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1. Agenda for Day 4
Portfolio Management
Lunch Break
Case Studies
Open Session/ Q&A
IM aCS 2010
Printed 11-M ay-11
For Classroom discussion only Page 1

2. Portfolio management essential to evaluate whether
results aligned with strategy
Components of Strategy Performance and portfolio composition
Profits
Capital
Budgeting
Interest Expenses
Product Mix Interest Income
Interest on Deposits
Customer Mix
Interest on other Borrowings
Delivery
Channels
Fee Income
Operating Expenses
Risk Appetite
Organisation
structure Treasury Income Losses due to defaults,
liquidity mismatches
IM aCS 2010
Printed 11-M ay-11
For Classroom discussion only Page 2

3. Measures that describe a portfolio (Retail)
Salaried vs. self
employed
Seasonin
Geography g
Demogr
NPAs
aphics
Age
Original
and
LTVs
residual
tenure Loan
Portfolio
Delinque Loan
ncies /
Amount
Overdues
NIM FOIR
IM aCS 2010
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For Classroom discussion only Page 3

4. Summary of Approach - Modeling
Approach :
Dataset – Sample borrowers 1.Construction of Indices on
Grading Scale HL1 - HL10 qualitative parameters –
1.Model Training Sample:
XX accounts
Objective parameters 2.Discriminant Analysis
2.Model Validation Sample: on quantitative & qualitative
XX accounts parameters
Subjective parameters
3.Calibration to grading scale
IM aCS 2010
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For Classroom discussion only Page 4

5. Explanatory Variables in the Home Loan Model
Type of
Age
+ Organisation
Quality of Borrower
Index Educational Designation
Qualification (salaried)
Length of
Years of Banking
Qualitative Service /Business
+ No. of Residence
Cost of Living Index Marital Status
dependents type
- to Cost -
Loan Fixed Obligation / Income
Quantitative
EMI/NW Loan Amount Income
- + +
IM aCS 2010
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For Classroom discussion only Page 5

6. Qualitative Indicators
Age of Applicant
Based on the Life Cycle Hypothesis where the investment/saving life cycle of an individual
has four phases:
1. Expenditure Phase: High on Debt
2. Accumulation Phase: Low debt, Investment
3. Sustenance Phase: No Debt, Investment
4. Rundown Phase: Use of wealth for livelihood
Applicant is likely to have higher surpluses in the Accumulation and Sustenance
Phases
IM aCS 2010
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For Classroom discussion only Page 6

7. Qualitative Indicators
Educational Qualification
Higher educational qualification implies
1. Higher job security
2. Higher future earning potential
3. Alternative employment opportunities
Hence, higher educational qualification of the applicant indicates better continuing payment
ability
IM aCS 2010
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For Classroom discussion only Page 7

8. Quantitative Indicators
Illustration: Fixed Obligation to Income Ratio (FOIR)
Median 33%
Higher the FOIR, lower is the 25%
Median 33%
20%
capacity of the applicant to absorb
Frequency
15%
the negative shock in net income. 10%
Hence, higher the FOIR, lower is the 5%
ability of the applicant to meet 0%
10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75%
FOIR
unforeseen expenses.
FOIR = (Monthly Instalments on 1. From the data it is observed that if FOIR
exceeds 47%, about 50% of the cases
all loans* + Monthly Rent) / Net default.
Annual Income 2. The optimum range for lending in terms
Note: Consider net annual income, of most favorable default experience is
the 25%-40% FOIR zone.
loan EMI , rent of applicant & co-
obligant, while calculating the FOIR
* Includes the estimated instalment for the proposed loan also in the calculation IM aCS 2010
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For Classroom discussion only Page 8

9. Quantitative Indicators
Illustration: Loan to Cost Ratio (LCR)
Loan to Value Ratio
20%
Importance of this indicator 18%
16%
14% Median -53%
Lower the LCR, greater is the 12%
10%
8%
applicants contribution towards the 6%
4%
asset i.e. loss in event of default 2%
0%
Below 10%- 20%- 30%- 40%- 50%- 60%- 70%- 80%- Above
increases for the applicant. 10% 20% 30% 40% 50% 60% 70% 80% 90% 90%
Hence, if LCR is low, in case of The optimum range in terms of most
default by the applicant, the Loss favorable default experience is the 45-
65% LCR zone.
Given Default for the bank will be
lower
Default rates are around 35% higher for
LCR= Loan Amount/ Cost of the LCR being in the above 75% zone
Asset to be acquired
IM aCS 2010
Printed 11-M ay-11
For Classroom discussion only Page 9

