A partnership in risk

As regional and global competition for new business and market share increases companies will naturally take on more credit risk, and to stay out of trouble this risk must be managed at both the individual and the portfolio levels. High-end software is playing an increasingly important role in this risk management, but like most IT-related decisions the choice of vendors can be bewildering. And often, to get a total solution, a company might have to deal with several vendors.

But for credit risk management, at least, the field has been narrowed. MoodyÆs Risk Management Services and RiskMetrics have announced an alliance that will see their credit risk management solutions integrated into one product.

The two companies say that the incorporation ofááMoodyÆs RiskCalc tool into RiskMetricsÆ CreditManager application will enhance its analysis of portfolio risk and credit exposure with a suite of default prediction models for public and private firms.

CreditManager is a stand alone application for the measurement and analysis of portfolio Value-at-Risk (VaR) due to credit events including upgrades, downgrades and defaults. It is used mainly by banks, central banks, asset managers and traders.

VaR is an increasingly popular statistical measure of risk exposure that was developed in the late 1980s for the trading desks of large financial institutions. It expresses risk in intuitive rather than mathematical terms. For example, a portfolio may be said to have a 5% chance of losing $2 million in the next week.

VaR was originally designed to assess market risk, but it is easily extended to address credit risk, as RiskMetrics have done with the CreditMetrics methodology behind the CreditManager product. But risk management experts warn that different companies selling VaR tools use different methodologies, so comparison between calculations can be complicated.á

Model building

Bringing more quantitative analysis to CreditManager, RiskCalc is a set of tools for generating default probability. The tool for public companies is based on a hybrid of two models - a structural model based on Merton theory and a statistical model based on analysis of historical data.

But the RiskCalc tool for private companies is the most unique feature that MoodyÆs is bringing to the partnership. To provide risk assessment and default modeling for firms without traded equity the tool leverages MoodyÆs Credit Research Database, which holds the financial statements of 28,000 private firms as well as 1,600 private firm defaults.

By using different data for private and public firms, RiskCalc offers more reliable modeling of the default risk of individual obligations. By introducing these models into CreditManagerÆs portfolio analysis, the two companies have produced an application that more accurately assesses risk, particularly where a portfolio includes privately held companies.

Andrew Kimball, managing director of Moody's Risk Management Services says the move is particularly good for his existing customers. "It is an important step for us to be able to offer clients of our RiskCalc default models access to RiskMetrics analytic software.öáá