Measure Lending Success with Risk-Rating

Shrinking margins heightens importance of credit quality.

January 2, 2013

How do you measure the success of your loan portfolio? For most credit unions, success is measured in growth.

But with ever-shrinking margins, the measurement of your portfolio should include an assessment of loan quality based on the current credit quality and interest rates earned.

For lenders that risk-rate their loan portfolios, there is a quick approach to measuring the loan portfolio’s credit quality. This is done by reapplying the current loan policy guidelines to all of the loans in the portfolio.

This analysis should include a rescoring of the credit scores and measurement of the loan to value on collateralized loans. Then, based on the results of the credit scores and the current loan to values, you can reapply the interest rates you would have used if the loans were underwritten today.

Once you have established the current rate that is earned and the rate that would have been earned, you can perform a net present valuation of both portfolios using the stated maturity. If your portfolio is trending as higher-risk, you will get a lower net present value on the reassessed portfolio.

Lenders that don’t risk-rate their portfolios may need to perform more a comprehensive evaluation of the loan portfolio. This can be performed using a multi-dimensional analysis that will help you identify specific, embedded losses in the portfolio at the loan level.

There are several providers in the market that can assist you with a software platform, providing a “do-it-yourself” approach. Or you can use a full-service provider that will help you measure and understand the process of evaluating risks and losses.

In either case, what you are looking to understand is the embedded losses at the loan level within your loan portfolio and the direction of risks over the term of the portfolio’s life.

Once you have identified the higher-risk loans within the portfolio you will need to calculate your anticipated loss at the loan level based on the current value of any collateral. This anticipated loss then becomes your discount to the portfolio’s projected earnings using each loan’s stated interest rate.

Using this approach you measure your anticipated earning over the life of the loan, less your expected losses, to calculate your net interest return.

In all cases, there is no perfect approach to evaluating the success of the loan portfolio. But with the advances in technology over the last few years, this process has become much more efficient and easier to perform because we are not limited to sampling or ratios to evaluate success.

For the first time we can consider every loan in the portfolio and measure the risks and success of our lending strategies based on specific criteria. This ultimately helps your members manage their debt—and protects your capital and bottom line.





STEVE MILLER is director of operations for Twenty Twenty Analytics, a CUNA Strategic Services alliance provider.