Risk News at-a-Glance

Week of June 28, 2010

Whenever available, links to the full article are provided at the end of each abstract. In some cases, content may not be available online, or may require an individual subscription to access.

Risk News Archive

Operational Risk
Chief Executives Believe Overwhelmingly That Sustainability Has Become Critical to Their Success
Operational Risk: Risk Management IT Set for Increased Spending
Financial Institutions Regain Confidence, Strengthen Risk Management

Enterprise Risk
I, Witness
How to Implement Successful Enterprise Risk Management
Is U.S. Ready for Chip & PIN?
Citi Begins Offering Customers Contactless-Payment Stickers

Securities Lending
Trade Group Proposes ‘Best' Process for Moving Collateral

Consumer Lending
Mortgages Face New Rules
Study: Nearly One in Five Mortgage Defaults Are 'Strategic'
4.69 Percent: Mortgage Rates Hit an All-Time Low
All US Rates But 1-Year ARM Hit Record Lows in Freddie Mac Weekly Survey
Interest Rates Likely to Remain Ultra-Low
New TransUnion Study Quantifies the Benefit of Consumer-Lender Loyalty
Treasury Yields to Rise by Year-End: Survey
High Default Rates Forecast on Modified Home Loans
Slow Pace of Repos Aggravates Problems in Housing

Credit Risk

US High Yield Defaults Plunge in 2010
Risk Center (06/22/10) ; Bertsch, Brian

Fitch Ratings' recent report looks anew at high yield defaults, examining critical credit and default drivers and the obstacles that remain one year after the worst recession in decades. The rate of U.S. high yield defaults has decelerated noticeably in 2010 to a full year rate of about 1 percent, a level below even the most positive market predictions. Between January and May 2010, only nine issuers defaulted, impacting a combined $1.7 billion in bonds. Last year, 151 issuers defaulted on nearly $119 billion in bonds, producing a default rate of 13.7 percent. The decline in defaults has been so precipitous that on a trailing 12-month basis the default rate is already down to below 6 percent, but this level is largely a result of last year's defaults. Defaults in 2010 have been both fewer and smaller. "The recession claimed many of the weakest companies," said Mariarosa Verde, managing director of Fitch Credit Market Research. "The resilient group that made it through now needs meaningful and sustainable multi-year growth, not simply cost containment, to fully restore credit quality. On that front, there are still hurdles ahead."
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Industry Exec: CRE Sales To Bounce Back
Banker & Tradesman (06/18/10) ; McMorrow, Paul

James McCaffrey, managing director of the sales brokerage Eastdil Secured, expects commercial property sales to rebound this year to 2004 levels as both investors and financiers try to take advantage of a bottoming market. McCaffrey remarks, "The big deal market is back. The equity for big deals has been raised, and the debt market is back. In the next 60 to 90 days, you're going to see dramatic numbers on sales volume and on pricing." Nationwide, Eastdil's for-sale portfolio has more than tripled in recent months. In Boston alone, the firm has approximately $5 billion in deals queued up, including the Bay Colony Corporate Center in Waltham and a 1.3 million-square-foot industrial portfolio owned by AMB Property Corp. Debt markets are also pushing things along, McCaffrey notes. Easy debt helped push commercial sales to record levels more than $18 billion in deals closed in 2007, according to CB Richard Ellis. When that debt froze in 2008 and 2009, sales followed falling to less than $1.1 billion last year.
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Commercial Property to Stay 40 Percent From Peak, Pimco Says
Bloomberg (06/16/10) ; Levy, Dan

According to Pacific Investment Management Co. (or Pimco), U.S. commercial property values are slowly recovering, but could remain as much as 40 percent below their 2007 peak levels. As lenders dispose of assets or restructure debt on properties where valuations have dropped below loan levels, over $500 billion of real estate will likely hit the market. This, in turn, will keep "general" prices down for at least the next three to five years, Pimco reports. The California-based firm manages the world's largest bond fund. In a report based on research in 10 U.S. cities, Pimco writes: "Capital is clearly returning to commercial real estate, helping to stem the value decline in the sector. Optimism should be tempered, because national price indices are misleading when transactions are limited and fail to reflect the significant uncertainty around property valuations." Such factors as potential re-regulation, an increased savings rate, and high unemployment are among the factors that will "lengthen the deleveraging process and suppress a recovery," the study concludes.
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Commercial Real Estate Loan Prices Improve in April
Sys-Con Media (06/10/10)

