of the company, not its creditors, you must think like an owner.  Is there a viable business plan?  What is the company’s competitive advantage?  What is the company’s plan for growth?  How will the company enhance returns to shareholders? You must understand the pressures management is facing.  Is the share price dropping?  You can bet that management will do something to push it up, like a share buyback, special dividend, divestiture, or acquisition (or even worse, they will “manage” earnings).  Is the owner (whether a private equity shop or a family) interested in selling the company?  Perhaps they will defer capital projects (or, once again, “manage” earnings). 2) I will think like a debt analyst.  OK, you must understand the owner’s perspective, but you must also keep in mind that what is good for the owner is not always good for creditors.  For example, shareholders love high growth companies – they get higher equity valuations (and their managers often get higher compensation).  But high growth often means high risk and, perhaps, low or negative cash flow.  Remember, a business plan can be good and appropriate for the company, and at the same time, high risk from a credit perspective. 3) I will avoid elevator analysis.  No one needs you to tell them if sales (or margins or leverage) went up or down.  People can see that themselves by looking at the numbers.  Your job is describe why the...

Risk Culture in Action

Risk culture is the way people behave about risk. But people, organizations, and risk are all complex and dynamic. It’s important to have a formal concept of risk culture, but perhaps the best way to explain it is through examples. Dan Sparks at Goldman Sachs In 2006, Dan Sparks was the partner in charge of mortgage trading at Goldman Sachs, and by mid-year he was troubled by growing risks in the mortgage markets. For the next six months he tried to escalate his concerns. In Sparks’ words: ”It was tough…and I mean tough…the rigor that Goldman Sachs puts on people is unbelievable…especially when there’s a concern…I went up there to the 30th floor…five times…’We’ve got a problem…Here’s what’s going on. Here’s what I don’t understand. Here’s what I’m worried about.’ As soon as you do that…they get the risk controllers and all kinds of people involved…I mean they’re all over it.” In December David Viniar, Chief Financial Officer, convened a meeting to discuss Sparks’ views. The decision was to “get smaller, reduce risks, and get closer to home.” As a result, Goldman ultimately gained $4 billion from hedging its mortgage exposures. For more on risk management at Goldman read Money and Power by William D. Cohan. Madelyn Antoncic at Lehman Brothers Madelyn Antoncic was Chief Risk Officer at Lehman Brothers from 2005 to 2007. Before joining Lehman, she’d been a mortgage trader at Goldman Sachs, head of market risk at Goldman Sachs, and head of market risk at Barclays. In 2005 she was Risk Magazine’s risk manager of the year, and in 2006 she was named one of the...

So What Exactly Is Risk Culture?

Consider the sad story of UBS. In 2007 it suffered $38 billion in losses on mortgage back securities, requiring a $60 billion capital infusion from the Swiss government to keep from going under. In 2008 it paid out $19 billion to clients it had duped into buying worthless auction-rate securities. In 2009 it had to pay the U.S. government a $781 million fine for helping wealthy Americans evade taxes. In 2011 it took $2.3 billion in losses on a $12 billion trading position built up without authorization by one trader, who hid it by booking fictitious hedges. This is more than a series of unfortunate incidents. It’s a pattern that points to terrible problems with risk and controls at one of the world’s largest and (formerly) most prestigious financial institutions. How could things go so wrong for so long at UBS? Critics were quick to attack the firm’s risk culture: “At UBS, It’s the Culture That’s Rogue” by James B. Stewart and “Questions Arise About UBS Risk Controls” by Alistair MacDonald and Deborah Ball. Even the company acknowledged it had to improve its risk culture: “UBS 2007 Annual Report (page 10).” And the problem ran deep. “The problem isn’t the culture,” one investment banker said, “The problem is that there wasn’t any culture. There are silos. Everyone is separate…People cut their own deals, and it’s every man for himself…People thought of themselves first, and then maybe the bank, if they thought about it at all.” Too deep for management to fix. Sergio Ermotti, the CEO brought in to fix risk at UBS after the 2011 trading crisis, has decided...

My Favorite Bank Ethics Story

The Background: I was a vice president at a global bank, responsible for a diverse group of clients in North America.  One of my clients was considering a major reorganization of its business and restructuring of its balance sheet, and it hired my bank as financial advisor.  Since we were a lender to client and a restructuring could have impacted our position, the bank saw the conflict and (with the consent of the client) set up separate teams.  Given the size of the assignment and the large potential fees, the advisory team was led by the bank’s Vice Chairman, and included the head of my department, who was my boss.  My “team” (really just me and an associate) was responsible for the bank’s balance sheet – our counterparty risk and our lending position, including a large syndicated loan for which we were the agent. The Setup: The advisory assignment went on for several months, during which I could not discuss the client with my boss or anyone else on the advisory team.  This led to some strange situations, like running into people from my bank in the elevator at the client’s headquarters (a very silent ride), or sitting across the table from them in client meetings. Finally, key elements of the restructuring began to emerge.  To make it work, one large asset of the client had to be quickly and quietly sold.  This is when my boss called me into his office and gave me the term sheet showing our bank buying the asset.  But, since he was on the advisory team, he couldn’t buy it.  It was up...

Risk Culture at MF Global?

By the time they grew to $1.5 billion, Michael Roseman, MF Global’s Chief Risk Officer, was concerned about the firm’s positions in bonds of Italy, Spain, Portugal, Ireland and Belgium. He was worried the trade might endanger the entire firm if the financial problems in Europe got too tough. Roseman believed MF Global didn’t have enough liquidity to withstand a credit rating downgrade. Roseman joined MF Global in 2008 to improve risk-management culture after a rogue trading incident cost the firm $140 million. As the Euro sovereign positions grew to $6 billion, they blew through trading limits that he had helped put in place before John Corzine, MF Global’s new CEO, became his boss. It was Roseman’s job to get the directors to approve any increases in those trading limits. He made at least three separate requests to increase sovereign debt exposure. Each time, directors asked him about the risks of the trade. And each time, in spite of the fact it challenged the CEO’s pet strategy, he did what he was supposed to do: he outlined the risks as he saw them. But Corzine insisted on maintaining the trade, even threatening to resign if the board did not back him. So Roseman was replaced, and a new risk officer, Michael Stockman, took over in March 2011. But he was not allowed to weigh in on the broader implications of the sovereign debt trades, including the risk of ratings downgrades, loss of investor confidence, and funding problems. Which, of course, is exactly what happened. By October, MF Global had succumbed to a liquidity squeeze and filed for bankruptcy. This...