Default rates are one of the most important metrics in loan analysis, and it's important to understand the various methods used to calculate default rates. At Cascade, we use four different primary methodologies to measure default: Rolling DPD, Strict DPD, Number of Installments, and Percent of Payment in the last [x] days. The standard methodology is Rolling DPD, but new methodologies can be computed to provide more accurate results. Loan analysis is a complex process, but understanding the way default rates are calculated is an essential part of the process. By understanding the different methodologies used to calculate default rates, you can make more informed decisions when analyzing loans.
Strict DPD measures the number of days a client has a negative outstanding balance, starting from the missed payment date until they fully repay the negative balance. Rolling DPD, on the other hand, takes into account the client's ongoing payments, reducing the negative balance as they make payments and resetting the default date to the last missed payment. The Number of Installments method calculates the count of missed installments based on the average scheduled installment over negative outstanding balance. Lastly, Percent of Payment in the last [x] days calculates the ratio of actual payments received to expected payments within a specified time frame.
Different methodologies are used to calculate default rates in loan analysis for a variety of reasons. One important factor is regulation. Central banks often require lenders to report default rates using specific methodologies, ensuring consistency and transparency in the industry. For example, Basel II, a global regulatory framework for banks, provides guidelines for calculating default rates. Additionally, loan products with different payment frequencies may require different methodologies. Institutional Debt investors also have specific ways of looking at portfolio companies through a standard methodology.
Walking through an example is the best way to understand the different methodologies - let’s assume the following scenario:
To help view the Real Payment Schedule - we align the payments
By comparing and contrasting the methodologies, loan analysts can determine which method suits their needs and objectives best. It's important to remember that the choice of methodology can impact the accuracy of default rates and the overall risk assessment of the loan. Ultimately, understanding the nuances of these methodologies allows for better decision-making in loan analysis and mitigates potential risks in Asset Backed Lending, Loan Tape Analysis, and computing Borrowing Bases.
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