The aggregate value of commercial real estate (CRE) loans priced by DebtX that collateralize CMBS increased to 76.4 percent in April from 75.9 percent as of the end of this year's first quarter. A year earlier, loan values were 79.4 percent. DebtX Chief Executive Kingsley Greenland comments, "The increase in U.S. CMBS collateral prices was the result of tightening credit spreads and a flattening of the Treasury yield curve. Those factors more than offset a deterioration in commercial real estate fundamentals." DebtX priced a total of 58,352 CRE loans during April with an aggregate principal balance of $691 billion. These loans collateralize 625 U.S. CMBS trusts. DebtX continues to rank as one of the world's top full-service loan sale advisors for commercial, consumer, and specialty finance debt.
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Using Technology to Improve Credit Risk Oversight
TMCnet.com (06/14/10)

While governments and regulatory bodies are trying to revive their economies and are pressuring banks to increase their lending, the industry's ability to manage credit risk remains weak. This situation is boosting a re-evaluation of credit risk management processes and underlying technologies, in order to minimize the exposure to current and future credit losses. A new report, "Using Technology to Improve Credit Risk Oversight," from the Bharat Book Bureau, examines the growing exposure to credit losses that drive the adoption of credit risk oversight strategies and technologies. It provides insight into the integration of credit risk with other risks and the blending of business processes and technologies. Although in many cases banks already have credit risk management systems in place, they were, for the most part, bypassed or ignored with a false confidence in securitization. The focus on oversight demands that banks provide a more comprehensive view of their credit risk exposure. One of the main needs is to record and monitor risks, so that a bank is always completely aware of its overall credit risk exposure. Therefore, banking organizations need to implement much more advanced systems to manage risks and capital.
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Market Risk

Basel Committee Announces Adjustments to the Basel II Market Risk Framework
Risk Center (06/21/10)

The Basel Committee on Banking Supervision has agreed to make adjustments to the "Revisions to the Basel II Market Risk Framework." The adjustments announced June 21 apply to elements three and four of the revised market risk framework released in July 2009; securitization positions held in the trading book will be subject to the Basel II securitization charges similar to securitization positions held in the banking book, and so-called correlation trading books are exempted from the full treatment for securitization positions, qualifying either for a revised standardized charge or a capital charge based on a comprehensive risk measure. In regard to element three, "the Committee has reconfirmed the capital charge for non-correlation trading securitization positions, i.e. to base it on the sum of the capital charges for net long and net short positions. However, for a transition period of two years following the implementation of the market risk revisions, the charges may be based on the larger of the capital charges for net long and net short positions. During this period of transition, there is a need to ensure that there is not undue recognition of hedging between economically unrelated positions." In regard to element four, the Committee, in line with its announcement in the July 2009 market risk revisions that it would consider a floor for the correlation trading securitization positions, agreed to set this floor at 8 percent of the standardized measurement method.
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House and Senate in Deal on Financial System Reform
New York Times (NY) (06/25/10) ; Wyatt, Edward

U.S. House and Senate conference committee members, after 20 hours of negotiations, reached an agreement early on June 25 to reconcile the two versions of financial reform. U.S. House conferees voted along party lines 20-to-11 to approve the legislation, while Senate conferees voted along party lines 7-to-5 in favor of the final legislation. The conference committee approved the Volcker Rule that restricts banks' proprietary trading and derivatives regulations, which would require financial firms to spin off their derivatives trading operations. U.S. Senate Banking Committee Chair Chris Dodd (D-Conn.) said, "One goal of these limits is to reduce participation in high-risk activity that can cause significant losses at institutions which are central to the financial system. A second goal is to end the use of low-cost funds -- to which insured depositories have access -- to subsidize high-risk activity." However, the Volcker Rule was modified to enable banks to use no more than 3 percent of their own funding to invest in hedge or private equity funds and any investments in these entities cannot total more than 3 percent of the banks' tangible equity. Derivatives regulations are not as restrictive as they were originally, but would require banks and parent firms to segregate a significant portion of their derivatives trading business. Meanwhile, an exemption was provided to auto dealers for federal consumer protection regulations issued by the proposed consumer protection agency, and the U.S. Securities and Exchange Commission was charged with the authority to require stockbrokers and financial advisors to adhere to a fiduciary duty that ensures clients' interests are met when investment advice is given. The final bill is expected to be voted on the week of June 28.
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Fed Study Suggests Rates Will Stay at Record Lows Until '12
New York Times (06/15/10) P. B3 ; Chan, Sewell

