Quantify your portfolio risk
Identifying and reacting to changes in your portfolio
Many institutions have seen changes in their portfolios as a result of economic turmoil. Identifying and reacting to these changes are vital to a successful lending program. Portfolio changes can be addressed in two key areas: new applicants and existing loans.
To understand the potential risk of new applicants, changes to the “through-the-door population must be analyzed.
These changes can be measured using the following tools:
- Actual versus expected score distribution report: This report measures the distribution of new applicant scores (actual) compared with a benchmark distribution (expected). The benchmark distribution can be from a recent validation, a model development sample or historical distributions. Tracking the differences between the actual and expected populations can determine how the risk of new applicants has changed over time. These differences may result from fluctuations in the economy, changes in marketing strategy, product mix, applicant mix and geographic concentration.
- Mean score: The mean applicant score is the average score received by the through-the-door population. Along with the actual versus expected report, the mean score is tracked over time to illustrate how applicants’ scores have changed.
- Volumes and rates: Statistics such as application volume, approval and booking rates also can measure broad changes in the through-the-door population.
Understanding the differences in the new application population helps institutions manage risk and meet goals, as it guides them in the following actions:
- Adjusting cutoff scores to maintain both risk and approval targets
- Reviewing policy rules, loan terms and conditions to ensure they are mitigating risk due to lower-scoring applicants
- Updating their pricing program to account for changes in tier distribution
Once loans are on the books, it is important to closely track their performance to understand how broader environmental factors are affecting the portfolio. The following are tools for tracking these changes:
- Short-term delinquency reports: These reports track the delinquency and losses of newly booked loans. Identifying problem loans within the portfolio at an early stage will allow institutions to proactively manage these accounts. Delinquency and loss rates of loans at a specified vintage can also be compared over time to determine if strategy changes for new applications are effective.
- Validation or score performance reports: These reports assess the scorecard’s ability to distinguish between creditworthy and noncreditworthy applicants. They validate the predictive power of the scorecard by determining how well the model separates bad and good accounts. These reports are essential for identifying scorecard degradation due to population changes and establishing benchmark distributions for future reporting. Additionally, these reports provide bad and loss rates by score interval. These rates can be compared with previous reports to show the magnitude of changes in bad and loss rates over time.
Understanding the changes in the existing loan portfolio can allow institutions to manage the portfolio by:
- Focusing collections efforts on high-risk accounts
- Reviewing line management strategies and closing or reducing line amounts for the score ranges that have increased risk and maintaining or increasing line amounts for those scores with lower risk
- Incorporating results in regular reviews of loan approval criteria and adjusting cutoff scores, policies and rates offered
By closely monitoring changes to both the through-the-door and existing populations, institutions can identify changes and proactively manage risk. This will help to ensure a successful lending program in these turbulent times.