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When credit risk ratings don’t match expectations: What next?

Kylee Wooten
Posted by Kylee Wooten

Consistency in risk ratings is critical for commercial lenders. There are plenty of best practices to follow when choosing your risk rating factors to ensure an effective and consistent risk rating process. Risk rating becomes a craft: the more you do it, the better you become at it. When you’re going in and rating a loan, you usually have a gut feeling of what your rating is going to come out at, based on your experience. However, every once in a while you complete the scorecard and see a score you didn’t expect – what do you do you next?

Check your inputs

Alison Trapp, who leads the credit risk practice for Sageworks Advisory Services, suggests that double-checking your inputs should be your first reaction – even if it is probably an obvious answer. From accidentally pressing the wrong key to clicking the wrong dropdown on a menu, a small miscue could make a big difference in your report. Look out for those quick, simple solutions first whenever you get an unexpected score.

Downgrade on expectations, upgrade for performance

Occasionally, you may have a one-off reason that you’re differing. This difference is usually because your analyst has information on your borrower that has not yet made its way into the financials or other scorecard inputs yet. For example, if an analyst knows that a borrower just lost their biggest customer, they are going to take that into consideration immediately, rather than waiting for it to flow through the financials before they downgrade that credit. This situation is consistent with Trapp’s saying, “downgrade on expectations, upgrade on performance.” In this case, there’s no bigger issue at hand and it’s simply a one off situation. “You may have more than one ‘one-off,’ but there’s nothing broken in the overall system,” she says. “If you do run into this type of situation, document why you’re assigning a final rating that differs from the scorecard and move on.”

Assess your rate of difference

On the other hand, you may have a systematic problem. If you’re responsible for managing the overall portfolio, it’s important to pay very close attention to the rate of difference from the scorecard to the score you had expected, and to make sure that the rate of differences over time remain relatively stable. This is something that the institution should be looking at regularly. “How many cases do you have where you have someone disagreeing with a scorecard up? How many cases do you have where they’re disagreeing down? And is that stable?” Trapp said. “If you start to see a lot of differences where you didn’t before, it may be time to reevaluate your scorecard. It may also be that something came into the market that changed things.” For example, the 2013 leverage lending guidance changed how risk ratings were done on leveraged loans, including the amount of time a loan would have to be paid off. These types of changes could create differences in your scorecard, and would signal a need to reevaluate your rating system.


For additional resources on risk ratings, read more on best practices or watch the webinar Answers to the Most Often Asked Risk Rating Questions for more information.

tags: credit risk management, credit union, risk rating