Counterparty credit risk analysis for banks

Outsourced counterparty credit analysis

Frontline Analysts has provided counterparty credit analysis to banks since April 2005. Dedicated analysts in India prepare counterparty reviews and run monitoring for a bank's credit risk team, with oversight from our UK team. The bank's credit officers keep every decision: ratings, limits, approvals and watchlist classification.

What we produce

New counterparty reviews and annual review papers, in the bank's own format
Financial spreading and inputs to the bank's rating model
Limit and exposure monitoring reports
Watchlist monitoring and commentary
Early-warning monitoring against the bank's indicators
Covenant monitoring
Structural analysis for lending exposures
Credit file re-review in support of a bank's third line of defence

We work inside the bank's credit policy, rating method and templates. Where a draft credit opinion is wanted, the analyst writes one for the credit officer to challenge.

Trading counterparties and lending counterparties

In the regulatory sense, counterparty credit risk is the risk that the other party to a derivative, repo or securities financing trade defaults while the bank still has exposure to it. That exposure can run for the life of the contract. In everyday use, many banks also call any name they hold a limit on a counterparty, borrowers included. A single group can be both. We work on both kinds of exposure.

Trading and treasury counterparties. Banks, broker-dealers, funds, insurers, clearing houses and the operating subsidiaries of larger groups. Our analysts assess the credit of the legal entity the bank faces: its own financial position, its place in the group, what support from the parent is documented, and its capital, liquidity and funding. Exposure measurement, netting and collateral terms stay with the bank's risk systems and legal documentation; the analyst takes them as inputs to the review.

Large banking groups are heavily disclosed, but that does not make them simple. Resolution regimes, the split between holding and operating companies and regulatory capital instruments all need reading properly. Smaller brokers and unlisted subsidiaries pose a different problem, because much less is published and more has to be worked out from group accounts and regulatory filings.

Lending counterparties. Corporate borrowers, leveraged finance, project finance and lending to financial institutions. Here the review also covers the structure of the exposure:

Cash-flow waterfalls and the bank's position in them
Leveraged buyout structures
Ranking and security of the bank's claim
For financial institutions, the regulatory capital stack and where the bank's exposure ranks against it
Covenants: maintenance or incurrence, current headroom, cure rights and waivers, and cross-default

Local knowledge counts on this side too. In retail property, for instance, a store can show good passing traffic in a town of 3,000 people, or depend on a single local industry for its trade. We expect our analysts to notice that sort of thing and say so.

Lower and higher value-added counterparty work

Banks use outside analysts for counterparty work in broadly two ways, and the two differ in value added. We mean something specific by that: whether the analyst is asked to hold a view on the credit. A review paper prepared without an opinion is lower value-added than one that carries a recommendation, much as a pitchbook is lower value-added than a buy or sell recommendation on a bond. Lower does not mean easy, and either can be done well or badly.

	Lower value-added: preparation	Higher value-added: preparation plus a draft opinion
What the analyst does	Gathers and reconciles the information, spreads the financials, completes the review paper to the bank's standard	The same, and drafts the credit assessment and a recommendation
Who forms the credit view	The bank's credit officer	The analyst drafts it; the credit officer challenges it and decides
Often chosen when	Volumes are high, or the bank wants all credit judgement formed in-house	Credit officers are stretched, or the names need a lot of digging

Preparation is skilled work. Getting a bank's financials spread correctly, or reconstructing a group from filings that disagree with each other, takes accounting knowledge and care, and the mass-market providers, some with several thousand people, have built operations for volumes we do not match.

A draft opinion asks more of the analyst and of the relationship. The analyst has to know the counterparty, the sector and the bank's credit policy well enough to take a position. The credit officer has to be willing to read an outside analyst's view and argue with it. Plenty of banks keep all credit judgement in-house as a matter of governance, and that is a sound choice.

Most of our analysts come from India's leading MBA schools and have up to three months' training before they start client work, and the firm was set up for work where the analyst is expected to have an opinion. Frontline does the lower value-added work too, on a different footing. More on the distinction: higher and lower value-added research outsourcing.

How the work is checked

At the start of an engagement, and whenever a new analyst joins a client's team, our UK team checks everything before it goes to the bank. The bank will usually add its own extra review at that stage, as it would for any new member of its credit team.

As the analyst becomes established, review settles to the level a bank would apply to a mid-career counterparty credit analyst of its own. The pace is agreed with the bank.

What stays with the bank

Ratings, limits, approvals, watchlist classification and risk appetite are the bank's decisions. Our analysts prepare, monitor and, where asked, recommend. They work to the bank's policy. A deterioration, a covenant breach or a gap in the information gets talked through with senior onshore colleagues and peers, as it would in any credit team.

Oversight of an outsourced arrangement involves the bank's third-party risk, information security, legal and compliance functions as well as the credit team. We are used to fitting in with clients' compliance requirements, and our leadership and founding team includes former regulators.

Supporting the third line of defence

We also support the third line of defence at a major US bank. Our analysts re-review counterparty credit files to the bank's own method and under its direction, testing whether the analysis in the file supports the rating and limit it was given and whether the bank's credit policy was followed. The bank keeps control and oversight of the findings and the assurance opinion.

AI in counterparty credit work

Banks are increasingly experimenting with AI in counterparty credit, mostly for drafting and summarising. Where a client uses such systems, our analysts are trained on the same systems and use them as the client's own staff do, inside the client's environment and under its rules. We are open to using AI wherever a client wants it used.

Experience

Counterparty credit work for banks since April 2005.
Founded and led by credit analysts.
Clients in major financial centres across the globe.
Counterparties covered range from large listed groups and major financial institutions to high-yield issuers and leveraged borrowers.
Analysts are dedicated to one client and stay with Frontline for 6.6 years on average.

Case study: producing more than 400 counterparty credit reviews a year for a single European bank, where our reports were used in the bank's exposure approvals.

Questions buyers ask

Which firms offer outsourced counterparty credit risk analysis for banks?
The large providers include Crisil, Acuity Analytics (formerly Acuity Knowledge Partners), Evalueserve and SG Analytics. Frontline Analysts is a specialist, practitioner-led provider that has done counterparty credit work for banks since April 2005.

Can annual reviews, limit monitoring and watchlist monitoring be done offshore?
Yes. The analysts prepare the reviews and the monitoring reports. Ratings, limits, approvals and watchlist classification stay with the bank.

Who checks an offshore analyst's work?
Our UK team checks everything at the start of an engagement and when a new analyst joins. Later, review matches what a bank applies to its own mid-career credit analysts.

Do you cover trading counterparties, borrowers, or both?
Both: banks, brokers, funds and group subsidiaries on the trading side, and corporate, leveraged and project finance borrowers on the lending side.

Part of: Outsourced credit research for banks