Advanced Credit Risk Analysis and Management

4

Fundamental Firm/Obligor-Level Risks

The number of risks that can affect the performance of companies is infinite. While taking a credit decision, it is vital to cover at least the most important risks that affect the fortunes of an individual business firm. As we have seen earlier, credit risks should be studied from two angles – firm level or business unit level and portfolio level. Obligor risks are studied to understand the probability of credit loss (viz. credit risk) from a single customer. Portfolio risk analysis attempts to examine credit risks on a wider scale and studies the likelihood of loss emanating from the exposure to particular classes of customers. Firm-level credit risk is relevant from the point of view of portfolio risk as well.

Just as the construction of a skyscraper requires the utmost care in placing each building block, so the construction of a healthy credit portfolio requires careful selection of obligor risks. Portfolio credit risk is the cluster of firm-level credit risks, although the study of the behaviour of credit risks at portfolio level needs a different approach. We will cover the credit portfolio risks later. In this chapter we will examine the firm-level forces impacting credit risk.

4.1 FIRM (OR) OBLIGOR RISK CLASSIFICATION

Firm credit risk analysis involves two parts – the study of (a) business risks or operating risks and (b) financial risks. The bifurcation of overall credit risk into two is important because a business firm can fail ...