Commitments

[wrongsaidfred]

Hi David,

This may be a really dumb question, but in the readings about expected and unexpected loss the term commitments seems to be used to describe two things: the total amout the the bank has "committed" to loan to the other institution and sometimes it is just used to describe the portion of the committed amount that is not yet outstanding (has not been drawn).

Is there a proper definition as far as adjusted exposure is concerned?

While I am on the subject, drawdown is also slightly ambiguous. For instance, if a bank extends a $10,000,000 line of credit and $6,000,000 is outstanding and the drawdown is expected to be 80%, would this mean that 80% of the total $10,000,000 will be drawn or 80% of the remaining $4,000,000 will be drawn in addition to the $6,000,000 that is already outstanding?

The whole idea is easy enough, but the way the terminology gets thrown around is not always consistent.

Any help you could provide would be greatly appreciated.

Thanks,
Mike

 

[David Harper CFA FRM]

Hi Mike,

Yes, it has come up before, the author (Ong) apparently uses "commitments" both ways. If we look at Ong's table 4.2.

• "Original Commitment" (COM); e.g., $10 million
• Outstanding (OS) = $5 million; i.e., has been drawn down by the borrower
• "Unused Commitment" = $10 - 5 = $5 million

Ong uses it both ways, but i think the important view is:
Adjusted exposure (AE) = OS + UGD * "Unused Commitment"; which is the same as (also expressed)
Adjusted exposure (AE) = OS + UGD * (Original commitment - OS)

The point is, what's exposure? exposure includes 100% of the outstanding (i.e., it can all be lost!) plus some % (UGD) of the unused commitment, which is like an option the borrower has, so just multiply that by some % to put a value on the option.

Re: drawdown: yea, that's specific to Ong (it has a hedge fund meaning). I think he means it, in your example, to refer to the 80% of the $4 million (the unused commitment), so i *think* he means it to equal UGD, as the fraction that converts the "optionality" into an AE. But the exam should use UGD as drawdown has other connotation.

Thanks, David

 

[wrongsaidfred]

Great.

Thanks for the explanation.

Mike