The Federal Reserve is unlikely to raise interest rates until 2012 because of high unemployment and low inflation, concludes a new research paper by the San Francisco Fed. Although the study does not represent the Fed's official position, it could be significant considering that Janet Yellen, president of the San Francisco branch, is President Obama's choice for vice chairmanship of the central bank.
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Lawmakers Agree to Expand Audit of Federal Reserve
Washington Post (DC) (06/17/10) P. A15 ; Dennis, Brady

On June 16, Congress reached a compromise on the expansion of audits for the U.S. Federal Reserve that would allow the Government Accountability Office (GAO) to examine the operations of the Fed and require additional disclosures from the central bank, while maintaining the independence of its monetary policy. The language broadens the base text found in the U.S. Senate's financial reform measure allowing the GAO to audit not only emergency lending programs, but also the Fed's discount window and its purchases and sales of government securities. While Democrats claim the language will make the central bank more transparent, Republicans say that only a full audit of the Fed would ensure transparency and "ensure accountability at an institution that has unfettered powers and whose colossal errors of judgment were a crucial cause of the crisis," noted U.S. Rep. Scott Garrett (R-N.J.). A decision to eliminate a Senate provision allowing the president to appoint the head of the Federal Reserve Bank of New York was deferred until a later date. Other compromises included requiring the U.S. Securities and Exchange Commission to study conflicts-of-interest issues among credit ratings firms and implementing regulations after two years. On June 17, lawmakers are expected to tackle provisions to reduce leverage at financial firms, provide federal regulators with resolution authority, and establishing a industry-paid fund to liquidate large, failing firms.
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Fed's Bullard: Strong Global Recovery Under Way
Reuters (06/14/10) ; White, Stanley

The Federal Reserve is unlikely to raise rates until the recovery of the U.S. economy becomes more firm, St. Louis Federal Reserve Bank President James Bullard said Monday during a conference in Tokyo. The central bank's policy makers, which are scheduled to meet next week, are expected to remain committed to holding rates to a very low level for an extended period. Bullard, a voter on the Fed's interest-rate setting panel this year, said the gross domestic product of the U.S. economy could return to pre-global crisis levels by the third quarter, although inflation is a concern due to the large budget deficit and the central bank's easy monetary policy; he also said job creation in the private sector should increase in the summer.
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Operational Risk

Chief Executives Believe Overwhelmingly That Sustainability Has Become Critical to Their Success
Risk Center (06/23/10) ; Allieri, Chris

Despite recent discouraging economic events, 93 percent of CEOs say that sustainability will be necessary to the future success of their companies. Additionally, CEOs believe that within the next 10 years their companies will arrive at a tipping point that fully synthesizes sustainability with core business, including its capabilities, processes, and functions and across international supply chains and subsidiaries. These are a few of the main findings of a survey of 766 chief executives around the world released June 23 by the United Nations Global Compact and Accenture. Along with an online survey, the study included in-depth interviews with 50 of the world's leading CEOs. According to the survey, "A New Era of Sustainability: UN Global Compact-Accenture CEO Study 2010," the global recession did little to quell corporate commitment to sustainability. On the contrary, 80 percent of CEOs say the recession has underscored the importance of sustainability. As businesses move to meet the challenges of the financial crisis, sustainability is being highlighted as a driver of cost efficiencies and revenue growth.
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Operational Risk: Risk Management IT Set for Increased Spending
RiskCenter (06/01/10) ; Silcock, Liz

