Scoping Out Credit Risk

Bloomberg ran a story last week about the price of credit default swaps for Bank of America recently soaring. Referenced in the article was the Markit CDX North America Investment Grade Index “which investors use to hedge against the losses on company debt or to speculate on creditworthiness.”

Trying to get a good handle on overall credit risk is not a new problem and there are a number of products out there that attempt to do it. Markit’s CDX North America Investment Grade Index does it by watching the prices of credit default swaps of 125 representative companies. All 3 ratings agencies (Moody’s, S&P, and Fitch) have their own default rate indices and Kamakura’s Troubled Company Index provides an “analyst-handcrafted” measure of overall credit risk. These indices and tools have been around for a while and are accepted by the industry as key benchmarks of overall credit risk; however they all have one limiting similarity: they all focus on a small cohort of large, highly visible and (generally) public corporations.

The data used by these tools comes from bond markets, CDS prices, or analyst judgments making them excellent indicators of credit risk within that universe; and honestly right now, the best available indicator of overall credit risk too (which is why they have become accepted standards). However, when it comes to the millions of mid-market and small firms that account for billions in commercial lending, the relevance of these indices comes into question. The credit risk of the largest 100 companies is not necessarily analogous to the credit risk in the smallest 100 or the middle 100. In fact, you could reason that some big businesses and small businesses might have opposing relationships. Does Borders going out of business boost the small town bookseller? It sure might. An index that only looks at larger company data could lose this resolution.

WAIN Street’s Business Credit Health Index (BCH Index) can help with this by expanding the scope and resolution of credit health information. It builds on what Markit, Kamakura, and the ratings agencies do and increases the breadth of input data. The BCH Index takes data from every one of the 30 million businesses in the US, blends it with other information, and provides a usable benchmark of business credit health for the entire country. The WAIN Street index, because the data comes from factual information on businesses of all sizes, is pertinent to all businesses including the ever important mid and small market ones.

Indices like WAIN Street provide new knowledge that enables investors to manage risk more effectively, create new financing options, and unlock liquidity. This in turn helps businesses grow in the long run. By using an unprecedented amount of data with such broad scope WAIN Street’s BCH Index, when accepted like other metrics, will help bring previously untapped opportunities to many mid-market and small businesses.