Modelling credit losses of a retail portfolio
Deyan IVANOV
Retail Risk Methodology and Validation
Raiffeisen Bank International AG
0. Agenda
1
Types of Loan Loss Provisions in the Retail Segment of RBI
2
Individual Loan Loss Provisions (ILLP)
ILLP – Treatment of Restructured Accounts
ILLP – Calculation steps
3
Portfolio-based Loan Loss Provisions (PLLP) - Overview
PLLP – Flow Rates, Loss Factors, Transition Matrix – Definitions and Examples
PLLP – Gross Provisions, Recovery Models, Net Provisions - Calculations
4
Alternative provisioning methodologies – Basel 2
5
Experience from the roll-out across the RBI Group
6
Challenges/Issues
Slide no.2
1. Types Of Loan Loss Provision models in RBI
 Portfolio-based loan loss provisions
 Flow rate model or Transition Matrix model – to calculate “Gross Provisions”
 Vintage Recovery model – to calculate final “Net” Provisions
 PD/LGD - based model
 Individual loan loss provisions
 Accounts in Loss status (in Retail currently defined as 180+ =>Absorbing
status)
 Early Losses (Frauds, Bankruptcy, etc.)
 Certain Restructured loans (if NPV is lower than actual balance)
Slide no.3
1. Types Of Loan Loss Provisions in RBI (cont’d)
Provisions
Balance
New volume
No provisions
Accounts with no
delinquencies
Accounts with no
delinquencies
PLLP
1_90 accounts
1_90 accounts
90_180 accounts
90_180 accounts
180+ accounts
360+ accounts
Slide no.4
NPL
ILLP
180+ accounts
360+ accounts
2. Individual LLP - Overview
If objective significant evidence of loss exists individually, such accounts
are excluded from the Portfolio-based Loan Loss Provisions and these
accounts shall be evaluated individually
ILLP are allocated for the following cases:
Accounts in Loss
status (180+ dpd)
- Recovery
collection starts at
this point
Slide no.5
Early Losses:
Restructured loans:
-Frauds
-Re-agings
-Bankruptcies
-Extensions
-Deceased
customers
-Rewrites
2. Individual LLP - Accounts in 180+ dpd
 Individual Loan Loss Provisions at 100% of gross exposure must be
applied for any exposure which is 180 days past due
 If there is a mortgage or a pledge of a vehicle (or other assets in case of
leasing) is repossessed (and not sold yet) at those accounts, Provisions
are set at 100% of Net Exposure (Gross Exposure reduced by discounted
Weighted Collateral Value)
 If the collateral is other than real estate or repossessed asset, Gross
Exposure is not reduced as we believe that non-repossession of the
collateral before 180+ (7 months) suggests one of the following
problems:

no possession of collateral

the collateral is not liquid

operational breakdown
Slide no.6
2. Individual LLP - Early Losses
 Early losses are accounts which are identified as uncollectible
(likelihood that a loan will be paid is very low)
 ILLP at 100% of the exposure is allocated for such accounts, it may be
reduced by discounted WCV of real estate or already repossessed assets
 Typical examples of Early Losses are:



Slide no.7
Frauds – there are some evidence (received official information)
about a fraudulent activities of the customer, our partners or internal
fraud is detected (e.g. at underwriting)
Bankruptcy – a court decision is available
Deceased customers – there is official information
2. Individual LLP – Basic rules in Restructuring

In order to prevent artificial improvement of the portfolio quality out of
restructuring activities, RBI has set the following rules for restructured accounts:
 borrower must show a renewed willingness and ability to repay the loan;
 this is observed for at least three months after the restructuring and is extended by any
period of significant reduction* of the instalment
 account shall not be restructured more than once within any 12-month period and
twice within any 3-year period => If breached, ILLP at 100% on the net exposure.
 additional funds/limit can not be advanced to enable new payment;
 A newly opened account which replaces the old account as a result of restructuring is
considered a restructured account as well

Definition of Significant reduction:
 The new instalment is lower than the interest only payment
 For FX denominated loans – out of devaluation of the LCY the new instalment in EUR is
lower than the original one
 The new reduced instalment caused extension of the tenor beyond the maximum
product tenor set by RBI Retail Credit Policy

The maximum period of temporary significant reduction may not exceed 12
months
Slide no.8
2. Individual LLP - Impairment of Restructured Accts.