Financial institutions around the world will spend more on risk management-related technologies, according to three studies released by Chartis Research. The increase in spending is partly attributed to financial firms' responses to economic recessions, regulatory changes, and a desire to quell financial misconduct. "Financial institutions realize they must continue to invest in strong risk management IT systems," explains Peyman Mestchian, managing partner at Chartis, based in London. "One of the main lessons learned from the financial crisis was that risk management systems weren't up to the job." Chartis' research highlights key areas in risk management IT where financial services companies will maintain or increase spending. The Chartis reports, which can be downloaded at www.chartis-research.com, also identify demand-side trends, best practices, top software vendors, and competitive environments. The firm forecasts that Solvency II technology expenditures will increase to $1.67 billion by 2013, and that global spending for market risk software and technology will be $1.28 billion in 2010, increasing to $1.8 billion by 2014.
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Financial Institutions Regain Confidence, Strengthen Risk Management
Collections & Credit Risk (06/10) Vol. 15, No. 5, P. 4 ; Waggoner, Darren

The financial services industry is more optimistic about its prospects for revenue growth and profitability compared to a year ago, and continues to strengthen risk management, according to this year's survey of senior risk management executives by the Economist Intelligence Unit. Nonetheless, the 346 respondents to the February survey expressed concern about future regulations, while noting that regulatory requirements could demand more of the attention of risk managers than day-to-day risk management. Although 60 percent of the senior risk management executives in the banking and insurance industries have a clear risk strategy, silo-based approaches to risk management are still a problem, considering fewer than half believe they understand how risks interact across business lines. Also, the survey reveals that enterprise risk management is still a work progress, as respondents continued to express disappointment over data quality and availability. Only 39 percent of respondents believe they are effectively collecting, storing, and aggregating data. Eighty percent are investing more in data quality and integrity. They also say relying too much on risk models and problems with the data that populate those models are key failures in financial risk management.
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Enterprise Risk

I, Witness
Risk & Insurance (05/10) Vol. 21, No. 4, P. 38 ; Taylor, Laura

Aon Global Risk Consulting Enterprise Risk Management (ERM) Global Practice Leader Laura Taylor says the ways in which firms approach ERM is changing. Previously, approaches to ERM adoption were either too rules driven or too conceptual, which made it difficult to integrate the strategy into corporate processes. More recently, Taylor notes that organizations are looking for ways to integrate ERM with strategic goals. To do this, firms must examine how and how well risk is being mitigated, determine the current and desired levels of ERM maturity at the organization, and create strategies to enhance the strengths and mitigate the weaknesses of the organization. Moreover, a corporate risk profile needs to be outlined and risk information should be integrated into the management decision processes.
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How to Implement Successful Enterprise Risk Management
Smart Business (06/10) ; Cendrowski, Harry

The global economy poses numerous threats for firms that could include geopolitics, supply chains, legislation, credit markets, and transformative technologies. Organizations can reduce risks and identify new opportunities for growth by implementing enterprise risk management (ERM) processes. Harry Cendrowski, the managing director of Cendrowski Corporate Advisors, says ERM processes require such things as a culture of risk awareness, clear communication of a corporate risk/reward strategy, active risk event identification, continuous assessment of risks, timely response to identified risks, sound data collection and communication procedures, and monitoring functions that ensure risks are being properly managed. Cendrowski observes that culture is not something that can be instituted but is a result of the action of management. It is vital for management to establish the appropriate tone at the top and to reward staff for being aware of risks. This means that channels must exist for employees to bring potential risks directly to the attention of management. At companies with boards of directors, these individuals can help ensure management’s actions foster a culture of risk awareness. The board itself is not responsible for an organization’s day-to-day operations, but is responsible for making sure that management implements the company’s strategic vision and conforms to its risk management policy.
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Is U.S. Ready for Chip & PIN?
BankInfoSecurity.com (06/01/10) ; Kitten, Tracy

