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