A credit portfolio is a summary of all credits provided to the borrowers (individuals in our case) at various times and for various terms. Naturally, some borrowers will find themselves in financial difficulties, unable to pay interest. Risk managers must evaluate loan risks, portfolio returns and many other aspects.

One possible approach is through introduction of risk classes so that borrowers’ migration between classes can be observed and understood. This produces transition matrices. Frequency of risk class changes is analyzed. It seems that this frequency correlates with credit age. Further we call it “maturation effect”. This correlation exercises strong influence on behavior of a credit portfolio - often stronger than macroeconomic impacts and changes in credit quality.

Working with RRAS requires us to decide on the meanings of terms we will use. A glossary of terms has already been developed, although it does not cover all credit portfolio behaviors we are interested in. We will now try to put in order the mix of internationally used definitions and designations. Clear definitions are requisite to make sense of portfolio behavior.

Important definitions

Vintage – is loans grouped by a certain common characteristics. Loans within a vintage have some unique properties in terms of their quality, prepayment options, renewability. These properties are a result of grouping. Most groupings combine credits by region forming particular pools with the special pay-down terms, interest rates and time of disbursement.

Risk class (RC) – overdue interest condition, measured in DPD (days past due):

  • RC0 – 0~DPD;
  • RC1 – 1-30~DPD;
  • RC2 – 31-60~DPD, etc.

Figure 1 shows a sample graph where 120+ DPD loans are considered written-off. There are two absorbing states in this example: Charge-off (C/O) and Pay-Down (P/D).

Figure 1. Markov chain for a consumer credit portfolio, unrestructured.

Month on book (MOB) – is vintage age in months.

Days past due (DPD) – is time overdue.

Loan term – is another way to group loans. We will call a part of a portfolio grouped by credit term a tenor. Significant changes of a portfolio’s term structure have direct consequences for its behavior.

LTSterm – is accumulated charge-offs with DPD 120+ at loan term’s end. A shortened notation for a tenor then will be 120+ (ever)@Term. A state of 120+ is considered absorbing.

LTS – is accumulated charge-offs with DPD 120+ at maximal loan term’s end for a generation. A shortened notation for a generation with maximal term then will be 120+ (ever)@MaxTerm. A state of 120+ is considered absorbing.

PV (Present value — is the sum of capital lent.

FV (Future value) — is the amount a creditor expects to receive, including debt servicing and interest.

Rec (Recovery) — is the ratio of collected debt after a charge-off to the amount charged-off. The collected amount includes both servicing and interest for the loan.

Opex (operation expense) — is the cost of operations, i.e. disbursement and servicing of a loan. Opex is calculated as annual net expense divided by portfolio size.

D (Duration) — is a loan’s lifetime calculated as a function of average monthly payment.

Common acronyms

ABCP — Asset-backed commercial paper

ADC — Acquisition, development and construction

AMA — Advanced measurement approaches. Use qualitative and quantitative criteria of internal banking systems to evaluate operational risks.

ASA — Alternative standardized approach

CCF — Credit conversion coefficient

CDR — Cumulative default rate

CF — Commerce financing with raw products

CRM — Credit risk minimization

EAD — Exposure at default

ECA — Export credit agency

ECAI — External Credit Assessment Institution, a rating agency

EL — Expected losses

FMI — Future marginal income

HVCRE — High-volatility commercial real estate

IAA — Internal assessment approach

IPRE — Income-producing real estate

IRB-approach — Internal ratings-based evaluation of capital-covered loan risks through customer ratings

LGD — Loss given default

M — Maturity, actual pay-down term

OF — Object financing

PD — Probability of default

PF — Project financing

PSE — Public sector enterprises

QRRE — Qualifying revolving retail exposure, portfolios of revolving (renewable) retail loans, including credit lines and overdrafts

RBA — Rating-based approach

RUF — Revolving underwriting facility

SF — Supervision formula

SL — Specialized lending

SME — Small and medium enterprises

UL — Unexpected losses