Lenders Develop Analytics To Quantify Effects Of Gulf War

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Asked to quantify the economic impact of a war in Iraq, risk managers are scrambling to compute the impending damage to banks' credit portfolios and, if possible, to prevent any harm.

Lawrence Mielnicki, director of corporate retail credit risk analytics for FleetBoston Financial Corp., said last week that in response to senior management concern Fleet has developed new models to gauge the effects of a war on the asset quality of its retail portfolio. Building such models, he said, is not a long-tested science like credit scoring-a risk management tool that does not apply to systemic events like stock market crashes, terrorist attacks, and natural catastrophes.

In this new territory of analytics, creditors are cobbling together new formulas and guessing at the crucial unknowns in the equation-perhaps foremost, how long a war is apt to last.

"A systemic risk is a problem outside the control of a lender and generally outside the control of a borrower," Mielnicki said in a speech at the National Collections and Credit Risk conference in Las Vegas, sponsored by Credit Union Journal publisher Thomson Media. Components of Fleet's models include macroeconomic effects, industrywide estimates (for example, losses to all Visa USA credit cards), and the lender's likely portion of the losses based on credit quality.

The game is not simply to weed out the ostensibly risky accounts in advance, he said. "But given the fact that you have some level of 'bads' in your population," lenders should try to anticipate "how those 'bads' will change as the result of a specific event."

Mielnicki said he would not recommend using such models as detailed forecasting tools; gauging systemic risk is speculative and imprecise.

Nonetheless, the potential shock to asset quality is serious enough to warrant estimating. Fleet ran two scenarios in its analysis: a short war and a long war. In the first, "the credit picture actually got better," he said. In a drawn-out conflict, Fleet's credit quality was not harmed at first, but when Mielnicki allowed for a war lasting 10 years, "that did produce negative results" that would prompt Fleet to adjust credit standards and collections efforts, among other things.

Length Of Action Determining Factor

Patricia Frazier, a vice president of business development at First Data Corp.'s Western Union, said a lengthy war in Iraq would probably affect consumer bill payment. Delinquencies are already at record levels, and this problem would be compounded.

"If a war occurs and it's quickly over, it may be there's no impact on the economy," Frazier said. "But if it drags on, consumer confidence will continue to diminish."

That would mean more delinquency and, for financial companies and others, weaker cash flow. Marcia Tal, the executive vice president of decision management at Citigroup Inc.'s Citi Cards, said predicting a portfolio's performance during a time of volatility-"from a period of peace and prosperity to one of war, terrorism, and recession"-is both more difficult and more necessary. Citing the Federal Reserve's 11 interest rate changes (six up and five down) during the past two years, Tal said: "For us at Citi, these swings are so momentous. The levers of our profitability are continuously being challenged."

A lot hinges on the mediation between risk analysis and business strategy, an area Citi calls "decision management," she said.

Richard Brown, the chief economist at the Federal Deposit Insurance Corp., said in an interview that at this point no bank should be surprised if the nation does go to war in Iraq. Most lenders have already taken into account higher short-term oil prices, he said. Indeed, he said, the start of a war would be good for the economy in one sense-it would put an end to all the nervous wondering about whether there will in fact be one.

"In a period of uncertainty, people take all the bad possibilities into account," he said. "Right now, uncertainty has real costs."

For example, Brown said, businesses have been putting off decisions and investments.

"Just going from uncertainty to certainty and knowing what the outcome will be" can boost consumer confidence, he said.

Brown said he did not think economic predictability is impossible in the post-9-11 climate of the threat of further terrorist attacks on U.S. soil.

"There are other situations in the world involving wars and terrorism, and they have found ways to do business," he said. "I would never say there are conditions under which a business can't figure out what to do."

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