Roll Rates, Markov Chains, Flow Rates, or whatever you call them in your part of the world, are metrics which measure the transition of loans in a portfolio from one DPD bucket to another. Roll rates can offer a dynamic picture of a portfolio's health beyond static snapshots like delinquency rates (DPD/NPL). Here's a deeper dive into their potential meanings and significance:

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Predicting Portfolio Performance

Analyzing historical roll rates allows lenders to not only estimate defaults but also understand the velocity of deterioration. A high roll rate from"Current" to "60+ Days Past Due" suggests borrowers are rapidly falling behind, prompting swifter action compared to a gradual increase.

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Identifying Early Warning Signs

Beyond just increases, roll rates can reveal specific patterns. For instance, a consistently high roll rate from "30 Days DPD" to "Current"might indicate aggressive collections efforts that push short-term payments but don't address underlying issues. This may lead to an increase in future defaults.

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Benchmarking Collection Effectiveness

When comparing roll rates, consider factors like:

• Industry Standards: Compare your roll rates to the average performance of similar lenders in your niche.

• Loan Type: Defaults are more likely for riskier loans (e.g., unsecured personal loans) compared to conservative ones (e.g., senior secured debt). Adjust benchmarks accordingly.

• Economic climate: Roll rates might naturally worsen during recessions. Analyze trends over time to identify concerning deviations from historical patterns within your specific context.

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While roll rates offer valuable insights, it's important to acknowledge their limitations.

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Limited Forward Looking

Roll rates rely on historical data, assuming future behavior will mirror past trends. This might not hold true during:

• Economic Downturns: Unexpected economic crises can dramatically increase defaults, rendering historical roll rates less predictive.

• Regulatory Changes: New regulations or industry shifts can impact borrower behavior and repayment patterns.

• Changes in Collection Strategies: If a lender modifies collection tactics, historical roll rates might not reflect the effectiveness of the new approach.

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Sensitivity to Portfolio Composition

Roll rates are heavily influenced by the makeup of a portfolio. Here's why:

• Loan Type: Riskier loan types (e.g., startup loans) naturally have higher default rates and consequently, higher roll rates. Comparing a portfolio of small business loans to one with mostly investment-grade corporate debt wouldn't be an apples-to-apples comparison.

• Borrower Characteristics: Portfolios with a higher concentration of borrowers with weaker creditworthiness will inherently have higher roll rates.

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Combining Roll Rates

These limitations can largely be mitigated by combining Roll Rates with other credit quality indicators like credit scores, loan-to-value ratios, and economic forecasts for a more comprehensive picture. 

By incorporating roll rates into their analysis, private credit investors and lenders gain a more nuanced understanding of portfolio risk and can make data-driven decisions for:

• Portfolio Construction: Prioritize loans with historically stable roll rates, indicating a lower likelihood of default.

• Loan Restructuring: Identify borrowers at risk and work with them to modify loan terms before they fall into deeper delinquency.

• Collection Strategies: Tailor collection efforts based on the specific delinquency stage borrowers are transitioning into i.e. if high numbers of DPD 7 borrowers are falling into DPD90 buckets, then bring forward collection efforts, don’t wait!

While limitations exist, roll rates, when used thoughtfully, are a powerful tool for navigating the complexities of private credit investing and lending.

Want to learn more about how Cascade helps fintech lenders prepare for, raise, and manage debt facilities? Book a demo with our team.