Credit Risk Models

August 24 – 26, 2010

 AGENDA
 1st Case Study : Credit Rating Model
Borrowers and Factoring (Accounts Receivable Financing) pages 3 – 10

 2nd Case Study : Credit Scoring Model

Automobile Leasing pages 11 – 20

 3rd Case Study : The Validation of Internal Rating Systems pages 21 – 28

 Credit Risk Model : What is Credit Risk Model? page 29

What Properties to be expected! page 29
Application page 30
 1st Case Study

Credit Rating Model

Borrowers and Factoring
(Accounts Receivable Financing)

3
 Credit Rating Model ….. (1)

Model Development

Portfolio Data Calibration and

Analysis Analysis Mapping

Data Performance Implementation

Preparation Test Recommendation

Data Data Accuracy Blind Test

Cleansing Partition

Univariate Correlation Multivariate

4
 Credit Rating Model ….. (2)

Portfolio Analysis

Distribution of Financial Statements and Default Data

-Year; Business Type / Group / Concentration; Size

Performance Number of
Window Accounts

Coverage Bad
Definition

5
 Credit Rating Model ….. (3)

Data Preparation

Data Cleansing Data Partition

Existing and Variables Sample Dimension of

Completeness of -Financial Ratio
Data -Qualitative Data
Grouping Sampling

Correction of Loan Status

Data compared to
In Sample / Product Type
Financial Performance
Out-of-Sample
Logic Out-of-Time Asset Size

Out-of-Universe Business Type

6
 Credit Rating Model ….. (4)

Data Analysis

Univariate Correlation Multivariate

Logistic Screening
Multiple Logistic
Regression Criteria
Regression

Quantitative Make
Business Sense
Understandable /
Qualitative Intuitive
Powerful

Enough
observation to
develop and
validate model

7
 Credit Rating Model ….. (5)

Performance Test

Accuracy Blind Test

8
 Credit Rating Model ….. (6)

Calibration and Mapping

Calibration Mapping

9
Credit Rating Model ….. (7)

10
 2nd Case Study

Credit Scoring Model

Automobile Leasing

11
 Credit Scoring Model

Scorecard Development

Portfolio Analysis Model Development

Portfolio Vintage Data Model

Distribution Analysis Gathering Building

Test on Similarity and/or Differentiation Data Preliminary

of Bad Rates Cleansing Variable Selection

Variable
Purposes of analyzing portfolio:
-To understand the overall picture of portfolio
Classing
-To know the portfolio’s default rates in terms of Marginal and Cumulative Default Rates
-To help set the sample group to be collected for model development

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 Model Development ….. (1)

Data Gathering

Performance Bad Sample Variables

Window Definition Size

Independent Dependent
Variables Variables

Borrower’s Collateral’s Facility’s Loan

Characteristics Characteristics Characteristics Status

13
 Model Development ….. (2)

Data Cleansing

Data Exploration Problem and Solution

Number of Fields Number of Missing Error from Data

Complete Cases Value Transformation

Extreme Discrepancy of
Reliability of Missing
Value Data
Data Data
Vague /
Unclear Data

14
 Model Development ….. (3)

Variable Classing
Classing is process of automatically and / or interactively binning and grouping interval, nominal, or
ordinal input variables in order to

Manage the Improve the Select predictive Make the Weight

number of predictive power characteristics of Evidence – and
attributes per of the thereby the
characteristics characteristics number of points
in the scorecard –
vary smoothly or
even linearly
across the
attributes

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 Model Development ….. (4)

Variable Selection

Preliminary Statistical

Missing Consistency Univariate Multivariate

Value data analysis data analysis

Completeness and relationship with

other variables

16
 Model Development ….. (5)

Model Building

Why Logistic Regression!

-It can handle discrete variable or qualitative variable.
-The dependent variable need not to be normally distributed.
-The dependent variable need not to be homoscedastic for each level of the independents.
-Normally distributed error terms are not assumed.
-It does not require that the independents be interval.

17
 Model Development ….. (6)

Model Building

Sample Accuracy

Training Out-of-time Type I & II K-S

Sample Sample errors Statistics

Testing
Discriminatory Power
Sample
of the model : The
maximum difference
between the
cumulative percent
good distribution and
the cumulative
percent bad
distribution

18
 Model Development ….. (7)

Criteria for Model Selection

Accuracy : Type I & II Consistency of testing results Number of Variables Including or excluding
errors; K-S statistics among Training, Testing and in the model Policy Indicators in
Out-of-time Samples the model
Example of Gain Table

19
 Model Development ….. (8)

Scorecard Implementation and Application

20
 3rd Case Study

The Validation of Internal Rating Systems

21
 Scope of Work and Validation Aspects
Scope of Work

Analyze the discriminatory power Analyze the connection between Analyze the rating process
of rating models PD and Grade

Analyze the stability Analyze the models design

of rating models
Validation Aspects

22
 Validation Method
Study and Analyze Data
from Documents

Statistical and Interview and

Mathematical Default Probability Model Site Visit
Tests Validation

23
 Validation Results
Quantitative : Discriminatory Power
Type I & II errors in theory Type I error of each model

Density Function for Good Cases

Density Function for Bad Cases
Project Financing <15M
Cut-Off Point
Relative Frequency

Project Financing <15M;

Hire Purchase; Leasing

Hire Purchase and Leasing

Rating Class
Type I error Type II error

Project Financing >= 15M Factoring

24
 Validation Results

Quantitative : Discriminatory Power (ROC Curve)

Project Financing < 15M;

Project Financing >= 15M Factoring
Hire Purchase; Leasing

25
 Validation Results
Quantitative : Stability

Project Financing < 15M;

Project Financing >= 15M Factoring
Hire Purchase; Leasing

2006
Overall
2007

2008

% PD from Actual Default Rate : ADR (%)

26
 Validation Results
Quantitative : Calibration
S&P’s
Default Rate
PF >= 15M

PF >= 15M PF < 15M

PF < 15M;
HP; Leasing HP: LS

HP: LS Implied PD PF < 15M;

HP; Leasing

PF < 15M

Actual Default Rate (%) of each model compared to Actual Default Rate (%) of each model compared to
Implied PD (%) by CQC Grade S&P’s Default Rate by Rating

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Executive Summary

28
 Credit Risk Model ….. (1)
What is Credit Risk Model?

 A tool used to evaluate the level of risk associated with applicants or borrowers.
 It consists of a group of characteristics, statistically determined to be predictive in separating “good”
and “bad” accounts.
 It provides statistically odds or probability that an applicant or borrower with any given rating or score
will be “good” or “bad”.

What Properties to be expected!

 Understandable
 Powerful
 Calibrated
 Empirically validated

29
 Credit Risk Model ….. (2)
Application

 Origination Decisions
 Given the risk and a fixed price, is the asset worth taking?
 Given the risk, what price is required to make the asset worth buying?

 Portfolio Optimization
 To reduce the portfolio’s risk, concentrations of risk and how the risk can be diversified must be known.

 Capital Management
 To set capital, the loss level is needed.

 Credit Process Management

 To gain the efficiencies of application processing that comes through automation.
 To gain control and consistency in lending practices for the entire credit portfolio.
 To identify the variables which are important in the credit evaluation process
 To improve delinquency statistics while maintaining desired approval rates

30
 Credit Risk Model ….. (3)

Credit Risk Model

only classifies and predicts risk;
It does not tell the lender
how to manage it.

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