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The Credit Risk Iceberg: Part 1: Introduction

Everyone knows the phrase “just the tip of the iceberg”.  The phrase reflects the fact that upwards of 90% of an iceberg is underwater.  This means that the shape and dimensions below the surface are very difficult to discern.  We use the Iceberg analogy at S&P Capital IQ to discuss one of the major challenges in counterparty analysis.  Namely, getting a handle on the risks of the counterparties to which you are exposed.

Above the surface, we depict the exposures which have credit ratings and generally a wealth of qualitative and quantitative information available for assessment.  These rated exposures are generally the larger-sized public companies, or in some cases, private companies with public debt.  If the vast majority of risk exposures are rated, then the tools needed to complete a credit assessment are much more readily available.  There are on the order of 10,000 companies globally with ratings information.

In many cases, some counterparty exposures may be unrated, but the “80/20” rule may apply and having the full credit picture of rated exposures may be sufficient as they are the bulk of the monetary exposure.  However, for many credit analysts, unrated companies make up a large number, a large percentage or a critical part of their coverage universe.  In these cases, it is vital to look “below the surface” to get the full credit picture.

How important is it to go beyond rated exposures?  Earlier this year, S&P Capital IQ surveyed over 350 firms globally about their counterparty assessment needs and practices.  Those within Corporations, Commercial Banks and Insurance Firms indicated that greater than 50% of their exposures were private, on average.  The vast majority of private companies are unrated.  Similarly, between 20% and 30% of their exposure had revenues of less than $25mm and 40-50% of their exposure had less than $100m in revenues.  This mix of exposures aligned with their top challenges which included the getting data on counterparties and [reducing] the time spent on analyzing those counterparties.

For the remainder of the iceberg that lies below the waterline, we look for sources of data and available analytics for assessing public and private companies. On the data front, our first priority is to find the data and then make sure it is presented in a normalized format to allow for global comparison.  After we have the data, we can then apply relevant credit analytics to build a full credit picture and allow comparison of the entire iceberg (rated and unrated public and private companies).  We examine these topics in the next two blog installments.

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