Wild credit cycle for new risk management chief

PHILADELPHIA – Kevin Blakely picked quite a time to start his new job as president and chief executive officer of the Risk Management Association.

Subprime-mortgage turmoil, a pullback on easy credit for leveraged buyouts, and a widespread uptick in bad loans on banks’ books have unsettled the nation’s securities markets.

“The market is very nervous right now and probably rightfully so,” Blakely said Tuesday, his first day at the not-for-profit organization that helps financial institutions develop methods to ensure they get paid for the risks they take.

The association, founded in 1914, was originally named for Robert Morris, the financier of the American Revolution, who ended up in debtor’s prison.

Blakely, who worked as a federal banking regulator before spending 17 years at Key Bank in Cleveland, said banks had gotten much better at measuring risk, especially since the last downturn in 2001-02, but have not eliminated the credit cycle.

“We’ve come a long way in developing new methods of modeling risk, but we haven’t been through a major business cycle yet when these methods have been tested,” he said.

Along with advances in the mathematical models of risk promoted by Blakely’s group have come an abundance of new financial products that enable companies to protect against specific forms of risk, and the emergence of hedge funds as a major source of liquidity.

And that’s where a new, untested level of risk comes in. When a company buys protection against an unfavorable movement in interest rates from another financial institution, it expects to be reimbursed for its loss.

“If the counterparty happens to be a big firm, a JPMorgan, a Citigroup, or something like that, I’m pretty confident that they are going to be there when I need them,” Blakely said.

“If, on the other hand, it’s some small hedge firm that I don’t know much about, they may not be there when I need them.”

Another major factor affecting the markets today is the growth in securities, such as those backed by subprime mortgages that are pooled and sold in pieces - called tranches - to investors, based on the level of risk.

In theory, this means that risk has been diffused through the capital markets, but it also raises a potentially serious problem.

“I don’t think we really know where all the pieces and parts have gone, because people have the ability now to spread it so far and wide, and I don’t think we are really going to find out until we go through a business cycle.”

A conversation about credit with Blakely, 56, does not stray far from the notion that credit cycles are never going away.

And if the beginning of a downturn is at hand, Blakely, who counted four credit cycles in his 34-year career, knows what to expect as easy credit dries up.

“You go through the bad parts, and you spill all the blood,” he said. “We need to expect that.”

He is hopeful, however, that “when the losses come, they will be more temperate,” thanks to the techniques developed by the Risk Management Association in conjunction with industry.