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The N-Abler Platforms bring a compelling innovative solution to the industry; its independent loan grading. Rather than provide overall pool ratings that often speak little to what is in the pool, the N-Abler grades each individual asset within the pool. This brings a level of transparency and reporting analysis to a portfolio clearly desired by stakeholders, regulators and auditors.
Internally the individual loan gradings can be utilized for a wide range of risk management functions. With the loan level credit risk information senior management can implement more targeted revenue strategies to better price out the potential risk within individual loans. For the users the N-Abler has straightforward web based access to the grading functions through on-line originations tools. These can be used directly in the original loan granting process, providing underwriters with expert, but easy to use tools. The grading system can also provide metrics with understandable comparative views for external board members, assisting them in governing their institution.
Understanding the N-Abler credit scoring models
At the core of every N-Abler service offering are the credit grading and collateral grading tools. Each loan in the portfolio is assigned a grading based on the value of an individual asset rather than a single rating assigned to the entire pool.
The N-Abler gradings go beyond market values, appraisals and calculation of cash flows. Each Platform’s grading tool incorporates key economic factors that affect the value of the credit or the underlying security of the loan. Many of these factors are rarely brought into current market values. For example: the necessity of the asset to the borrower’s revenue generating capabilities has no place in a general market valuation. It does however have a very distinct impact when looking at the potential of a loan to default. This factor is but one of the elements taken into consideration in the N-Abler gradings. Each grading tool incorporates a number of economic factors as they apply to the type of loan being scored.
The grading tools can be used in two ways (1) as the loan is originated and the information is collected at the time of the application or (2) on periodic basis, with a data extract from the F/I.
As the resulting gradings come from an independent third party source the F/I can then use the resulting report as support (i) for its own portfolio management decision processes, and (ii) for discussions with their regulators on their portfolios’ risk profile when assessing capital adequacy.
Credit Grading
The Credit Grading model that produces the credit grade is based on points of data resident in each loan and translates the imbedded credit risk in the loan into a score on a 5.0 point scale. The credit grade is a numerical representation of the potential of a client’s overall capacity to repay the loan. It does so by assessing the borrower’s credit score in conjunction with the other economic factors referenced earlier. There is a score for each individual loan, which allows the credit risk of a portfolio, or series of asset classes to be ranked; the higher the score, the better the quality of the customer’s credit.
A score of between 3.5 and 5 on the scale indicates the F/I has good-to-strong expectation of full loan repayment directly from the borrower meeting their schedule payments. From the borrower’s perspective it means they should have a wide range of options available to them to secure a loan from many different lenders.
A score of between 2 and 3 on the scale indicates the F/I has moderately strong repayment capacity. The information shows weakness in some areas of concern. This may highlight the need for more timely monitoring or direct collection intervention should the loan move into delinquency.
A score of between 0 and 1.5 on the scale indicates the loan has definitive weaknesses. Loans carrying these scores can be successful but should carry flags throughout their term accompanied by predetermined workout or liquidation strategies that can be acted upon early in a delinquency cycle.
A score of R on the scale indicates the F/I should consider rejecting the loan because one or more of the primary grading factors have fallen outside system embedded accepted parameters.
The data fields used in the algorithms to determine the score are specific to the asset class; however, the resulting score is not. For example, the credit risk of a consumer loan with a grade of 4 provides a similar risk exposure and probabilities as a mortgage with the same grade, although the absolute amounts of the loans are different. This allows the F/I to assess the risk inherent in a portfolio and across asset classes.
Collateral Grading
The N-Abler also provides separate grade indicators which assess the value of the underlying asset that is security for the loan – the collateral grading. Very distinct from just an asset appraisal value, the grading process looks at a number of external economic factors that can impact the liquidity value of the loan’s underlying security if it is realized on. It can, for example, distinguish the value to the F/I between two properties with the same current market value. The N-Abler will assign a higher grading to one asset over the other where there is a higher likelihood the F/I can recover the full value of its loan in a more timely manner.
The Collateral Grading is also a 5 point scale that assesses the likelihood the amount lent can be realized on through the sale of the underlying collateral. This grade scale reflects such characteristics as the marketability of the asset, ability of the asset to retain value, and the use of the underlying asset. Going back to our earlier example, a piece of equipment is used to generate income would have a higher collateral grade over one that the business does not rely on all else being equal (e.g. delivery trucks vs. photocopiers). A house located in a major urban center would have a higher grade, all else being equal, than a rural property, because of the stronger likelihood of less time on the market.
Similar to the Credit Grading, the higher the Collateral Grading the higher the expectation the lender could recover the loan amount from the sale of the asset. The data fields used in the algorithms to score are specific to the collateral class.
Purpose and Use of the Gradings
A vast of amount of information is used in the credit granting process. It is often daunting to analyze and put into the context of the lender’s overall business. An N-Abler grading is a compilation of all the information used to determine the credit decision, in one concise number. The grade along with other information such as branch, loan officer, rates, etc can be used to help management understand the relative amount of credit risk being assumed, along with where and how it is being assumed.. It allows for the effective communication to all levels of the organization of the measure of over all credit risk exposure the organization has taken in.
Second, but equally important, the gradings provide key indicators or flags for how the loan should be managed once funded. Loans with lower scores can potentially be risk mitigated through pre-identified recovery strategies. Internal collection resources can be assigned to better manage a loan at earlier stages of delinquency. For example a loan with a higher credit grade compared to its collateral grade should be monitored closely throughout its term, with more frequent customer updates being obtained, or early contact at the first signs of delinquency. Where the opposite is in play (higher collateral grading and lower credit grading) the lender can decide to allocate less collection resources and focus on getting updated information on the underlying security, or in worsening conditions take earlier steps to secure the asset for sale.
As the credit and collateral grades are independent of the lending institution, the grades allow for the comparison of results, metrics of the organization to the grades. There is no one right answer when assessing credit as long as the risk is understood, any material variation can be investigated, reviewed and updated. An organization may use the credit scoring model for many purposes including:
- Assessing credit at the time of origination as credit is being granted
- Assessing pricing strategy in the context of the level of credit or collateral risk taken
- Assessing the on-going mix of credit risk within give portfolios or across the balance sheet
- Assessing the underwriting skills of individual loan officers, branches, locations, to help management set objectives, and conduct performance reviews
- Assessing estimates of realization values of delinquent loans based on their collateral grades
- Assessing Fair Value accounting estimates as it relates to the credit quality and realization values
- Assessing underwriting standards – is the lending institution getting the credit quality it expects from its guidelines.
- Assessing the credit profile of portfolio for purchase at the individual loan level.
- Providing the Board with independent 3rd party credit assessment
To watch a presentation on the best practical applications of the N-Abler’s loan level grading for your organization, click here.
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