Positive Credit Ratings – Will you make the Grade? Financial Review article

This is nothing new however it is common in commercial rather than retail markets. In australia banks often lend (for commercial) with base rate plus margin. E.g. Bank bill rate plus 3.0%.

For commercial lending banks have two key risk grading systems – one for lending margin and the other for risk grade

e.g.

Rating 1 to 24 for client risk grade. To get a low number you need consistant turnover, profits, assets, clean credit, length with current bank etc etc etc. It is almost impossible to establish a risk grade without putting all the data through a computer.

The second grading is say ‘A’ to ‘J’ and this relates to equity e.g. Borrow up to 10% of residential or 7% of commercial property and you might be “A”. Borrow an extra 10% and you are “B”…

catergory “D” is standard LVR e.g. 80% residential or 70% commercial.

With all this in mind. A client who is D7 might be an average 80% LVR investor. Category “F” might be a company wanting to lend prodominantly property secured however also have some reliance on other assets e.g. Debtors and stock etc (total debt might be 100% of property assets). Category J is either borrowing twice the value of property or NIL property e.g. Unsecured overdrafts.

Cars loans might be G and say a 200k beam saw might be H ( reflecting a car is better security than a Beam Saw).

Banks before BASIL (Basal is a bank term for when banks around the world met is Basil to establish a universal approach to risk grading etc).

NAB was only A to D as opposed to A to J.

Before basil nab could lend 80% on residential and 70% on commercial. This was category B (cat A was half these LVRs). CAT C was up to double standard LVRs. Cat D was above double standard LVR.

Problem was 81% LVR was considerred the same risk as 159% LVR for pricing ( both were cat C).

Basil allowed the banks to more closley monitor risk and hold different levels of capital reserves for each risk grade – (they have to hold more cash liquid assets for 100k lent CAT F than 100k lent CAT B. Therefore cost of funds is higher for riskier category. Hence higher margin over base rate.

Risk grading is already here for home loans however it does not effect pricing. It does however effect paper work requirement E.g. CBA might not need bank statements for refinance if CAT 1 or 2. They need 6 months statements for all other clients.

NAB has risk grade charts with say 1 to 24 along the top and A to J down the side. If you are low right your margin over bank bills is higher than top left.

I don’t think pricing will change based on risk grade in retail banking – you will have a better chance of a discount though if you are graded well.

Banker

I thought I did pretty well with spelling given it was all on the phone… Basil, Basal or Basel – you obviously know what I meant.  By the way Committe is actually spelt Committee (extra ‘e’).

It might have been central bank based however I was at NAB at the time and we had a whole team sent over there – so did ANZ and I would assume quite a few other banks.  NAB Introduced changes to risk grading almost straight away: all business bankers had to go through training to adopt new polices as a result of Basel…

Central bank or actual banks – it allowed the banks to hold less capital in compassion to lending if they adopted the new guidelines – therefore a direct correlation to pricing on a deal per deal basis.

The non-cental banks/regulators were in the crowd, not on the field. That's why they have to resort (now) to arguing from the sidelines about the (new) proposed liquidity arrangements. If you want to get yourself up to speed, Harvard Law has a detailed summary at http://blogs.law.harvard.edu/corpgov/2010/01/07/basel-committee-proposes-strengthening-bank-capital-and-liquidity-regulation/

Actually, the topic and article relate to positive credit reporting which is unrelated to the capital rules (old or new).

Positive credit reporting allows Australian credit reporting businesses to collect and provide additional information to credit providers. As you know, currently in Australia we only have negative credit repotting in that credit reports show basic info around credit applications plus any defaults registered. Once the required Privacy Act changes are implemented, the existing negative data will be supplemented by positive data such as outstanding loan balances, payment history and the like.

This will give credit providers (all, not just banks) a better picture of the outstanding debts of a potential borrower, along with further details as to how and when they pay. Of course, this is good for the honest, reliable borrower and bad for the borrower who "forgets" the odd credit card or, though not subject to a formal default, is showing erratic payment behaviour.

Capital requirements are a different thing altogether and apply to APRA-regulated lenders.

NAB are using the "advanced internal ratings" regime under Basel, allowing them – subject to a range of criteria and processes too boring to go into here – to "self assess' and apply capital based on actual risk rather than the blanket "category" approach. Essentially, it provides a capital "reward" for banks that can show a more sophisticated approach to risk, which is more than simply further adding additional segments to commerical risk rating matrices. Giving the relatively homogenuous nature of residentially backed lending, it is unlikely to impact directly on pricing of those loans. Positive credit reporting and developing improvements in credit scoring engines, may well, on the other hand, see moves towards risk-based pricing in the vanilla mortgages space.

No, positive credit reporting does not exist in the commercial sector because it does not exist in Australia. What you are seeing in the D&B reports is the aggregation of publicly available data plus the output of our exisitng negative reporting system. This is why D&B themselves were one of the most vocal lobbyists for the introduction of positive credit reporting in Australia (we are one of only 4 countries in the developed world who operate exclusively under negative credit reporting).

As I said in my previous post, positive credit reporting is contingent upon changes to the Privacy Act, thereby allowing credit reporting agencies to obtain information currently not permitted to be disclosed on credit reports. It is happening and will have an impact of the ability of certain borrowers to obtain credit as the lender will have greater transparency to the borrower's actual position and payment history. Whether this ultimately extends to risk-based pricing for prime resi mortgages will be a question of the effort vs. return for the lender.

If you like to learn more, why not check out Dunn and Bradstreet:
http://dnb.com.au/Header/News/Learning_Centre/Credit_Risk/Campaign_for_consumer_credit_report_reform/index.aspx