SOFR, credit quality and scenario construction

The week on, June 13-19, 2020

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Credit problem: SOFR faces uphill struggle in loan market

Furnishing Libor’s replacement with a credit-sensitive spread is proving to be a Sisyphean task

Scared of fallen angels? So are the rating agencies

Data shows rating agencies more reluctant to downgrade firms at the investment-grade boundary

Don’t let a good crisis go to waste

As supervisory stress tests take a backseat, banks look for new ways to gauge extreme risks


COMMENTARY: Discredit analysis

Thirteen years ago, Standard & Poor’s credit analyst Shannon Mooney unwittingly won herself a little bit of immortality when she told a colleague worried about a risky mortgage-backed security (MBS): “We rate every deal. It could be structured by cows and we would rate it.” At the time, the manifest failure of the three leading rating agencies to properly report the risks of the US MBS market was headline news, but it led to less reform in credit risk assessment than many had expected – or hoped. And, reports this week, there are still reasons to be concerned that in some areas credit risks are not being accurately measured.

One example is the reluctance of agencies to push ratings over the boundary from investment grade to junk; for all three major agencies, downgrades that cross the BBB-BB line (or its equivalent) are much less common than downgrades in other parts of the risk spectrum. The reason isn’t clear; there is no such reluctance around sovereign issuers, or around moves across the line in the other direction.

In particular, there’s no evidence that this reluctance stems from commercial motives – from a fear that issuers who are downgraded to junk status, and are therefore cut off from the massive market of investment-grade debt buyers, will take their business to a rival agency in future. However, similar commercial motives were behind the MBS rating failures before the 2008 financial crisis, a US government commission found in 2011.

Whatever the reason, this reluctance has had a striking effect on the debt landscape; fully half of the investment-grade bond market is now BBB-rated, and issuers’ leverage levels are near multi-decade highs. So far, rating agencies are holding back from pushing their customers en masse over the boundary to junk status; this may not last indefinitely as the Covid recession bites deeper.

There are echoes of 2008, too, in the minefield of Chinese credit analysis. Implicit guarantees of off-balance sheet investment vehicles came back to bite parent companies – and the same was true of government-sponsored mortgage companies Fannie Mae and Freddie Mac.

Now, analysing Chinese corporate credit leans heavily on assumptions about the willingness of government, provincial or national, to support companies as they hit financial difficulties. Historically, this willingness has been extensive but neither universal nor unlimited, and liable to evaporate with little notice. It also means a healthy state-linked company can bow to political demands even at the cost of its own financial well-being.

Faced with the prospect of a nearly unprecedented Covid recession of its own, the Chinese credit market’s opacity and unpredictability will hardly be a comfort for outside investors, and even local analysts with better sight of the political risk factors may find themselves wrong-footed.



At Eurex, listed derivatives margins doubled during the explosion in volatility whereas cleared OTC margins were up only around 20%. Eurex’s chief risk officer comments on suggestions that swaps clearing houses fared far better in March than their exchange-traded counterparts, due to OTC models being calibrated at higher confidence levels and with a five-day margin period of risk.



“A couple of years ago, ESG was a helpful add-on for companies but wouldn’t really drive your bottom line that much. Now we’re seeing more and more situations where if you don’t have a focus on ESG then you’ll start losing out on access to funding and capital” - Arthur Krebbers, NatWest Markets

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