Alternative profit scorecards for revolving credit

The aim of this PhD project is to design profit scorecards for a revolving credit using alternative measures of profit that have not been considered in previous research. The data set consists of customers from a lending institution that grants credit to those that are usually financially excluded due to the lack of previous credit records. The study presents for the first time a relative profit measure (i.e.: returns) for scoring purposes and compares results with those obtained from usual monetary profit scores both in cumulative and average terms. Such relative measure can be interpreted as the productivity per customer in generating cash flows per monetary unit invested in receivables. Alternatively, it is the coverage against default if the lender discontinues operations at time t. At an exploratory level, results show that granting credit to financially excluded customers is a profitable business. Moreover, defaulters are not necessarily unprofitable; in average the profits generated by profitable defaulters exceed the losses generated by certain non-defaulters. Therefore, it makes sense to design profit (return) scorecards. It is shown through different methods that it makes a difference to use alternative profit measures for scoring purposes. At a customer level, using either profits or returns alters the chances of being accepted for credit. At a portfolio level, in the long term, productivity (coverage against default) is traded off if profits are used instead of returns. Additionally, using cumulative or average measures implies a trade off between the scope of the credit programme and customer productivity (coverage against default). The study also contributes to the ongoing debate of using direct and indirect prediction methods to produce not only profit but also return scorecards. Direct scores were obtained from borrower attributes, whilst indirect scores were predicted using the estimated probabilities of default and repurchase; OLS was used in both cases. Direct models outperformed indirect models. Results show that it is possible to identify customers that are profitable both in monetary and relative terms. The best performing indirect model used the probabilities of default at t=12 months and of repurchase in t=12, 30 months as predictors. This agrees with banking practices and confirms the significance of the long term perspective for revolving credit. Return scores would be preferred under more conservative standpoints towards default because of unstable conditions and if the aim is to penetrate relatively unknown segments. Further ethical considerations justify their use in an inclusive lending context. Qualitative data was used to contextualise results from quantitative models, where appropriate. This is particularly important in the microlending industry, where analysts’ market knowledge is important to complement results from scorecards for credit granting purposes. Finally, this is the first study that formally defines time-to-profit and uses it for scoring purposes. Such event occurs when the cumulative return exceeds one. It is the point in time when customers are exceedingly productive or alternatively when they are completely covered against default, regardless of future payments. A generic time-to-profit application scorecard was obtained by applying the discrete version of Cox model to borrowers’ attributes. Compared with OLS results, portfolio coverage against default was improved. A set of segmented models predicted time-to-profit for different loan durations. Results show that loan duration has a major effect on time-to-profit. Furthermore, inclusive lending programmes can generate internal funds to foster their growth. This provides useful insight for investment planning objectives in inclusive lending programmes such as the one under analysis

The democratization of credit and the rise in consumer bankruptcies

Financial innovations are a common explanation for the rise in credit card debt and bankruptcies. To evaluate this story, we develop a simple model that incorporates two key frictions: asymmetric information about borrowers’ risk of default and a fixed cost of developing each contract lenders offer. Innovations that ameliorate asymmetric information or reduce this fixed cost have large extensive margin effects via the entry of new lending contracts targeted at riskier borrowers. This results in more defaults and borrowing, and increased dispersion of interest rates. Using the Survey of Consumer Finances and Federal Reserve Board interest rate data, we find evidence supporting these predictions. Specifically, the dispersion of credit card interest rates nearly tripled while the “new” cardholders of the late 1980s and 1990s had riskier observable characteristics than existing cardholders. Our calculation suggest these new cardholders accounted for over 25% of the rise in bank credit card debt and delinquencies between 1989 and 1998

The narrative and the algorithm: Genres of credit reporting from the nineteenth century to today

Credit reporting is a contested process whereby parties with distinct interests (borrowers, lenders, and intermediaries) jointly construct the form, method, and style of credit assessment. In contrast to theories that argue information should grow more secure and credit relationships more transparent over time, the conflicted struggle over representation produces different styles or “genres” of credit evaluation that are compromises between the interests of the different parties. Thus, in the United States, trade credit reporting in the nineteenth century evolved an enduring narrative reporting style, incorporating heterogeneous forms of information not easily reducible to a single quantitative score. Lack of institutions for sharing information between creditors, legal precedents, and strong resistance among borrowers to overly intrusive surveillance made the narrative report the best means to handle the diverse business credit market. By contrast, lenders in the consumer credit market established information sharing capabilities, which were enhanced after World War II when banks developed the credit card and card verification systems. Fair credit laws in the 1960s and 70s actually reinforced the move to quantitative scoring based on information shared among creditors, eventually institutionalizing the FICO score as the prime method of consumer credit evaluation.credit score; credit reporting; credit; information economy; surveillance; FICO

The use of Asset-Backed Securitisation as a strategic control tool by Edcon's Onthecards Investments.

