Retail Lending Examination Procedures

Step 3: Apply loss factors to the current portfolio.

Step 3 is to forecast losses for the existing portfolio by applying the loss factors for each bucket (developed in step 2) to the current portfolio. In this example the portfolio’s expected loss rate over the next four months is 2.93 percent.

The major advantage of roll rate analysis is its relative simplicity and considerable accuracy out to nine months. Portfolios are often segmented by product, customer type, or other relevant groupings to increase precision and accuracy. Roll rate reports are used extensively by collection managers to anticipate workload and staffing needs and to assess and adjust collection strategies.

The main limitation of roll rates is that the predictive power of delinquency roll rate declines after nine months. The delinquency focus causes forecasts to lag underlying changes in portfolio quality, especially in the relatively large current bucket. Portfolio quality changes occur because of factors such as underwriting and cutoff score adjustments, product mix changes, and shifts in economic conditions. Roll rate analysis may underestimate loss exposure when these factors cause portfolio quality to weaken. Finally, roll rate methodology assumes loans migrate through an orderly succession of delinquency stages before charge-off. In actuality, customers often migrate to charge-off status after sporadic payments or rush to that status by declaring bankruptcy.

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