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Credit risk management in an asset-based lending environment.

Article Excerpt
The need to monitor the performance of collateral on an ongoing basis makes asset-based lending labor intensive, often requiring a significant investment in information systems and specialized personnel who have intimate knowledge of the borrower's business. Here is how it's handled at GMAC.

Credit risk management has improved with age. In the past 10 years, in fact, improved analytics, derivative and structured credit products, and growing liquidity for loans in the secondary market have brought a healthy glow to the field. And now techniques long used for managing large corporate borrowers are successfully being applied to middle-market lending.

Financial services companies--such as GMAC, whose portfolio of commercial credit risk is made up primarily of asset-based loans (ABL)--face particular challenges that require a slightly modified approach to measuring and monitoring credit risk. Unlike traditional cash-flow-based bank loans, ABL relies less on the borrower's financial and operational performance and more on the quality of the underlying collateral.

The GMAC Credit Risk Management Framework

With assets exceeding $275 billion, GMAC ranks among the 10 largest U.S. banks. While GMAC competes with commercial banks in many different markets, as an asset-based lender GMAC markets its financial services primarily to small to mid-size borrowers that have limited access to the capital markets for financing. The loans are generally illiquid and highly structured. In addition, the borrowers tend to be highly specialized. A large financial services firm, GMAC has products and markets that are extremely heterogeneous and diversified. Thus, the credit risk management framework needs to be extremely flexible to be applicable across all business lines. At the same time, while GMAC has aimed to develop a common framework across all its credit--granting activities, the framework also needs to have the capability of being tailored, when necessary, to be relevant to all the businesses. The need for this flexibility is extremely important within the context of asset-based lending, which frequently involves fairly complex structures with a wide variety of different collateral types.

The GMAC credit risk framework is based on a uniform risk-rating scale that ultimately will be applied to all subsidiaries and that seeks to harmonize all commercial and retail credit activities across the corporation. A new 23-grade scale--designed to closely mimic those of the major commercial credit rating agencies--is based on the notion of expected loss and provides the granularity necessary to effectively measure true credit risk exposure. Over time, GMAC plans to...

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