Covenants: crisis of confidence

Financial covenants that rely too heavily on ratios are just not sophisticated enough to predict the likelihood of default, argues Sarah Woo. Loan originators must learn a trick or two from their colleagues in portfolio management and develop quantitative models to measure credit quality.

The typical commercial loan portfolio manager faces a problem not of his making every day: he has to deal with assets passed down to him from his bank’s origination desk that do not make a lot of commercial sense. Their risk-adjusted return is rarely calculated at origination and their performance pricing grids and loan covenants are frequently based on measures the manager probably does not believe properly reflect a comprehensive view of credit risk.

It shouldn’t be just the portfolio

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