RMPG Learning Series CRM Workshop Day 4

IMaCS 2010Printed 11-May-11

Page 1For Classroom discussion only

Agenda for Day 4

Portfolio Management

Lunch Break

Case Studies

Open Session/ Q&A



Portfolio management essential to evaluate whether results aligned with strategy

Interest Income

Fee Income

Treasury Income

Profits

Interest Expenses

Interest on Deposits

Interest on other Borrowings

Operating Expenses

Losses due to defaults, liquidity mismatches

Capital Budgeting

Product Mix

Customer Mix

Delivery Channels

Risk Appetite

Organisation structure

Performance and portfolio compositionComponents of Strategy



Measures that describe a portfolio (Retail)

Loan Portfolio

Seasoning

NPAs

LTVs

Loan Amount

FOIRNIM

Delinquencies /

Overdues

Original and

residual tenure

Demographics

Salaried vs. self employed

Geography

Age



Summary of Approach - Modeling

Grading Scale HL1 - HL10

Objective parameters

Subjective parameters

Approach : 1.Construction of Indices on qualitative parameters –

2.Discriminant Analysison quantitative & qualitative parameters

3.Calibration to grading scale

Dataset – Sample borrowers

1.Model Training Sample: XX accounts

2.Model Validation Sample: XX accounts



Explanatory Variables in the Home Loan Model

Fixed Obligation / Income

IncomeLoan AmountEMI/NW

Quality of Borrower Index

Cost of Living Index

Age

Educational

Qualification

Length of

Service /Business

Designation

(salaried)

Type of

Organisation

Years of Banking

Marital StatusNo. of

dependents

Residence

type

Loan to Cost

Qualitative

Quantitative

+

+

- -

- + +



Age of Applicant

Based on the Life Cycle Hypothesis where the investment/saving life cycle of an individual has four phases:

1. Expenditure Phase: High on Debt

2. Accumulation Phase: Low debt, Investment

3. Sustenance Phase: No Debt, Investment

4. Rundown Phase: Use of wealth for livelihood

Applicant is likely to have higher surpluses in the Accumulation and Sustenance Phases

Qualitative Indicators



Qualitative Indicators

Educational Qualification

Higher educational qualification implies

1. Higher job security

2. Higher future earning potential

3. Alternative employment opportunities

Hence, higher educational qualification of the applicant indicates better continuing payment

ability



Quantitative IndicatorsIllustration: Fixed Obligation to Income Ratio (FOIR)

Higher the FOIR, lower is the

capacity of the applicant to absorb

the negative shock in net income.

Hence, higher the FOIR, lower is the

ability of the applicant to meet

unforeseen expenses.

FOIR = (Monthly Instalments on

all loans* + Monthly Rent) / Net

Annual Income

Note: Consider net annual income,

loan EMI , rent of applicant & co-

obligant, while calculating the FOIR

Median 33%Median 33%

FOIR

0%

5%

10%

15%

20%

25%

10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75%

Fre

qu

ency

Median 33%

FOIR

0%

5%

10%

15%

20%

25%

10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75%

Fre

qu

ency

Median 33%

* Includes the estimated instalment for the proposed loan also in the calculation

1. From the data it is observed that if FOIR exceeds 47%, about 50% of the cases default.

2. The optimum range for lending in terms of most favorable default experience is the 25%-40% FOIR zone.



Quantitative IndicatorsIllustration: Loan to Cost Ratio (LCR)

Importance of this indicator

Lower the LCR, greater is the

applicants contribution towards the

asset i.e. loss in event of default

increases for the applicant.

Hence, if LCR is low, in case of

default by the applicant, the Loss

Given Default for the bank will be

lower

LCR= Loan Amount/ Cost of the

Asset to be acquired

Importance of this indicator

Lower the LCR, greater is the

applicants contribution towards the

asset i.e. loss in event of default

increases for the applicant.

Hence, if LCR is low, in case of

default by the applicant, the Loss

Given Default for the bank will be

lower

LCR= Loan Amount/ Cost of the

Asset to be acquired

0%2%

4%6%8%

10%

12%14%16%

18%20%

Below10%

10%-20%

20%-30%

30%-40%

40%-50%

50%-60%

60%-70%

70%-80%

80%-90%

Above90%

0%2%

4%6%8%

10%

12%14%16%

18%20%

Below10%

10%-20%

20%-30%

30%-40%

40%-50%

50%-60%

60%-70%

70%-80%

80%-90%

Above90%

Median -53%

Loan to Value Ratio

� The optimum range in terms of most favorable default experience is the 45-65% LCR zone.

� Default rates are around 35% higher for LCR being in the above 75% zone



Other important factors which should be considered for appraisal

Credit Track Record

� Past credit record depicts the attitude of the person in honouring his

credit obligation. “Wilful default” are one of the causes for a number of

defaults.