Restructured loans (other than Deferrals) are always to be checked for
impairment, if:
 the interest rate is lower than it was upon account opening (except
where the interest rate is decreased in order to conform to current
market conditions);
 the maturity is extended and the instalment amount is unchanged;
 there is a reduction in the amount of debt (principal, interest, fee)
and this reduction is not charged off against P&L.
If NPVnew (Net present value of new instalment plan) < NPVold,
a 100% provision for the NPVold-NPVnew must be booked!
Slide no.9
2. Individual LLP – DPD of Restructured Exposures

After restructuring the account should be kept in the same delinquency
bucket it was prior to the restructuring for at least 3 months – introduce a
parallel DPD counter and “freeze” the restructured dpd (DPDr)

Any new delinquency (DPDc) during the observation period is “added” to
the DPD at the date of restructuring and thus the provisioning bucket is
determined. Respectively, the observation period is restarted until 3
consecutive instalments are repaid in time and in full. (total DPD=DPDr+DPDc)

If a customer has paid all due payments within the observation period, the
account is put to the current bucket and added to the portfolio assessment (!
– provided there was no impairment due to restructuring) and the dpd before
restructuring is no longer maintained.

If during the observation period the total DPD reached 180+ it can not go to
current bucket but will stay in 180+ forever
Slide no.10
2. Individual LLP - Summary
I
Individual Loan Loss Provisions ILLP1 ( Early losses, 180+ accounts -unsecured)=>
Net Provisions = 100% of Exposure
II
Individual Loan Loss Provisions ILLP2 ( Early losses,1 80+ accounts - secured)=>
Net Provisions = 100% of Exposure – discounted WCV for Mortgages,
repossessed Vehicles and leasing assets
 Market value must be estimated at the time of entering 180+ (or not older than 6
months)
 WCV is calculated according to GD Collateral evaluation using certain discounts
 WCV must be further discounted to consider the time when we plan to sell the
collateral (time value of the money)
III
Individual Loan Loss Provisions ILLP3 ( check Restructured Loan for Impairment)=
Net Provisions = PLLP @ restructuring da(using special DPD and observation period)
+ Impairment due to a restructuring
Slide no.11
3. Portfolio-based LLP - Overview
Flow
Rate
AVG
Flow
Rate
Gross
Provisions
Recovery
Rate
Risk
Costs
Slide no.12
Loss
Factor
Net
Provisions
Influence
on P/L
Flow rate
model
Provisioning
calculation
3. Portfolio-based LLP - Flow Rate Model
Flow rate is calculated as a ratio – the balance in dpd bucket from actual month
over the balance in the previous dpd bucket from previous month (maximum
100%)
It is based on the assumption that an account either flows down or is paid out
Bucket (i)
Previous month
balance Bi(t-1)
Current month
balance Bi(t)
Current (1)
B10[1]
B11
1-30 dpd (2)
B20
B21 [2]
FR2
= min(100%; B31/B20)
31-60 dpd (3)
B30
B31
FR3
= min(100%; B41/B30)
61-90 dpd (4)
B40
B41
FR4
= min(100%; B51/B40)
91-120 dpd (5)
B50
B51
FR5
= min(100%; B61/B50)
121-150 dpd (6)
B60
B61
FR6
= min(100%; B71/B60)
151 - 180 dpd (7)
B70
B71
FR7
= min(100%; B81/B70)
180+ (8)
B80
B81
100%
Monthly Flow rate (%) FR
FR1[3] = min(100%; B21/B10)
[1] B10 – balance of loans in the category (Current Bucket) in month “t-1” (previous month)
[2] B21 – balance of loans in the category (1_30) in month “t” (current month – for which the reporting is done)
[3] FR1– Flow rate (%) of rolling from Current bucket to 1-30 dpd bucket corresponding to the actual month (t) for
which the reporting is done.
Slide no.13
3. Portfolio-based LLP - Loss Factor Calculation
The Loss Factor reflects the probability that an account will flow from
current state to Loss (180+)
It is determined as the product of all flow rates between the bucket (where
an account is now) to the Absorbing state (180+)
Bucket (i)
Current (1)
1-30 dpd (2)
31-60 dpd (3)
61-90 dpd (4)
91-120 dpd (5)
121-150 dpd (6)
151 - 180 dpd (7)
Slide no.14
Probability of loss (Loss factor LF)
LF1 = AVG FR1 * AVG FR2 * AVG FR3 * AVG FR4 * AVG FR5 * AVG FR6 * AVG FR7
LF2 = AVG FR2 * AVG FR3 * AVG FR4 * AVG FR5 * AVG FR6 * AVG FR7