Thesis (MBA)-University of KwaZulu-Natal, Durban, 2004.This research report studies the application of Edcon's Asset-Backed Securitisation of OntheCards Investments in the retail industry. Asset-Backed Securitisation is a new concept in South Africa that has been largely practised in the financial sector. The research investigates Edcon's ability to adapt and apply the onerous and rigorous Asset-Backed Securitisation process to achieve their strategic and financial objectives. As Asset-Backed Securitisation is a new concept in South Africa, which was traditionally applied in the financial sector, the application of this tool in the retail industry would require drastic changes to the business practice of Edcon's credit operations and their strategic evaluation process. The first part of the research therefore concentrated on the evolution and theory of strategy. This discussion focussed on the evolution of the strategic planning process and eventually concluded with developments in the resource based theory. Strategic frameworks and evaluation techniques were also presented and reviewed. As part of the literature review, the theory on Asset-Backed Securitisation was also presented and International and South African Perspectives were reviewed with respect to the market for Asset-Backed Securitisation. Drawing from the literature review on strategy, a strategic evaluation model was developed for the evaluation of Edcon's strategic control tool of OntheCards Investments, their Asset-Backed Securitisation. The evaluation of OntheCards Investments was focussed on the structure of OntheCards Investments with respect to the theory of Asset-Backed Securitisation, an analysis of Edcon prior to the OntheCards Investments which took the form of a PEST Analysis, SWOT Analysis, Porter's Five Forces Model and a Life Cycle Analysis. The evaluation was concluded by conducting a v situational analysis of Edcon after OntheCards Investments and an assessment of OntheCards Investments with respect to its acceptability and suitability to Edcon's business. The conclusion drawn from the study was that Edcon had stretch goals and aspirations in OntheCards Investments. Edcon identified the critical success factors for OntheCards Investment and actively achieved the improvement in their credit management operations, which has now yielded an extreme competitive advantage that will not be easily imitated by their competition without major capital investment

Network-Based Models to Improve Credit Scoring Accuracy

Technological advancements have prompted the emergence of peer-to-peer credit services which improve user experience and offer significant reductions in costs. These advantages may be offset by a higher credit risk, due to disintermediation and information asymmetries. We postulate that networkbased information can be employed as a tool for reducing risks through an improved credit scoring model that increases the accuracy of default predictions. Our research assumption is proven by means of empirical analysis that shows how including network parameters in classical scoring algorithms, such as logistic regression and CART, does indeed improve predictive accuracy

Risk based pricing for unsecured lending

Thesis submitted in fulfillment of the requirements for the degree of Master of Management in Finance & Investment In the Faculty of Commerce and Law Management Wits Business School at the University of the Witwatersrand, 2015Risk based pricing has been a topic of discussion since the 2008 financial crisis as a result of the on-selling of packaged sub-prime assets. This paper will highlight the importance of correctly assessing risk within the framework of consumer credit provision. We will begin with a brief overview of the South African unsecured lending market, look into the definition of risk based pricing and the impact it has had in the market and conclude the paper by using a model by Robert Phillips to calculate the interest rate to be offered to a customer.AC201

