Section 15. Credit Portfolio Management

Credit portfolio management starts with adequate descriptions of the portfolio, of risk concentrations and of the various risk metrics that can serve as credit limits. This static view is the point of entry for more active portfolio management.

Enhancing the risk-return profile of the portfolio can minimize risk given return, increase return at constant risk, or improve both if the portfolio structure is inefficient. Optimization is always subject to funding and capital constraints.

Credit portfolio management optimizes the existing portfolio within constraints, and, then goes beyond by freeing-up capital for facilitating origination while keeping credit risk concentration within limits.

The techniques for expanding origination under capital and funding constraints are essentially to off-load the risk from the balance sheet of the bank. Securitizations have been critical for expanding the origination business. Credit derivatives have a wide set of usages, such as customizing the credit portfolio risk profile and complying with limits, either hedging portfolio risk by buying credit derivatives or taking exposures synthetically by selling credit derivatives.

Both techniques have become hot issues in the financial crisis since they were vectors of contagion to the entire system. However, there is a difference between the sound economics of securitizations and using credit derivatives for hedging and transactions that can be seen as pure arbitrage transactions, arbitrage between the price of credit risk in the balance sheet and the price in capital markets, or arbitrage of regulations and rating agencies. The current status of securitization and credit derivative is mitigated. Some argue that they are the necessary vehicles for financing the economy while others see more their recent adverse effects of excess securitizations. The future will strike a compromise between the two views. Whatever the regulations will be, those techniques deserve full recognition as credit portfolio management as well as origination facilitating tools, in as much as they remain in line with sound economics.

This section covers credit portfolio management in three chapters.

• Portfolio analysis under a static view of the portfolio structure along risk metrics and business dimensions is an intermediate step. Portfolio optimization follows well-known principles, as inspired from market portfolio optimization by rebalancing exposures for improving the Sharpe ratio (Chapter 57).

• Credit portfolio management relying on securitization is fully expanded in several steps, from the setting up of securitization SPEs to the structuring of asset-backed notes issued by SPEs, the economic consistency of securitization vehicles, their economical effects on the originating bank, and up to assessing the resilience of these structures (Chapter 58).

• Credit portfolio management relying on credit derivatives, which completes the main aspects of active credit portfolios (Chapter 59).

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