LF3 = AVG FR3 * AVG FR4 * AVG FR5 * AVG FR6 * AVG FR7
LF4 = AVG FR4 * AVG FR5 * AVG FR6 * AVG FR7
LF5 = AVG FR5 * AVG FR6 * AVG FR7
LF6 = AVG FR6 * AVG FR7
LF7 = AVG FR7
3. Portfolio-based LLP - Transition Matrix Model
TMM is based on a matrix that describes the probability of moving the accounts
(exposures) from one state (BOP) to each of the other states (EOP) over two
periods, generally just the probability of a move to Loss state is used at the end.
EOP State (after 7 months)
EURO
B
O
P
S
t
a
t
e
new Volume
Current MOB1_12
Current MOB 13_24
Current MOB 25_36
Current other
1_30
31_60
61_90
91_120
121_150
151_180
Total
Paid / Loss
Current Current Current
Net Bal
MOB1_1 MOB
MOB
Current
Loss
BOP
2
13_24
25_36
other
1_30
31_60
61_90
91_120 121_150 151_180 Paid
(180+) Loss (180+)
5.079
4.741
0
0
0
0
0
0
62
0
0
276
0
0,00%
90.608 62.755
9.571
0
0
3.914
1.909
2.120
1.794
1.495
915
5.926
208
0,23%
73.071
0 45.134 10.916
0
2.587
2.332
2.346
2.207
1.776
1.330
4.130
314
0,43%
64.720
0
0 32.095 13.446
4.233
2.223
2.055
2.660
1.019
1.586
4.880
524
0,81%
107.398
0
0
0 76.576
8.906
2.447
2.240
2.156
2.159
1.640 10.061
1.214
1,13%
20.497
543
803
1.801
477
6.102
3.527
1.340
883
633
585
1.029
2.771
13,52%
5.888
138
165
150
150
37
850
465
189
138
334
254
3.019
51,27%
3.931
0
94
42
100
39
48
264
126
53
213
143
2.808
71,43%
3.520
0
0
14
21
26
36
46
113
82
152
92
2.937
83,45%
3.566
0
0
0
0
0
4
7
11
29
123
72
3.322
93,14%
4.889
0
0
0
0
0
0
33
35
44
58
55
4.664
95,40%
383.166 68.176 55.769 45.017 90.770 25.844 13.375 10.917 10.237
7.427
6.936 26.918 21.781
This model calculates using the complex account behaviour (all possible
movements are taken into account) in contrast to FRM.
Slide no.15
LF%
3. Portfolio-based LLP - Recovery Models
 Accounts that went into Loss status (180+ dpd) can be partly (or fully)
recovered in the future as an outcome of internal collections or debt
sales
 All payments that came after an account reached Loss status are
considered recoveries
 Recovery rate can be calculated either by using Vintage recovery
model (strongly recommended) or Simple recovery model
 Irrespective of the model used the Debt sale accounts must be excluded
from the recovery modeling data (only exception is if it is a forward flow
type of deal)
Slide no.16
3. Portfolio-based LLP - Simple Recovery Model
Recovery Rate% =
Recovery in last 12 months 1
180+ new in last 12 months 2
1) Sum
of payments in last 12 months on accounts after they reached Loss
status 180+; regardless whether they reached Loss status in last 12 months
or sooner
2) Sum
of balances of those accounts that rolled in Loss status 180+ in the
last 12 months
This model is possible only for retail and only for those countries, who
have not the recovery history to build the Vintage recovery model
Slide no.17
3. Portfolio-based LLP- Vintage Recovery Model
Vintage Recovery model estimates the recoveries after Losses (180+)
The output of VRM is a recovery ratio, which represents the portion of
accumulated payments (recoveries) after Losses divided by the amount
that rolled into 180+
Discount Factor must be
taken into account
Recovery Rate
60%
50%
40%
The discount rate to be
used is the APR which
was in force at the time
the account entered
Loss status
30%
20%
10%
0%
1
3
5
7
9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47
Time Since 180+
Slide no.18
3. Portfolio-based LLP - Vintage Recovery Rate
Month, when account
rolled into 180+
Account balance at roll to 180+; see also comments to mortgage ptf.
Months since write-off
Write off
Loss date
date
A1
Write-off
Amount
amount
at Loss
A2
Months since Loss
1
2
3
4
A3
B
C
D
Slide no.19
5
6
7
8
4. Alternative provisioning methodologies
Set the Loss Event status to BII-default
Performing loans:
» Loss Factor
PLLP
=
On-bal exposure
» Basel II’s EAD
LGD » (1-RR)
PD long-avg
LIP factor
given a default,
economic loss ratio
default probability
(1y horizon)
Loss identification
period
» Basel II’s 1 year expected loss
… scaled by LIP factor
Non-performing loans (“Basel II defaulted”):
Slide no.20
ILLP (secured)
=
ILLP (unsecured)
=
On-balance exposure – PV of future expected Cash Flow
On-balance exposure
BEEL
4. Alternative provisioning methodologies
The existing methodology also needs updates:

