Introducing the CB Specialist series, a monthly chat with various thought leaders across the Credit Benchmark community. In today’s post, David Carruthers, Head of Research at Credit Benchmark breaks down the basics of the Credit Benchmark Consensus indicator (CBC).
The CBC is a 21-category scale explicitly linked to probability of default estimates sourced from major banks. A CBC of bbb+ is broadly comparable with BBB+ from S&P and Fitch or Baa1 from Moody’s.
Q1: How is the CBC derived?
DC: The CBC is similar to the scales used by the large rating agencies, but it is explicitly linked to Probability of Default (PD). Quorate PDs are mapped to their appropriate CBC category. The PD breakpoints and midpoints for the CBC scale are based on the PD-rating scales used by IRB banks; summaries of these are available in published Pillar 3 reports. The CBC breakpoints are designed to maximize the fit between the single CBC scale and the various published bank scales. These breakpoints are regularly reviewed with the CB methodology committee.
Q2: What do you mean by Quorate?
DC: Quorate PDs are those derived from three or more PD estimates for the same legal entity. This ‘rule of three’ is similar to that used for bond prices by Bloomberg, and CDS prices by IHS-Markit. It is intended to preserve contributor anonymity by preventing scope for reverse engineering.
Q3: How is a CBC indicator different from a credit rating from one of the “Big Three” credit rating agencies (CRAs)
DC: The CBC uses an explicit quantitative mapping from PD to credit category. CRAs are required by regulators to publish a qualitative description of their ratings, although they also publish ex-post default frequencies for each category.
Q4: With these differences in mind, what is the unique value of the CBC vs. the CRAs – whether on its own merit or alongside the CRA ratings?
DC: The CBC is closely correlated with CRA ratings which gives users a high degree of confidence in the measure, although the CBCs tend to be slightly more conservative. The main value is in the extension of the CBC to unrated obligors, where there would otherwise be no credible standard for measuring credit risk.
Q5: What might practitioners be missing if they are not currently factoring CBC indicators in their analyses?
DC: The value of CBCs is derived from the high frequency of updates, clear trends and early warning of changes in credit status. Contributing banks have a strong financial interest in the accuracy of each PD. This helps the CBC to establish a true market view of credit risk which can be credibly extended to unrated entities.
Q6: Finally, what are the use cases for the CBC and related Credit Benchmark data within the industry?
DC: There are various use cases, including:
• Counterparty selection: determine accuracy of credit risk across a large set of unrated counterparties
• Benchmarking loan books: evaluate whether credit risk is being priced correctly
• Capital management: See where capital allocation is sufficient/insufficient across various parts of the business; and assess the influence of PD estimates on expected losses
• Pricing: Extend pricing to illiquid instruments with comparisons of the CBCs (based on real world probabilities of default) to market implied probabilities
• Credit Trend Monitoring: monitor and track consensus view on a counterpart’s credit health
• Macro Analysis: Macro analysis by industry and geography
• Portfolio Monitoring: Monitor risk estimate differences between own portfolio and bank consensus view, by geography or industry
• Supply Chain Risk Analysis: Track credit health across a company’s supply chain
• Business Planning: Portfolio analytics to support business planning decisions
• Obligor Screening: Screen and filter for obligors based on credit quality and other metrics
• Model Validation and Calibration: Fine-tune credit risk model assumptions
• Regulatory Interaction: Pinpoint and identify where bank PD estimates deviate substantially vs peers, ahead of regulatory reporting
• Trading: Compare Market Implied PD vs Credit Benchmark Real World PD
• Credit Pricing Validation: Credit pricing validation for trading
Would you like to see what the banks think about a particular name or sector? Send an email with your specific request to [email protected].
See Credit Benchmark Blogs for the latest CBC observations and individual indicators across various market sectors..