Nine Elements of Credit Approval for Cash Portfolios
In this research commentary, we offer a behind the scenes look at the credit approval process for cash investment portfolios. We discuss nine essential components to help clarify a process that can sometimes seem mysterious and intimidating.
- Beyond Ratings – What Makes Cash Unique
- The Credit Universe – It’s All About Supply
- Preliminary Screening – Compliance and Common Sense
- Macro Analysis – The Panoramic View
- CAMELS – The Fundamental Process
- Internal Ratings Systems – A Scorecard Concept
- Final Credit Approval – A Group Exercise
- Monitoring and Surveillance
- Credit Event Response – Risk Mitigation
For some treasury practitioners, the credit approval process for cash investment portfolios can be mysterious and intimidating. In day-to-day operations, they often make credit decisions, directly or indirectly, about their investments solely based on credit ratings. In the post-2008 era, a deeper understanding of the credit process is essential for cash investments, even if one uses outside managers such as money market funds. In this research commentary, we explain nine essential elements in the credit approval process for a cash portfolio.
1. Beyond Ratings – What Makes Cash Unique
First, one needs to recognize that credit approval for a cash portfolio is rather different than that of other fixed income investments. In addition to minimum credit requirements such as ratings, fundamental credit features for cash credits include:
- Minimum Loss Threshold: In general and by design, cash portfolios have a very low threshold for principal loss. In money market funds, a $0.01 loss on the net asset value can have grave consequences. Cash credit approval, thus, requires a higher degree of assurance.
- Held to Maturity Bias: Unlike trading portfolios, cash investments are often held to maturity. This means that the credits must be resilient in order to endure credit developments and market events until the maturity date.
- Conservative Bias: Because of the held-to-maturity bias, cash investments are income producing assets that often do not benefit from principal gains. The need for downside protection always outweighs any desire for upside potential.
- Priority on Liquidity: Due to the nature of cash accounts as sources of liquidity, the ease of converting into cash quickly and with minimum price concession is a key consideration.
- Pre-Trade Compliance: Because of higher demand on safety and liquidity, cash credits must typically be approved before they can be considered as candidates for a trade. Many firms maintain a list of pre-approved credits for this purpose, while non-cash credit departments typically do not.