Remove the absorption status at 180+ dpd
► Replace it with a “cure” period, e.g. 6 or 12 months

Move the loss definition from180+ dpd to 90+ dpd
► Use the Basel 2 default definition as a loss definition for provisioning

Adjust the outcome period for the Transition matrix model to 1 year
► Achieve comparison among the units who are using either the
Flow-rate model or the Transition matrix model or the PD/LGD
model

Estimate the LIP for the default-probability models who use 1-year
outcome period
Slide no.21
5. Experience from the roll-out across RBI Group

A Survey across all Network banks was performed recently, covering
the following components of Retail Provisioning Methodology







DPD
Portfolio segmentation
Restructuring
FRM,TMM, Loss Rate Calculation
Recovery Rate Calculation
ILLP / Collateral Value
Data processing and assessment (subjective)
 Based on responses to questionnaire with pre-defined answers, where
applicable
 NWUs were graded by the proximity of the local implementation to the
Group Directive standards
 Different topics were weighted to reflect importance/sensitivity
 ILLP and Restructuring topics got the highest weights (30% and 20%) as
they are playing the most important role regarding the provision
adequacy
Slide no.22
5. Experience from the roll-out across RBI Group
Private Individuals
Portfolio
segmentation
DPD
NWB
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
-
Loss rate
calculation
Restructuring
Conservatism
Recovery rate
calculation
ILLP (WCV)
8
9
9
1 0
9
8
8 .9
1 0
9
1 0
9
8
1 0
9 .4
9
9
7
9
9
5
7 .1
4
3 .3
6 .4
8
0
0
9
1 0
6
8
9
1 0
6
3
3
0
0
6
7
7
7
6
6
9
6
7
7 .3
9
9
3
7
8
8
6 .9
1 0
1 0
7
1 0
7
8
7 .8
1 0
9
9
8
7
6
7 .5
9
9
6
8
8
8
7 .9
1 0
9
4
7
8
6 .2
1 0
1 0
3
4
6
7
6 .1
9
9
6
7
8
7
-
-
Portfolio
segmentation
Restructuring
-
0
-
7 .2
-
NWB
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
Slide no.23
Loss rate
calculation
Recovery rate
calculation
ILLP (WCV)
-
Overall
PI
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
5 .0
MicroSME
DPD
NWB
Overall
Conservatism
NWB
Micro
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
6. Challenges - Data availability/volatility
Historical data is insufficient (immaterial portfolios or short
history) to develop reliable flow rate or recovery rates, OR
 Historical data is too volatile to calculate reliable factor
estimates


