Insights & News

Insights on risk management, model development, loss forecasting, CECL, and stress testing from practitioners who build the models. Thought before calculation, every time.

Credit Regimes and the Race against Defaults

When times are good, it’s easy to forget that they’ll end, even if the endpoint is unknown. Forgetting that can be very costly. We explain how the big risk builds during calm times. Losses in subsequent bad times can only be managed in good times. We hint at a new service that measures the risk to manage.

Credit Regimes: the Race Against Default Waves

private credit

Private Credit’s early growth resulted from regulated banks retreating from making riskier loans. With its capital structure, PC maintains an incentive to make riskier loans than banks. Credit losses tend to be either large or small, with no in-between, and we’ve been in a low-loss state for awhile. PC’S recent success may be attributed to the wrong factors.

Was Private Credit Fooled by Its Own Success?

stress testing

Banks estimate what they could lose in stress tests. Credit losses exist in regimes — long stretches of low losses punctuated by sharp, severe transitions. The only value of stress testing is deciding what to do before the shift happens, but most banks don’t. They should use the results to know when to hold, when to fold, when to walk away and when to run.

Regimes, Risk Management & Stress Testing

Recent Insights

The Seven Principles of an Effective Capital Adequacy Process
Spero Risk Associates has substantial experience with all aspects of CCAR, especially model development and validation. We have asked the questions, and we have successfully answered when others have asked. The seven principles of an effective capital adequacy process were published in August, 2013, in the Federal Reserve’s Capital Planning at Large Bank Holding Companies: Supervisory…
Read more: The Seven Principles of an Effective Capital Adequacy Process
Learning Opportunities from “A Christmas Story”
Learning is a benefit that is important enough to describe separately! Like much financial and credit model development, scenario analysis is research as much as development or construction. Scenario analysis leads to a better understanding of the relationships between the firm and its environment and risk factors. Note that these relationships change through time as…
Read more: Learning Opportunities from “A Christmas Story”
SR 12-7 and the Five Principles of Stress Testing
If CCAR/DFAST is the extent of a firm’s stress testing, then, (a) the firm does not comply with SR 12-7, particularly Principles 1 and 2, and therefore, Principle 5; (b) there are likely deficiencies in overall risk management and data governance/systems that prevent implementation beyond CCAR; and therefore, (c ) any beneficial synergies between or among other…
Read more: SR 12-7 and the Five Principles of Stress Testing
Does Unemployment Predict CRE Losses?
The Fed’s CCAR scenario narrative always leads with unemployment; so, banks feel compelled to use it as a parameter in their loss forecasting models. The problem is that unemployment peaks tend to lag CRE (and C&I) loss peaks, which isn’t a good characteristic for an explanatory variable, especially for stress testing and risk management.
Read more: Does Unemployment Predict CRE Losses?
CECL and the Corona Virus
The 4 R’s of CECL maintenance, and what an unprecedented shock does to models built on a decade of calm. Cap your scenario inputs to the historical sample, then adjust through a qualitative overlay framework. Also: why unemployment and the DJIA were poor choices.
Read more: CECL and the Corona Virus
Does Unemployment Predict Commercial Loan Losses?
The Short Answer: Historically, No, It’s the Other Way Around The Long Answer: let’s look at scatter plots and correlations and see the two large problems with using it. This is the third in a series of three posts. Two Regimes In our first post, Unemployment as a Commercial Loan Loss Predictor, we showed time-series…
Read more: Does Unemployment Predict Commercial Loan Losses?
Q1 2020 Large Bank CECL Reserves
Below are two graphs that show Q1 2020 credit reserves for large, domestic (mostly CCAR) banks — for all large banks reporting earnings as of April 24, 2020. So far, no bank on our list has delayed its CECL implementation — as permitted under the CARES Act.1 Both graphs show the initial CECL reserves, i.e.,…
Read more: Q1 2020 Large Bank CECL Reserves
Alternatives to Unemployment as a Commercial Loan Loss Predictor
Someone asked: for loss forecasting, what makes a better leading indicator than the unemployment rate? The answer is usually not another national variable. It’s segmentation. Partition by industry and geography and more intuitive regressors appear, like oil prices for energy defaults.
Read more: Alternatives to Unemployment as a Commercial Loan Loss Predictor
Unemployment as a Commercial Loan Loss Predictor
This the first in a sequence of three posts. The second describes alternatives to the unemployment rate for C&I loss forecasting, and the third one provides more evidence why the unemployment rate is a poor choice for C&I loss forecasting. Recently, we were surprised to learn that many banks use a forecasted unemployment rate as…
Read more: Unemployment as a Commercial Loan Loss Predictor
2017 – 2019 Federal Reserve and Company Run CCAR Results
Almost four years ago, we aggregated and published the Fed’s and Companies’ 2016 CCAR results. We’re surprised by the continued interest in those nearly four-year-old numbers; so, we asked one of our analysts to generate similar graphs for 2017, 2018, and 2019. Please note that a few observations from companies are missing; those firms purge…
Read more: 2017 – 2019 Federal Reserve and Company Run CCAR Results