10. Other important factors which should be considered for
appraisal
Credit Track Record
Past credit record depicts the attitude of the person in honouring his
credit obligation. “Wilful default” are one of the causes for a number of
defaults.
A bank could analyse credit track record based on:
1. Number of Cheques returned in last six month (Bank Statements)
2. Number of Credit Roll Overs in last six months (Credit Card
Statements)
IM aCS 2010
Printed 11-M ay-11
For Classroom discussion only Page 10

11. Other important factors which should be considered for
appraisal
Nature of Asset
In Housing Segment, assets gradually appreciate with time unlike many
other assets [Cars, white goods, etc.]. The chance of negative equity* will
be lesser and Loan to cost ratio will improve over the period of time.
* Negative equity: When the outstanding loan amount is lesser than the
value of the asset, chance of default is lesser.
Hence, chance of default is lesser in housing loan than other retail segments.
IM aCS 2010
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For Classroom discussion only Page 11

12. Other important factors which should be considered for
appraisal
Collateral Security
Additional collateral security lowers the net exposure of the bank. It increases the applicants
contribution in the asset thus effectively reducing loan to cost ratio.
Hence, if the Collateral Security is high, in case of default by the applicant, the Loss Given Default
for the bank will be lower
IM aCS 2010
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For Classroom discussion only Page 12

13. Balance Business flexibility with Asset quality
improvement
Trade-off between acceptance and NPA generation
100%
90% 62.2%, 79.3%
80%
% NPAs reduced
70%
60%
50%
40%
30%
20%
10% ICRA recommendation
0%
0% 20% 40% 60% 80% 100%
% proposals accepted
The objective is to strike a balance between business objectives (so that not too many cases are
rejected) and potential NPA reduction.
IM aCS 2010
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For Classroom discussion only Page 13

14. Portfolio analytics: Formation of Pools – cost effective
way of managing risks
Pool 1 Pool 2 Pool 3 Pool 4
Source of Income Salaried Salaried Self Emp Self Emp
LTV >70% >70% 50% - 70% >70%
FOIR <40% 40%-60% 40%- 60% >60%
NIM 2% 3% 3% 4%
Seasoning 18 18 12 18
Performance
Delinquency 10% 20% 15% 25%
NPAs 1% 2.5% 2% 3%
IM aCS 2010
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For Classroom discussion only Page 14

15. Understand how pool are formed by the bank
Maturity
Loan Product
FOIR EAD
• Size :3-5 % of total
LGD portfolio (e.g. of
Loan/ Land Value
Loan/Value housing loans)
PD
Calculate PD, •Each obligor :not
of Borrower
Risk Characteristics
Risk Characteristics
LGD, EAD Mortgage Loan
Home Loan LoanPersonal Loan
Against Property Loans for home repairs
Revolving Credit
more than 0.2%
Geographic Zone •Technique generally
used to segment:
Type of Borrower CHAID or expert
judgement
FOIR/
Income
Income
Networth
1. A pool is formed on risk and transaction characteristics
2. A pool is assumed to have homogenous PD and LGD and reduces the task of
individually rating obligors
2. IMaCS assume that bank will provide the Mortgage pools based on some of the
above described borrower or transaction characteristics
IM aCS 2010
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For Classroom discussion only Page 15

16. Understand Portfolio Characteristics of a bank’s Mortgage pool
IMaCS Preliminary analysis of portfolio data to assess Pool characteristics risk assessment
Portfolio size
Loan Schemes
Weighted loan tenure
Amount weighted portfolio default rate – 90+dpd, 180+dpd
Number weighted portfolio default rate – 90+dpd, 180+dpd
Delinquency Flow rates of difference buckets
Average tenure of the loans
Average ticket size
Average month on books
Weighted IRR
Location
Customer categories/Borrower type(Salaried-Govt. /reputed company/Others, Professional, Self employed)
FOIR Ratio(Fixed Income to obligation ratio), Income of the borrower
LTV ratio
Recovery /Security Information
The portfolio is further segmented based on the above described parameters
IM aCS 2010
Printed 11-M ay-11
For Classroom discussion only Page 16

