by. Dennis Child
The past eight years have been traumatic for most financial institutions. We in the lending business witnessed how dramatically loan portfolios can change over relatively short time frames and how detrimental those changes can be.
Federal and state regulators have made it clear they are going to focus more of their resources on making sure financial institutions are doing a better job of managing the risk in their investments and loan portfolios than in the past. A credit migration tool designed around stochastic methodology is an essential part of managing credit risk in consumer loan portfolios. Stochastic methodology magnifies the directionality of credit migration and expands its value with statistical analysis that identifies variables which predict the risk factors of loans. A variety of vendors have developed and offer these models in the marketplace.
Based on data gathered over the past twenty-five years, TCT has come to the following ten conclusions regarding consumer loans:
- A borrower’s financial situation can change quickly—impacting his ability to pay existing debt or take on new debt
- Loan portfolio book-values are dynamic and continually changing as a result of borrowers’ finances and shifting credit scores
- Constantly monitoring credit scores (by individual borrower and by pools) is the most efficacious method to forecast impending delinquencies and charge-offs
- A financial institution’s profitability and future existence is critically impacted by its shifting loan yields and loan delinquency and charge-off expenses
- 80 percent to 90 percent of total delinquencies and charge-offs are attributable to loans that have experienced a drop of two or more credit grades from the original score