Track Changes and Mitigate On

By Robert Phelan, CFA, GARP

( , 973-2727-3603,

March 17, 2020

In 1939 prior to WW II, the British government created a poster saying, “Keep Calm and Carry on.”  Given the dramatic impact of the Coronavirus, the world cannot carry on as usual.  Recently, I have worked on recession preparation with risk managers in asset management, payment firms, and banks.  I would say the more appropriate phrase for today is, “Track Changes and Mitigate On.”  My experience includes the 2001 business recession, and the 2009 recession driven by the collapse of the housing market.  In both cases, exposures and risk decisions were carefully tracked, and mitigation actions were executed to reduce potential losses, but not to the extent that it accelerated customer defaults.

The global economy is in a fast corner of economic, political, and social change.  Therefore, risk managers need to guide their company through this bumpy corner.  In this environment, the risk drivers are a loss of demand (revenue) as well as issues in the supply chain (inventory, services, and margins) coupled with extended leverage (debt and liquidity) in the oil, airlines, live events, travel, restaurant, asset management, lending, and retail industries. What makes these risk drivers so impactful is that consumer spending accounts for 70% of the GDP (Bloomberg).

Chief Risk Officers are acting on their recession plans consistent with actions taken in other functional areas, e.g., employee protection, customer support, capital preservation, and overall business activity. Today, I will discuss risk pitfalls that may trip up some of the less experienced risk managers.

What are some of the risks and strategies to consider?

  • Risk 1 – Loss Forecasting has Significant Uncertainty

Risk managers, in conjunction with the CFO, need to present estimates of near-term credit losses and margin compression.  For credit risk, I have worked with firms on looking at the predictions of PD, EAD, LGD, and volatility multipliers based on segment exposures in their portfolios, their agility in controlling excess exposures, and availability of extended financing for customers.  Except for recalculating acquisition strategy, most risk management actions are focused on tracking changes and mitigating risk in customers’ exposures.  The new Current Expected Credit Losses (CECL) requirements provide some leeway on forecasting losses (WSJ – Coronavirus)

  • Risk 2 – Model Risk and Decision Science Gaps

The model prediction of risk (default, volatility, credit recovery, liquidity risk) may severely under-predict risk because most firms did not have in their key risks the broad loss of revenue and operational issues associated with a rapid contraction.  Rebuilding machine learning models will not improve prediction given the recency of risk data, and no clarity on the full credit impact.  I have seen models under-estimating risk because spend on business and consumer credit cards has declined. Historically, lower spend is prudent in a credit cycle. In this environment, it is just a reaction to no demand. Most models are lacking risk variables covering the declining revenue impacting the customers’ ability to cover debt service.  Traditional credit profiles need to be adjusted down.  The best visibility might be through realtime access to the bank account from companies like Plaid.

  • Risk 3 – Small and Medium Enterprise (SME) Vulnerability

The credit profile of many SME will be severely impacted by the decline in demand as well as employee issues as they manage through the coronavirus quarantine period.  However, I have warned clients against untenable line reductions or wholesale account cancelations reductions that will accelerate defaults.  I like the government proposal to enable SBA loans to SME businesses in partnership with their bank, credit union, and fintech payment company that has outstanding exposure to the business.  The bank, credit union, or fintech would share losses, under the proposal, with the SBA.  Many people estimate that three months is the length of this recession, but my experience in 2001 and 2008 indicated that SME’s need at least a year to recover from recessions.  Risk managers should have a one-year recovery loan available to assist SMEs in short term financial difficulty due to the Covid-19 situation.

  • Risk 4 – Regulatory Mandates could be Blocking Risk Actions

The CCAR regulatory stress tests are not representative of this downturn and the pending recession. The regulators should be disseminating information on best practices and government support. Risk managers should minimize efforts to create new hypothetical stress tests and focus on the current stress environment.

  • Risk 5 – Asset Valuation and Risk/Return Rebalancing Gaps

Many asset managers are not using benchmark reference pricing to inform portfolio risk/return optimization to drive rebalancing.  Banks and Investment Management firms do not actively hedge their P&L volatility due to credit risk and market risk volatility.   However, massive declines in the SPY, XLE, XLF, HYG, and BKLN ETFs provide indications for changes in the risk/reward profile in equities, high yield corporate bonds, and bank loan assets that should be monitored on behalf of asset management’s customers.

  • Risk 6 – Social Persuasion will Shift the Economics of Lending

The political environment is shifting to an acceptance of protecting borrowers under market and credit turmoil (WSJ – How to change anyone’s mind).  Of course, Donald Trump would accept changes in bankruptcy laws given that he has filed six times for his companies.  The new bankruptcy bill by Elizabeth Warren and supported by Joe Biden will address some deficiencies in the bankruptcy law. For example, student debt will be discharged in bankruptcy, home and car delinquencies will be protected for ongoing consumer’s use, and the time-period that bankruptcy appears on credit bureaus is sure to reduce soon.  Risk Managers need to evaluate the long-term economics of lending.

Carefully assessing, monitoring, and acting to reduce risk vulnerabilities protects the firm’s long-term economics but may increase other risks.  Inaction and internal focus expose a firm to obsolescence. Not addressing risks threatens survival and diminishes competitive advantage. Getting an independent risk assessment creates a dialogue on the prudent levels of risk action for any given environment.


Maurer, Mark. “Coronavirus Could Affect How Companies Forecast Credit Losses.”  The Wall Street Journal, Dow Jones & Company, 4 Mar. 2020,

Berger, Jonah. “How to change anyone’s minds.”  The Wall Street Journal, Dow Jones & Company, 21 Feb. 2020,

Matthews, Steve. “Five Early Warning Economic Indicators Show US Virus Shock.” Bloomberg, 14 Mar. 2020,

Author: RiskDirector, LLC

Risk Management Advisory and Consulting

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