17. Static Pool Analysis(SPA) to estimate weighted delinquency rates of
unseasoned portfolio
The delinquency rates estimated in first portfolio analytics give us standalone delinquency rates, which doesn’t give correct picture of the
portfolio delinquency rates as it seasons. Thus SPA tool is used to
- compute and compare delinquency cum loss rates across the different seasonings points ( for net loan originations in different years)
- approximate loss rates for partially (un) seasoned portfolio tranches
- assesses loss rates for the overall portfolio and portfolio segmented by tenure
Data requirement : Quarterly/Yearly Snapshot of the pool for at least two years to perform the static pool analysis and to project the
delinquency rates for unseasoned portfolio tranches
Loss cum delinquency rate= ((90+dpd outstanding using the YoB Band)* POS)/ Net quarter disbursements
Pool tenure 5-10year
Years on Book(Seasoning points) In Crores
Sanctioned FY
0-1 1-2 2-3 3-4 4-5 5-6 6-7 7-8 8-9 9-10 Net Disbursement
Year Estimated
<=2001 3.60% 4.00% 3.70% 40.9
2002 2.80% 3.00% 2.60% 4.10% 87.9 Unseason
2003 3.50% 3.60% 4.10% 4.50% 4.50% 125.1 ed
2004 4.30% 5.00% 4.90% 4.50% 3.80% 3.80% 136.3
2005 3.90% 4.10% 3.40% 4.50% 3.80% 4.40% 4.00% 181.5 portfolio
2006 4.70% 5.20% 4.10% 4.20% 4.30% 4.00% 4.20% 4.20% 189.4 delinquen
2007 2.00% 3.80% 4.10% 4.15% 4.00% 4.00% 4.20% 3.80% 3.00% 214.5
2008 0.6% 1.90% 3.20% 4.00% 4.20% 3.50% 4.70% 3.00% 3.00% 3.00% 266.8 cy rates
Current
2009 0.3% 2.20% 4.5% 4.20% 4.25% 4.00% 3.00% 3.00% 3.50% 3.50% 231.5
2010 0.1% 2.30% 3.90% 4.30% 4.15% 4.50% 4.40% 3.50% 4.00% 4.00% 440.8 Snapshot
deliquency
2.7 with product of highlighted delinquency %
Weighted Delinquency Rate of Mortgage pool for current sum of various seasoning point
their respective net disbursements rates
snapshot = %
Estimated delinquency rates for unseasoned portfolio(IMaCS Method)
- Delinquency cum loss rates for remainder tenure computed using a semi-log fn. IM aCS 2010
Printed 11-M ay-11
For Classroom discussion only Page 17
- Weighted year wise delinquencies adjusted for coefficient of variation

18. Estimating Expected Loss
The SPA helps in assessing Probability of default, where as Expected loss helps in assessing the actual loss after liquidating
the collateral . Expected Loss is computed as a product of =EAD* PD * LGD
Where EAD can be seen as an estimation of the extent to which bank may be exposed to counterparty in the event of and at
the time of counterparty’s default.
EAD= Balance outstanding Default cases + Interest accrued from NPAdate to cutoff date
PD is computed from SPA analysis weighted delinquency rates (As shown is previous slide)
LGD Computations : (1-p(Cure))*Economic loss+ Recovery Cost
EAD
Where P is Cure rates of NPA account after performance period
Economic losses= EAD-Discounted recoveries
Discounted recoveries= Min(∑RR x Vi x Discount factor, EAD)
i i
Annual interest rate =Opportunity cost of bank
Discount period=The period for which the recoveries are discounted
Recovery cost= Legal Cost + Recover department Cost
Sample EL and EL as a % of POS Computations
Case 1: Home loan default cases with POS 90 Cr and interest accrued till cutoff date is10 Cr with 2.7% Weighted
delinquency and LGD % of 55%
Expected Loss = (90+10)Cr*2.7% *55%= 1.48 Cr
EL as percentage of POS = 1.48 = 1.48%
100 Cr IM aCS 2010
Printed 11-M ay-11
For Classroom discussion only Page 18

19. Capital adequacy
Economic capital
Higher capital for higher LTV and FOIR loans
Higher capital for loans provided to self employed borrowers
Higher capital for longer tenure loans
Greater capital required in case of higher concentration in a demographic
segment
Should be at least equal to the regulatory capital required
Regulatory capital
As prescribed by Bangladesh Bank from time to time
IM aCS 2010
Printed 11-M ay-11
For Classroom discussion only Page 19

20. Risk Adjusted Return on Capital Employed
Risk Adjusted Return
Risk
Income Expenses
Adjustment
Fee and other Origination Provisions /
Interest Interest
non interest and servicing Expected
Income income Expense costs Loss
Capital Required (regulatory) / Employed (economic)
IM aCS 2010
Printed 11-M ay-11
For Classroom discussion only Page 20

21. Benefits of portfolio management
Enables proactive identification of problem pools and take decisions
related to portfolio rebalancing
Enables Decisions related to increased efforts for
Marketing for the best performing pool
Monitoring or collection for delinquent pools
Policy changes maybe required due to the result of analysis
Risk adjusted returns
High spreads but high defaults in a particular segment could mean lower
risk adjusted returns with respect to a lower spread and lower default
segments
IM aCS 2010
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For Classroom discussion only Page 21

22. DISCUSSIONS
IM aCS 2010
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For Classroom discussion only Page 22

23. All the contents of the presentation are confidential and
should not be published, reproduced or circulated without the
written consent of IFC, Bangladesh Bank and IMaCS.
IM aCS 2010
Printed 11-M ay-11
For Classroom discussion only Page 23