The United Nations Federal Credit Union's decision to start issuing chip and PIN Visa cards has revived the debate over the U.S.'s readiness to EMV payment cards. Advocates say the United States should embrace the chip and PIN standard, which has been widely adopted abroad because it offers better fraud protection than magnetic stripe cards. Visa expects that both contact and contactless chip technologies will offer opportunities to introduce dynamic data into card transactions, which would be a major anti-fraud advance. However, Viveca Y. Ware with the Independent Community Bankers of America cites the fragmented nature of the U.S. payments card landscape, and says that implementing EMV will entail banks ensuring that their networks and processors can process chip card transactions before issuing the cards. In the meantime, scores of merchants will have to buy and install new terminal hardware and ensure their processors have chip capability. "It's very much a chicken-and-egg scenario," Ware says. The biggest obstacle to widescale U.S. EMV adoption is the cost associated with replacing point-of-sale and card-reader hardware, in addition to the issuance of EMV-compliant debit and credit cards.
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Citi Begins Offering Customers Contactless-Payment Stickers
PaymentsSource (06/10/10) ; Hernandez, Will

Citigroup customers in select cities will receive contactless payment stickers this summer as replacements for contactless "toggles" they received in 2009 as part of a pilot in those markets. The chip-equipped, MasterCard-branded PayPass stickers let shoppers make purchases of up to $50 at the point of sale, and are connected to customers' credit accounts. The company already offers the stickers to a small number of customers via its online banking Web site. Some industry insiders see contactless stickers as a link to near field communication (NFC)-enabled mobile payments. NFC chips are distinct from contactless stickers in that they support two-way dialogue with other NFC chips, and in 2009 Citi ran a trial of NFC mobile payments in India. Citi says that two months into the pilot, about 800 participants made six or more purchases with their phones, while almost all consumers made at least one purchase. Traction for contactless payment sticker schemes is starting to build in the United States. For example, Bling Nation has had some success with a mobile payments sticker system that initiates debit purchases drawn on the accounts of its partner banks' customers.
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Securities Lending

Trade Group Proposes ‘Best' Process for Moving Collateral
Securities Industry News (06/14/10) ; Kentouris, Chris

The International Securities Association for Institutional Trade Communication (ISIITC) on June 14 unveiled a best practice workflow process and messaging system for moving securities used as collateral between fund managers, custodian banks, and other lending agents. The ISITC endorsed the Industry Standardization Organization-compliant 15022 messages for collateral used in securities lending and other transactions. The settlements working group of ISITC devised the sequence of message instructions and the data to be included in the messages to settle securities collateral at a custodian bank when the collateral is posted by either the fund manager or the broker dealer. The standardized information and workflows are designed to ensure the accurate movement of collateral to avoid errors resulting from the use of either proprietary message formats or faxes. Those errors include the fund manager sending the collateral to the wrong custodian bank or the custodian bank allocating the collateral to the wrong fund manager or broker dealer account. “We developed this market practice to address the disparate methods being used across the market f or instructing collateral settlements,” says Erica Choinski, executive sponsor of the ISITC Settlements Working Group. “To address this inefficiency, we think it is vital for those operating in the market to align their methods and we urge them to adopt the standards set out in this market practice.”
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Consumer Lending

Mortgages Face New Rules
Wall Street Journal (06/28/10) P. A4 ; Timiraos, Nick; Hagerty, James R.

While financial regulatory reform offers greater safeguards for consumers, some industry officials warn that it also may boost costs and reduce choices for them. Banks say the potential for greater legal liability could lead to higher costs for borrowers and make lenders skittish about introducing new products. Meanwhile, provisions demanding stricter checks on borrowers' ability to pay could make it more difficult and more expensive for those who rely on commission or seasonal income, as well as those who are self-employed, to qualify for loans.
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Study: Nearly One in Five Mortgage Defaults Are 'Strategic'
Wall Street Journal (blog) (06/28/10) ; Timiraos, Nick

About 20 percent of mortgage defaults in the first half of 2009 were "strategic," according to research that follows an earlier report from Experian. Although the absolute number of strategic defaults rose 53 percent from a year earlier, the share of borrowers who had the ability to pay their mortgages but stopped doing so was unchanged from the end of 2008. Stable home prices could determine whether strategic defaults reached a plateau and peaked in the fourth quarter of 2008; still, walk-aways could begin to account for a growing share of defaults if home prices do not start to pick up.
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4.69 Percent: Mortgage Rates Hit an All-Time Low
Washington Post (06/25/10) P. A11 ; ElBoghdady, Dina