� A bank could analyse credit track record based on:

1. Number of Cheques returned in last six month (Bank Statements)

2. Number of Credit Roll Overs in last six months (Credit Card

Statements)

Credit Track Record

� Past credit record depicts the attitude of the person in honouring his

credit obligation. “Wilful default” are one of the causes for a number of

defaults.

� A bank could analyse credit track record based on:

1. Number of Cheques returned in last six month (Bank Statements)

2. Number of Credit Roll Overs in last six months (Credit Card

Statements)




Nature of Asset

In Housing Segment, assets gradually appreciate with time unlike many

other assets [Cars, white goods, etc.]. The chance of negative equity* will

be lesser and Loan to cost ratio will improve over the period of time.

* Negative equity: When the outstanding loan amount is lesser than the

value of the asset, chance of default is lesser.

Hence, chance of default is lesser in housing loan than other retail segments.

Nature of Asset

In Housing Segment, assets gradually appreciate with time unlike many

other assets [Cars, white goods, etc.]. The chance of negative equity* will

be lesser and Loan to cost ratio will improve over the period of time.

* Negative equity: When the outstanding loan amount is lesser than the

value of the asset, chance of default is lesser.

Hence, chance of default is lesser in housing loan than other retail segments.




Collateral Security

Additional collateral security lowers the net exposure of the bank. It increases the applicants contribution in the asset thus effectively reducing loan to cost ratio.

Hence, if the Collateral Security is high, in case of default by the applicant, the Loss Given Default for the bank will be lower



Balance Business flexibility with Asset quality improvement

Trade-off between acceptance and NPA generation

0%

10%20%

30%

40%50%

60%

70%

80%90%

100%

0% 20% 40% 60% 80% 100%% proposals accepted

% N

PA

s re

du

ced

Trade-off between acceptance and NPA generation

0%

10%20%

30%

40%50%

60%

70%

80%90%

100%

0% 20% 40% 60% 80% 100%% proposals accepted

% N

PA

s re

du

ced

The objective is to strike a balance between business objectives (so that not too many cases are rejected) and potential NPA reduction.

ICRA recommendation

62.2%, 79.3%



Portfolio analytics: Formation of Pools – cost effective way of managing risks

Pool 1 Pool 2 Pool 3 Pool 4

Source of Income Salaried Salaried Self Emp Self Emp

LTV >70% >70% 50% - 70% >70%

FOIR <40% 40%-60% 40%- 60% >60%

NIM 2% 3% 3% 4%

Seasoning 18 18 12 18

Performance

Delinquency 10% 20% 15% 25%

NPAs 1% 2.5% 2% 3%



Understand how pool are formed by the bank

1. A pool is formed on risk and transaction characteristics

2. A pool is assumed to have homogenous PD and LGD and reduces the task of individually rating obligors

• Size :3-5 % of total portfolio (e.g. of housing loans)

•Each obligor :not more than 0.2%

•Technique generally used to segment: CHAID or expert judgement

Geographic Zone

Type of Borrower

Networth

Home Loan Personal Loan Revolving Credit

Income

Loan/Value

FOIR

Maturity

PD

LGD

EAD

Geographic Zone

Type of Borrower

Networth

Geographic Zone

Type of Borrower

Income

Mortgage Loan Loan Against Property Loans for home repairs

FOIR/

Loan/ Land Value

Loan Product

Maturity

PD

LGD

EAD

Risk C

haracteristics

of Borrow

er

Calculate PD, LGD, EAD

Risk C

haracteristics

of Borrow

er

Calculate PD, LGD, EAD

2. IMaCS assume that bank will provide the Mortgage pools based on some of the above described borrower or transaction characteristics



Understand Portfolio Characteristics of a bank’s Mortgage pool

� The portfolio is further segmented based on theabove described parameters

IMaCS Preliminary analysis of portfolio data to assess Pool characteristics risk assessment

� Portfolio size

� Loan Schemes

� Weighted loan tenure

� Amount weighted portfolio default rate – 90+dpd, 180+dpd

� Number weighted portfolio default rate – 90+dpd, 180+dpd

� Delinquency Flow rates of difference buckets

� Average tenure of the loans

� Average ticket size

� Average month on books

� Weighted IRR

� Location

� Customer categories/Borrower type(Salaried-Govt. /reputed company/Others, Professional, Self employed)

� FOIR Ratio(Fixed Income to obligation ratio), Income of the borrower

� LTV ratio

� Recovery /Security Information



Static Pool Analysis(SPA) to estimate weighted delinquency rates of unseasoned portfolio

The delinquency rates estimated in first portfolio analytics give us standalone delinquency rates, which doesn’t give correct picture of the

portfolio delinquency rates as it seasons. Thus SPA tool is used to

- compute and compare delinquency cum loss rates across the different seasonings points ( for net loan originations in different years)

- approximate loss rates for partially (un) seasoned portfolio tranches

- assesses loss rates for the overall portfolio and portfolio segmented by tenure

