Credit Swap

[VINCENTP]

Hello David,
I am not pretty sure about my solution with one of many cases I am trying to solve. I would very much thank you for your advice if you could give me some thought. Here is the case I am stuck with:
Bank A has bought a CDS protection from Bank B for notional of $100MM on 03/31/2015 for 5 years maturing 03/31/2018 to hedge a corporate loan against an oil refinery customer – ABC. The facility extended by Bank A to customer is for $150MM and the facility is maturing on 03/31/2017. The facility drawn by the customer as of today is $10MM. Betty Thompson can assume his own meaningful PD and LGD for customer ABC and Bank B and also the CCF/LEQ factor.
1.Show the impact of RWA with CDS protection and without CDS protection of hedging the loan
2.If the facility is maturing in 03/31/2019 instead of 03/31/2017 - can you show the RWA impact?
Again, I am very grateful for your help with your advice and wishing you a great weekend there.
Best regards,
Vincent

 

[ShaktiRathore]

Hi if i can give some thought,
W/o cds the RWA would be high comparatively compared to rwa with cds. Assume lgd =25% and PD=20% then exp loss once default occurs is .25*.20=5% so 5% loss is possible on facility which equals .05*150=7.5mm if initial RWA is x then as credit exposure of facility is covered by cds we assign net weight of 0 to loan so net Rwa remains x. But w/o cds rwa would invrease to x+7.5m.
When facility maturity is extended we simply increase PD=36% so now exp loss=.36*.25=9% or .09*150=13.5mm so rwa is increases to x+13.5mm higher than previous one.
Hope this helps
Thanks

 

[VINCENTP]

Hi ShaktiRathore,
Thank you very much for your thought and response. That really helps. I had the same thought that without CDS, RWA would be higher and the longer maturity facility is, the higher RWA would be. However, I could not go into the granularity like you did. Your approach really made a lot of sense to prove that your solution is accurate. Again, thanks a lot for your thought and help, ShaktiRathore.