Average interest on a 30-year fixed mortgage fell to an all-time low of 4.69 percent this week, down from 4.75 percent a week ago, reports Freddie Mac. Although rates have held below 5 percent since early May, Michael Fratantoni of the Mortgage Bankers Association notes that demand for purchase loans has fallen in six of the past seven weeks and now is at a 13-year low. Consumers have grown used to low rates, he explains, adding that they balk at buying because they are more concerned about stagnant wages and high unemployment.
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All US Rates But 1-Year ARM Hit Record Lows in Freddie Mac Weekly Survey
Risk Center (06/25/10) ; Fitzpatrick, Eileen

Freddie Mac on June 24 released the findings of its Primary Mortgage Market Survey (PMMS) in which the 30-year fixed-rate mortgage (FRM) averaged 4.69 percent with an average 0.7 point for the second to last week in June, a decrease from the previous week when it averaged 4.75 percent. This time in 2009, the 30-year FRM averaged 5.42 percent. For the week ending June 24, the 15-year FRM averaged 4.13 percent with an average 0.6 point, down from the previous week when it averaged 4.20 percent. This time one year ago, the 15-year FRM averaged 4.87 percent. Sales of both new and existing houses showed unanticipated declines last month. Existing sales dropped 2.2 percent, compared to the market forecast of a 6.0 percent increase, based on estimates published by the National Association of Realtors.
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Interest Rates Likely to Remain Ultra-Low
Washington Post (06/24/10) ; Irwin, Neil

Federal Reserve leaders affirmed the central bank's policy of ultra-low interest rates, acknowledging new risks to the U.S. economy from the debt crisis in Europe even as they expect economic growth to continue. The Fed's policymaking committee left its target for short-term interest rates between 0 percent and 0.25 percent to fuel growth and help bring the unemployment rate down from its current 9.7 percent. Most analysts now believe that rate hikes will not occur until well into next year.
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New TransUnion Study Quantifies the Benefit of Consumer-Lender Loyalty
Marketwire (06/22/10)

A TransUnion study finds that consumers with multiple account relationships with the same lender outperform consumers who maintain only one relationship with that lender. The survey analyzed the correlation between the number of consumer accounts that were 30 days or more delinquent and the number of accounts a borrower held with the target lender. Almost always, delinquency levels on first mortgages, home equity lines of credit, credit cards and auto loans decreased significantly as the total number of relationships the borrower had with a lender increased.
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Treasury Yields to Rise by Year-End: Survey
MarketWatch (06/21/10) ; Levine, Deborah

A poll of 18 primary government security dealers predicts a jump in two-year Treasury yields to 1.14 percent from 0.71 percent now and growth in 10-year yields to 3.62 percent from 3.21 percent -- moves that would curb demand for U.S. government debt. Most respondents do not expect the Federal Reserve to boost the fed funds rate until early 2011, as acting too soon could trigger deflation. More likely, it will minimize its balance sheet and undertake other initiatives to normalize monetary policy first.
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High Default Rates Forecast on Modified Home Loans
Wall Street Journal (06/16/10) P. A6 ; Hagerty, James R.

Potentially three-quarters of borrowers who receive lower mortgage payments under the Home Affordable Modification Program will redefault within 12 months, says Fitch Ratings. Borrowers with loans not backed by a federal agency will have a high default rate largely because they are still struggling with other debt obligations such as credit cards and car loans, according to Fitch's Diane Pendley.
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Slow Pace of Repos Aggravates Problems in Housing
American Banker (06/14/10) P. 1 ; Berry, Kate

Banks seeking to avoid huge losses have put off foreclosing on distressed properties, and foreclosure moratoriums and loan modification programs have permitted such delays. However, many in the industry believe now is the time to take action, shifting from modifications to foreclosure and allowing borrowers to make "dignified exits" in the form of short sales or deeds-in-lieu. High unemployment rates, the absence of tax credits for home buyers and strict underwriting standards will make it difficult for the glut of homes awaiting foreclosure to be absorbed, generating concerns about additional home price declines and an extended housing crisis.
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Risk News Archive