Data requirement : Quarterly/Yearly Snapshot of the pool for at least two years to perform the static pool analysis and to project the

delinquency rates for unseasoned portfolio tranches

Pool tenure 5-10yearYears on Book(Seasoning points) In Crores

Sanctioned FY Year

0-1 1-2 2-3 3-4 4-5 5-6 6-7 7-8 8-9 9-10 Net Disbursement

<=2001 3.60% 4.00% 3.70% 40.9

2002 2.80% 3.00% 2.60% 4.10% 87.9

2003 3.50% 3.60% 4.10% 4.50% 4.50% 125.1

2004 4.30% 5.00% 4.90% 4.50% 3.80% 3.80% 136.3

2005 3.90% 4.10% 3.40% 4.50% 3.80% 4.40% 4.00% 181.5

2006 4.70% 5.20% 4.10% 4.20% 4.30% 4.00% 4.20% 4.20% 189.4

2007 2.00% 3.80% 4.10% 4.15% 4.00% 4.00% 4.20% 3.80% 3.00% 214.5

2008 0.6% 1.90% 3.20% 4.00% 4.20% 3.50% 4.70% 3.00% 3.00% 3.00% 266.8

2009 0.3% 2.20% 4.5% 4.20% 4.25% 4.00% 3.00% 3.00% 3.50% 3.50% 231.5

2010 0.1% 2.30% 3.90% 4.30% 4.15% 4.50% 4.40% 3.50% 4.00% 4.00% 440.8

Estimated delinquency rates for unseasoned portfolio(IMaCS Method)- Delinquency cum loss rates for remainder tenure computed using a semi-log fn.

- Weighted year wise delinquencies adjusted for coefficient of variation

Estimated Unseasoned portfolio delinquency ratesCurrent Snapshot deliquency rates

Weighted Delinquency Rate of Mortgage pool for current snapshot =

2.7%

Loss cum delinquency rate= ((90+dpd outstanding using the YoB Band)* POS)/ Net quarter disbursements

sum product of highlighted delinquency % of various seasoning point with their respective net disbursements



Estimating Expected Loss

The SPA helps in assessing Probability of default, where as Expected loss helps in assessing the actual loss after liquidating the collateral . Expected Loss is computed as a product of =EAD* PD * LGD

Where EAD can be seen as an estimation of the extent to which bank may be exposed to counterparty in the event of and at the time of counterparty’s default.

EAD= Balance outstanding Default cases + Interest accrued from NPAdate to cutoff date

PD is computed from SPA analysis weighted delinquency rates (As shown is previous slide)

LGD Computations : (1-p(Cure))*Economic loss+ Recovery CostEAD

Where P is Cure rates of NPA account after performance period Economic losses= EAD-Discounted recoveriesDiscounted recoveries= Min(∑RR x Vi x Discount factor, EAD)

i i

Annual interest rate =Opportunity cost of bankDiscount period=The period for which the recoveries are discountedRecovery cost= Legal Cost + Recover department Cost

Sample EL and EL as a % of POS Computations Case 1: Home loan default cases with POS 90 Cr and interest accrued till cutoff date is10 Cr with 2.7% Weighted delinquency and LGD % of 55%

Expected Loss = (90+10)Cr*2.7% *55%= 1.48 CrEL as percentage of POS = 1.48 = 1.48%

100 Cr



Capital adequacy

� Economic capital� Higher capital for higher LTV and FOIR loans

� Higher capital for loans provided to self employed borrowers

� Higher capital for longer tenure loans

� Greater capital required in case of higher concentration in a demographic

segment

� Should be at least equal to the regulatory capital required

� Regulatory capital� As prescribed by Bangladesh Bank from time to time



Risk Adjusted Return on Capital Employed

Risk Adjusted ReturnRisk Adjusted Return

IncomeIncome

Interest IncomeInterest Income

Fee and other non interest

income

Fee and other non interest

income

ExpensesExpenses

Interest ExpenseInterest Expense

Origination and servicing

costs

Origination and servicing

costs

Risk Adjustment

Risk Adjustment

Provisions / Expected

Loss

Provisions / Expected

Loss

Capital Required (regulatory) / Employed (economic)



Benefits of portfolio management

� Enables proactive identification of problem pools and take decisions

related to portfolio rebalancing

� Enables Decisions related to increased efforts for� Marketing for the best performing pool

� Monitoring or collection for delinquent pools

� Policy changes maybe required due to the result of analysis

� Risk adjusted returns� High spreads but high defaults in a particular segment could mean lower

risk adjusted returns with respect to a lower spread and lower default

segments



DISCUSSIONS



All the contents of the presentation are confidential and

should not be published, reproduced or circulated without the

written consent of IFC, Bangladesh Bank and IMaCS.

Economy & Finance

RMPG Learning Series CRM Workshop Day 4