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Setting Up Risk Ratings

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PrecisionLender allows for borrower risk rating categories to be mirrored after the institution’s internal risk rating scale with as few or as many required. You can set up risk ratings at the Product level in the Administration section. 

 

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Risk Ratings for Commercial Loan Products

Important Note:

If you have Relationship Awareness, the Risk Rating names must be consistent throughout all commercial products

 

 commercial loan risk rating

Default

  • Risk Rating that is selected for this product when a lender creates a new loan.

Rating Name

  • Name that will show up for lenders and be used to identify this rating.

Target ROE Adjustment

  • The ROE Target will be adjusted by this amount when this Risk Rating is selected.

Category

  • Provides ability to group Ratings into specified categories.
  • Available categories to map Ratings are:
    • None
    • Pass
    • Internal Watch
    • Special Mention
    • Substandard
    • Doubtful

Usage Given Default

  • Applicable only to Lines of Credit and Letters of Credit.
  • For Line of Credit
    • Allows for estimation of the advance rate of a line of credit at the time of default.
  • For Letters of Credit
    • This option can be estimated by factoring the Usage Given Draw multiplied by the Probability of a Draw Occurring, where Usage Given Draw is likely to be high (100%), however, the likelihood is likely to be very low (5%) - the UGD would then be estimated at 5% (100% * 5%)

Origination Expense Factor

Servicing Expense Factor

Minimum Capital Allocation

  • One of the most critical elements in calculating Return on Equity (ROE), or Loan Profitability.
  • May be calibrated in a number ways in order to influence profitability targets based on the characteristics of the borrower and the lending opportunity.
  • A Minimum Capital Allocation setting is available at the Product and Risk Rating level in order to impose an absolute minimum at this cross-section in the event all other configuration options result in a Capital Allocation below a level believed to be acceptable for the characteristics of combined Product Type and Risk Rating.
Minimum Annual Loss
  • Annual Loss estimates are primarily configured in conjunction with specific Durations, which are explained below.
  • A Minimum Annual Loss setting is available at the Product and Risk Rating level in order to impose an absolute minimum at this cross-section in the event the calculated Annual Loss results in a level below what is believed to be acceptable for the characteristics of combined Product Type and Risk Rating.

Duration

  • Duration is a central concept to recognizing risk within PrecisionLender.  Annual Loss, Credit Capital, and Guarantor Factors are all configurable across multiple durations.
  • Each Duration period can be customized by either deleting a duration by clicking on the trash can, or adding a duration by clicking on the blue "Add Duration" button.
  • Our typical guidance to clients is to configure 12, 60 and 120 month durations. 
    • If setup this way, PrecisionLender calculates a monthly rate for each element of Annual Loss, Credit Capital, and Guarantor Factor in accordance with the term of the loan. 
    • For months 1 - 12:
      • The 12 month assumption is applied.  
    • For Months 12 -60:
      • The monthly rate is interpolated.
    • For Months 60 -120:
      • The monthly rate is interpolated.
    • For Months Greater than 120:
      • The "For All" assumptions are applied.
  • A key component of our on-boarding process and ongoing support with our clients is to provide a consultative partnership to assist in analyzing a client’s operating environment and employ industry standard practices in order to arrive at meaningful assumptions for Annual Loss, Credit Capital, and Guarantor Factor stratified across Duration periods. 
  • Annual Loss
    • Expected loss on a loan given the risk characteristics of the loan and the Risk Rating.
    • Can be configured to reflect duration risk by calibrating against configurable duration assumptions.
    • The result of the Annual Loss assumptions will flow into the Profit & Loss statement for an individual loan profitability calculation as Loan Loss Reserve expense charge.
  • Credit Capital
    • Configured to account for the required Capital (or Equity) to cover unexpected loss on a loan that reflects credit risk, rate risk, and duration risk
    • Key component in determining the denominator for our profitability metric – Return On Equity (ROE)
    • For a detailed review of this topic, please see the following article: http://lenderperformance.com/how-to-determine-capital-calculation/
  • Guarantor Factor
    • Impacts the Loss Given Default, the corresponding Loan Provision, and the Total Capital allocated to the profitability calculation of an Opportunity

 

 

Risk Ratings for Consumer Loan Products

Most of the Risk Rating fields for Commercial Loan Products are the same for Consumer Loan Products; however, there are a few that are different. Refer to the above section for the fields not listed here.

consumer loan risk rating

FICO Min

  • Minimum FICO score required to be in this Risk Rating

FICO Max

  • Maximum FICO score allowed to be in this Risk Rating

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