Gettysburg College Sustainability Proposal

In the fall of 2011, the Environmental Studies capstone class led by Professor Rutherford Platt was asked to write Gettysburg College’s first Sustainability Plan. The goal of the plan was to develop specific sustainable practices for the campus that were related to the three pillars of sustainability: economic, social, and environmental, and how integrating diligent sustainable practices into each of these respected pillars will result in a more conscious campus, community, and future. In 2010, Gettysburg College turned to the Sustainability Tracking Assessment and Rating System (STARS) to quantify the institution’s sustainability efforts, providing a self-check mechanism to encourage sustainability applications to all aspects of the College. The American College and University Presidents’ Climate Commitment was signed in 2007 by former Gettysburg College President Katherine Haley Will, declaring that Gettysburg College would become carbon neutral by 2032. Gettysburg College has made large strides in the search for sustainability, and aims to continue its dedication to furthering sustainable practice. The following plan outlines the six priority areas identified by the Capstone class: progress of the American College and University Presidents’ Climate Commitment, Dining Services, campus green space, community outreach, integration of sustainability into the Gettysburg College Curriculum, and the Sustainability Advisory Committee. The first priority area identified was monitoring and upholding the American College and University Presidents’ Climate Commitment (ACUPCC). Though creating new sustainability initiatives on campus is the driving force towards an increasingly sustainable college and community, it is imperative that these goals be carried out in full to maximize beneficial returns. In order to reach carbon neutrality, Gettysburg College hopes to increase energy efficiency in buildings, incorporate renewable energy sources on campus, and mitigate remaining emissions through the purchase of carbon offsets. To further the College’s progress, it is proposed that Gettysburg College continue its energy-efficient appliance purchasing policy, as well as create a policy to offset all greenhouse gas emissions generated by air travel for students study abroad. As stated by the ACUPCC, a Sustainability Committee should take responsibility for the updates and progress reports required to meet the goal of carbon neutrality. The second priority area identified was sustainability in Dining Services. Gettysburg College is home to 2,600 students, all of whom require three full meals a day. Dining Services accounts for a large fraction of Gettysburg College’s sustainability efforts, already implementing sustainability through composting, buying local produce, and using biodegradable products. The proposed on-campus sales cuts of non-reusable to-go items, a change in campus mentality on food waste, and improved composting practices will translate to an increasingly sustainable campus, as well as a well-fed campus body. The third priority was maintaining green space on campus. Ranked as the 23rd most beautiful campus in the United States by The Best Colleges, Gettysburg College utilizes campus green space to create an atmosphere that is conducive to activity as well as tranquility. The plan proposes that Gettysburg College and its grounds facilities continue their exceptional efforts, focusing on increasing the use of the student garden, creating a new rain garden or social area on campus, and converting unnecessary parking lots into green space. As these additions are completed, they must be introduced to the student body and faculty alike to assure these areas are known and utilized. The fourth priority was utilizing community outreach to spread awareness of sustainability initiatives on and off campus. To connect the sustainability-geared changes proposed in this plan, community outreach at Gettysburg College is assessed to estimate how well these initiatives are communicated and promoted to both potential and enrolled students, faculty, and other concerned parties. To evaluate the efficiency of communication at Gettysburg College, a quantitative assessment is presented to measure the ease of finding the sustainability webpage, the quality of sustainability-related topics available on the webpage, and quality of webpage design. The webpage is in need of improved text to image ratios, locations of sustainability topics, and data displays. Despite not having a link to the sustainability webpage on the Gettysburg College homepage, sustainability events should be covered and presented on the rotational news feed found on the homepage to maximize outreach to interested parties or simply to add to the definition of Gettysburg College. The fifth priority was integrating sustainability into the Curriculum to build a culture on campus that values academic rigor, supports students as they cultivate intellectual and civic passions, and promotes the development of healthy social relationships and behaviors. The proposed Sustainability Committee on Sustainability in the Curriculum (SCC) will hold sustainability workshops for faculty with the aim to instill sustainability into all academic disciplines, providing all Gettysburg graduates with a means to approach their professional careers in a fashion that is conscious of sustainability. The sixth and last priority was the Sustainability Advisory Committee. Established in 2007, the Sustainability Advisory Committee is currently under review, but it is recommended that the committee restructure itself in accordance with the new Sustainability Committee Bylaws. These bylaws aim to define the purposes, membership, governance, and involvement with the college. With a clearly defined set of goals and methodology, the Sustainability Advisory Committee will be able to improve the solidarity of the sustainability movement on campus as a whole. By following the propositions laid out in the Gettysburg College Sustainability Plan, the student body, faculty, and community alike will become a part of a multi-faceted progression toward a more sustainable future

