The Handbook of Credit Risk Management, 2nd Edition

CHAPTER 21Bankruptcy

Throughout this book we have attempted to provide help on how to avoid credit losses. Alas, even the best analysts and the most clever portfolio managers will at times face bankruptcies in their portfolio. In this chapter, after defining bankruptcy, we outline the common characteristics of companies that end up in bankruptcy proceedings and some early warning signals of the soon‐to‐declare bankruptcy companies. We conclude with some examples of high‐profile cases.

Some companies default due to their own problems, not as a result of the entire economy, nor even the industry they are in. The risk manager community calls this type of exposure an “idiosyncratic risk.” If fraud is not involved and sound risk management principles as described earlier in this book are followed, most creditors have time to analyze their positions, to reduce their exposures, to strengthen their transactions, and to diversify their portfolios, which will minimize idiosyncratic risk, and credit losses should be minimal.

However, if a major and unexpected event occurs and leads to a major economic crisis, many counterparties will default. The magnitude of the credit losses will depend on the quality and efficiency of the portfolio management efforts. A company able to reduce industry and single name concentration and to hedge its exposures with credit derivatives or credit insurance should suffer less than those companies that have neglected their portfolio management activities, ...