Solution:
 Use regional benchmarks (from other NWUs, RBI has highly
standardized Retail Credit Policy)
 Use longer averages
Slide no.24
6. Challenges – Revaluation of collaterals
Mortgages on residential real estate serve to reduce the loss
potential on an impaired asset
 According to the internal rules, it is required that collaterals are
revaluated ate least once per year; in a volatile market – more
often
 The mispriced collaterals lead to underestimation of the credit
losses, and
 Have an adverse impact on the overall recovery rate due to
the delayed realization process


Solution:
 Apply statistical methods for revaluation based on
market/own data
 Introduce additional discount for each year of delay in
revaluation
Slide no.25
6. Challenges - Discount rate for recovery model

The discount rate (APR) for the Vintage Recovery Model cannot
be applied for each account in the 180+ cohort due to system
limitations

Solution:
 Use exposure weighted APR from the total portfolio
Slide no.26
6. Challenges - Impairment test of multiple accts.
In many cases during the crisis time the bank have to address
quickly large number of aging exposures
 Banks prepare restructuring campaigns with predefined
conditions
 However, it is impossible from technical perspective to perform
individual impairment test


Solution:
 Group the exposures of same product, similar MoB, tenors,
interest rate, instalment amount, etc.
 Calculate the impairment rate for a sample of loans for the
concessions given (if any) or consider only the time-value of
money
 Apply the (average) impairment rate on all accounts from
the respective group
Slide no.27
6. Challenges – Impairment of revolving credits

In certain cases a revolving loan is restructured into an
instalment loan. How to estimate if there is impairment?

Solution:
 If the conditions on the instalment loan do not differ from the
market conditions for a similar loan or from the conditions
the bank will normally offer to its other customers, then no
impairment (write-down) will be assumed; Nevertheless, all
other provisioning rules apply (“freezing” the dpd for the and
the loan has to be monitored closely for subsequent
impairment
 If conditions are beneficial compared to the market average
or the ones the Bank generally offers, then impairment would
be measured against those conditions (e.g. discount the
new contractual CFs by the product average rate)
Slide no.28
6. Challenges – Consolidation of exposures

In certain cases several exposures can be merged into new
one with a longer instalment plan with the aim to reduce the
monthly burden of the obligor, e.g. a credit card and an
unsecured loan, or unsecured loan(s) with a mortgage loan.
How to estimate the impairment?

Solution:
 Discount the cashflows expected from the new exposure by
the weighted average EIR of the individual exposures.
Slide no.29
6. Challenges – Write-off rules

When to write-off?
According to IAS 39 the asset “can be derecognized if the contractual rights to
the cash flows from the financial asset are expired or if the financial asset was
sold”. RBI’s current internal rule:
a) time since last payment is longer than 360 days (payments below € 10 are
not considered for the calculation of the time since last payment);
b) all funded collaterals were charged up against the claim and further no
real estate collateral is pledged in favour of the group unit resp.;
c) the workout process is completed regarding realisation of the collateral
According to 2009 IASB ED “Financial Instruments: Amortised Cost and
Impairment, a write-off is “a direct reduction of the carrying amount of a
financial asset measured at amortised cost resulting from uncollectibility. A
financial asset is considered uncollectible if the entity has no reasonable
expectations of recovery and has ceased any further enforcement activities”

