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Back Testing of Credit Analysis Methodologies

January 5, 2011

Back Testing of Credit Rating Methodologies


From → Credit Analysis

  1. Chris Paciello permalink

    The sad reality is that a large percentage of “professional” investors don’t have a clue what they are doing. I wrote this a couple of years ago.

    All I can say is feel fortunate that you can take advantage that other market participants will give you.

    • Donald Davret permalink

      Excellent piece, Chris. As someone who invests his clients funds in a considerable amount of “high yield” bonds, I too have long dispensed with giving too much weight to the rating agencies’ annointing of credit quality to individual issues. While that doesn’t mean you can flat out ignore them, their failures in the mortgage bond arena was one of the lynchpins of the financial debacle we are living through, and climbing out of. They can no longer be regarded as gatekeepers, and besides, for investment purposes, all I care about is default risk. If someone is going to pay my clients over 100 bps or even more because of a BB rating over another issue with an A rating, and the issuing firm is still turning a profit and has adequate debt coverage, I can only be thankful for the opportunity to earn a decent return for my clients. As an example, Ford and Ford Motor Credit are STILL languishing at “junk” ratings, and while they are no longer priced that way by the market, the slowness to recognize TREND by the NRSROs is their biggest weak point as far as their usefullness is concerned. But I am happy to let it stay that way- it just makes my job that much easier. The same was true of any issuance related to travel or transportation: Royal Carribbean, GMAC, Hertz, Continental, et. al, were all rebounding on renewed strength from immediate post-Lehman lows in this area, and yet, the raters barely noticed. I “loaded the boat,” myself.

      Regarding Mr. Vincent’s examination of credit modeling, I feel that people too often predict the future by reading the past backwards- this is why so many retail investors commit funds at market tops. The past behaviour of markets, especially with so many more added variables, makes this more of an academic than a practical exercise. It always bothers me when I see analysts using charts that date back to the 1920s. Kind of like comparing the behaviour of a A380 Airbus to a DC-3. The fundamentals might be there, but after that, it’s a different world.

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