Quantitative Models for Prudential Credit Risk Management

The thesis investigates the exogenous maturity vintage model (EMV) as a framework for achieving unification in consumer credit risk analysis. We explore how the EMV model can be used in origination modelling, impairment analysis, capital analysis, stress-testing and in the assessment of economic value. The thesis is segmented into five themes. The first theme addresses some of the theoretical challenges of the standard EMV model – namely, the identifiability problem and the forecasting of the components of the model in predictive applications. We extend the model beyond the three time dimensions by introducing a behavioural dimension. This allows the model to produce loan-specific estimates of default risk. By replacing the vintage component with either an application risk or a behavioural risk dimension, the model resolves the identifiability problem inherent in the standard model. We show that the same model can be used interchangeably to produce a point-in-time probability forecast, by fitting a time series regression for the exogenous component, and a through-the-cycle probability forecast, by omitting the exogenous component. We investigate the use of the model for regulatory capital and stress-testing under Basel III, as well as impairment provisioning under IFRS 9. We show that when a Gaussian link function is used the portfolio loss follows a Vašíček distribution. Furthermore, the asset correlation coefficient (as defined under Basel III) is shown to be a function of the level of systemic risk (which is measured by the variance of the exogenous component) and the extent to which the systemic risk can be modelled (which is measured by the coefficient of determination of the regression model for the exogenous component). The second theme addresses the problem of deriving a portfolio loss distribution from a loan-level model for loss. In most models (including the Basel-Vašíček regimes), this is done by assuming that the portfolio is infinitely large – resulting in a loss distribution that ignores diversifiable risk. We thus show that, holding all risk parameters constant, this assumption leads to an understatement of the level of risk within a portfolio – particularly for small portfolios. To overcome this weakness, we derive formulae that can be used to partition the portfolio risk into risk that is diversifiable and risk that is systemic. Using these formulae, we derive a loss distribution that better-represents losses under portfolios of all sizes. The third theme is concerned with two separate issues: (a) the problem of model selection in credit risk and (b) the problem of how to accurately measure probability of insolvency in a credit portfolio. To address the first problem, we use the EMV model to study the theoretical properties of the Gini statistic for default risk in a portfolio of loans and derive a formula that estimates the Gini statistic directly from the model parameters. We then show that the formulae derived to estimate the Gini statistic can be used to study the probability of insolvency. To do this, we first show that when capital requirements are determined to target a specific probability of solvency on a through-the-cycle basis, the point-in-time probability of insolvency can be considerably different from the through-the-cycle probability of insolvency – thus posing a challenge from a risk management perspective. We show that the extent of this challenge will be greater for more cyclical loan portfolios. We then show that the formula derived for the Gini statistic can be used to measure the extent of the point-in-time insolvency risk posed by using a through-the-cycle capital regime. The fourth theme considers the problem of survival modelling with time varying covariates. We propose an extension to the Cox regression model, allowing the inclusion of time-varying macroeconomic variables as covariates. The model is specifically applied to estimate the probability of default in a loan portfolio, where the experience is decomposed the experience into three dimensions: (a) a survival time dimension; (b) a behavioural risk dimension; and (c) calendar time dimension. In this regard, the model can also be viewed as an extension of the EMV model – adding a survival time dimension. A model is built for each dimension: (a) the survival time dimension is modelled by a baseline hazard curve; (b) the behavioural risk dimension is modelled by a behavioural risk index; and (c) the calendar time dimension is modelled by a macroeconomic risk index. The model lends itself to application in modelling probability of default under the IFRS 9 regime, where it can produce estimates of probability of default over variable time horizons, while accounting for time-varying macroeconomic variables. However, the model also has a broader scope of application beyond the domains of credit risk and banking. In the fifth and final theme, we introduce the concept of embedded value to a banking context. In longterm insurance, embedded value relates to the expected economic value (to shareholders) of a book of insurance contracts and is used for appraising insurance companies and measuring management's performance. We derive formulae for estimating the embedded value of a portfolio of loans, which we show to be a function of: (a) the spread between the rate charged to the borrower and the cost of funding; (b) the tenure of the loan; and (c) the level of credit risk inherent in the loan. We also show how economic value can be attributed between profits from maturity transformation and profits from credit and liquidity margin. We derive formulae that can be used to analyse the change in embedded value throughout the life of a loan. By modelling the credit loss component of embedded value, we derive a distribution for the economic value of a book of business. The literary contributions made by the thesis are of practical significance. The thesis offers a way for banks and regulators to accurately estimate the value of the asset correlation coefficient in a manner that controls for portfolio size and intertemporal heterogeneity. This will lead to improved precision in determining capital adequacy – particularly for institutions operating in uncertain environments and those operating small credit portfolios – ultimately enhancing the integrity of the financial system. The thesis also offers tools to help bank management appraise the financial performance of their businesses and measure the value created for shareholders