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The Opportune Times
June 2009 / Edition #3

Many of our clients and candidates are trying to assess the impact of the current economy on their organizations, as well as their individual career aspirations. While the numbers look gloomy, we at Thorek/Scott and Partners have seen that market shifts, if approached correctly, can result in unparalleled opportunities for career seekers and those searching for new talent. Continuing our series in The Opportune Times, we now look at the state of talent in Credit Risk Management.

Credit Risk Management: Revaluing Risky Business

If ever there was a risky time to be in business, this seems to be it. Fear appears widespread, firms are in survival mode, and many banks are wondering whether the next surprise lurks within their own balance sheets. The reaction to this new reality has been a period of stunning caution. The credit crisis is the manifestation of this, as lenders are calling in their bets and holding their cash firm. Given how quickly the marketplace has shifted, the case for revaluating an organization's credit risk management strategy is stronger than ever.

At Thorek/Scott and Partners, we have seen the credit risk function in both large and small businesses evolve over the past decade. During that time, the money flowed, the influence of rating agencies came to the fore, and the name, reputation and pedigree of counterparties served as votes of confidence. Complex structured products ruled the day and internal credit risk management teams were lean, quantitative and modeling focused.

The past year has shown quite clearly that all the modeling in the world could not protect us from simple psychology. Whether you run a large financial institution or a medium-sized business, the case for strong credit risk management is now obvious. Today, the importance of attracting and retaining the right talent is ever more crucial to success.

While a background in applied mathematics may have been sufficient in the past, risk professionals now need to get back to basics of due diligence with an in-depth understanding not only of the products they are dealing with, but also the impact of their portfolio within the context of the business as a whole. Financial institutions and companies are going to find themselves conducting extreme scenario planning, building models and plans for defaults, bankruptcies, and other probable contingencies. On the ground level, that means assessing the risk on transactions and not underestimating the down side or the potential occurrence of a 'black swan' event.

No matter how conservative one is, risk is inevitable, and those who wish to thrive over the long term need to have the skilled resources that can effectively assess and manage those risks. We believe having the right team is going to be the differentiating factor between firms that seize the upside of this economy and those who falter and fail.

Ask the expert
Michael Thorek - CEO of Thorek/Scott and Partners, specialist in risk management.
checkmark Ask The Expert
1. What was the role credit risk management played in the credit crisis?

MT: Previously, credit risk due diligence was not a top priority as organizations purchased insurance as a hedge. Nobody really thought there would be this chain of events if the counterparty couldn't pay, let alone if the insurers couldn't pay. Organizations were basically doing credit deals, and they'd say "we're not looking for a big spread on this", and the insurers said the same. It kept everything artificially low, because no one was looking at the big risk lurking there. Organizations assumed the insurers would pay, and that turned out to be incorrect. The focus right now isn't on individual loan decisions in the banks, but on the counterparties the banks are dealing with namely other banks and financial institutions. In the last 6-9 months there has been a complete change in the thinking of how banks deal with other financial institutions. It has turned out that you can lose a lot more money in that type of business than with traditional credit losses.

2. What has changed with respect to credit risk management in this climate?

MT: In the past, there wasn't a strong emphasis on credit risk. Now institutions are really trying to deeply understand credit and consequences. Are we really hedged? What are the possible scenarios that could show the hedge may not be complete? It demands more of a comprehensive look, and it also requires pushing back a bit on the traders. You can no longer just accept that the risk is adequately spread. What a good credit risk person does is ask a simple question: if the worst possible scenario happens, where does that leave us? Banks are now doing "back to basics" analysis of financial counterparties and can no longer base decisions on ratings or the "too big to fail" argument. Who are our counterparties, why are we dealing with them, do we have too much exposure to a single counterparty? And what exposures do the counterparty have to OTHER counterparties? These are complex, but fundamental, questions.

3. What do the people currently doing credit risk management need in terms of new skills?

MT: Credit risk professionals now have more power than they did in previous years. Before, traders could say "We make billions, the deals are complex, just trust us." In this market, risk people are much more empowered, but you need to have the conviction and the experience to pose some fundamental questions to the business side. This requires being a bit of a naysayer sometimes, which means you could be depressing potential earnings and bonuses. That difficult relationship has always been a precarious balance to strike, but asking those tough questions is a risk manager's primary duty. Now risk managers must also understand liquidity and other market risks. Are our counterparties able to fund their cash obligations to us on a timely basis? How can we unwind large trading positions under adverse market liquidity scenarios?

4. Aside from banks, what are other areas where credit risk professionals can apply their skills?

MT: In business, there's risk everywhere. We're currently working on a search for an alternative mortgage finance company that is now setting up a market risk area, which is basically treasury risk oversight. This area will analyze the risk of hedging with treasury trades, and advise the management of that risk. Other areas where credit risk professionals are being sought out are in acquisitions pricing, corporate development, and market strategy. Fund managers are building up their risk management teams. Anyone involved with managing cash, fixed income, borrowing, investing, insurance and similar functions need to have a risk management policy and a qualified risk management professional to oversee implementation of that policy. The businesses that understand their risks are the ones that are going to get ahead in this economy. Every business needs to ask key questions. What could happen that could really jeopardize my business? What's the proper pricing on this deal? Those answers don't necessarily require complicated algorithms. In most cases what's needed are spreadsheets and informed questions.