Solution: (on the next page=>)
Slide no.30
6. Challenges – Write-off rules

Solution:
 point b) considered fulfilled also in any of the situations below:



Collateral is legally not enforceable
Low realization value of, illiquid despite of intensive remarketing
Collateral is situated in area of no demand (high crime, war conflict,
natural disaster, heavy pollution)
 Point c) fulfilled by preparation of a formal protocol for termination
of workout/collections process with all details of the past measures

Further considerations:
Why should the consideration of uncollectibility have to be preceded by
exhausting all legal means and giving up contractual rights on cash
flows? Isn’t it rather implied “that it is not practical or desirable to defer
writing off an essentially worthless asset even though partial recovery
may be realized in the future”*.
* IMF WP14/170 Supervisory Roles in Loan Loss Provisioning in Countries Implementing IFRS
Slide no.31
6. Challenges – Write-off (partial)
Shall a partial write-off be allowed?
In many cases the existing restructuring instruments (temporary
instalment reduction, grace periods, payment holidays, extensions
of final maturity) do not work due to continuous or permanently
reduced repayment capacity of the obligor and/or limited
maximum tenor of the exposure.
 Solution:

 It makes sense to split the original distressed loan into two sub-loans
- a “good” one which represents the portion of the original principal
that is expected to be fully collected along with contractual interest
as adjusted to the new (reduced) credit capacity of the obligor and
- a “bad” one which is deemed uncollectible, hence can be
provisioned fully and written-off.
 The same approach can be applied for a mortgage loan,
especially when the current LTV exceeds 100%
Slide no.32
6. Challenges – Interest income recognition

How to recognize the interest income from an impaired asset?
According to IAS 39, the interest income from an impaired asset should
be based on the original EIR applied on the current recoverable amount
of the asset.
However, in most of the cases it is not possible to implement due to
system limitations – an EIR is not available and/or the recoverable
amount is not available in the core-system

Solution:
 Continue the normal interest accrual based on the contractual
interest rate on the current principal and adjust the income for the
amortization of the fees and the percentage of impairment (offset
against provisions)
 Implement “stop-accrual” (switch-off the on-balance sheet
recognition of interest income vs. accrued receivables) and
recognize it on a cash basis
Slide no.33
6. Challenges – Loss Identification Period

How to estimate the loss identification period?
The Loss Identification Period is the time lag between the occurrence of
the actual loss event and the observation of the loss event by the lender.

Solution:
 Alternative 1: Approach a sufficiently large random sample of
customers/exposures in loss status and perform an inquiry on the
reason for and the timing of the loss event
 Alternative 2:
Slide no.34
6. Challenges – PIT vs. TTC- provisioning system
PIT- vs. TTC- provisioning system?
a PIT-provisioning system ensures losses are recognized and reported soon
after their occurrence, BUT increases volatility of P/L
► a TTC-provisioning introduces stability in the P/L BUT tends to underestimate
losses in distressed times
A change in Credit Policy provides for an increase in the maximum acceptable
DTI ratio. How do we know if we have made a mistake and how much do we
have to allow for this mistake?
►

Example for consideration:
► Under the current Flow-Rate model we would almost immediately spot the
increase of the delinquencies => we can shorten the averaging period for
the loss rate to 6 or even 3 months and thus increase gradually the
provisioning
► Under a PIT PD/LGD model we would use parameters calibrated based on
1-year old history => use behavioral scorecards with strong PIT-variables
(e.g. dpd-based) and have more frequent re-calibration
Slide no.35
Q&A
Slide no.36
Thank you!
Deyan IVANOV
Retail Risk Management
Methodology & Validation
Raiffeisen Bank International AG
Tel.: +43 1 71707-1962
Email: deyan.ivanov@rbinternational.com
Slide no.37