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Bad debt rates

Posted on 13 Jul 2006 by Zopa

This is the third (1st and 2nd) in an occasional series of posts on credit and credit scoring.

I thought it might be interesting to show some data on how delinquent loans emerge over the life of an unsecured loan. Delinquent loans (also known as being in arrears) are those that have missed at least one repayment - all the way through to being written off.

The graph below shows, for a personal loan portfolio with an average life of 3 years, how delinquency develops over the life of the loans. The X-axis shows months since the start of the loans, the Y-axis shows the percentage of loans that are in arrears, as a % of loans in arrears after 60 months (At 60 months, all remaining loans are in arrears, so the value of the curve = 100%)

The basic shape of the curve will be the same for all terms and credit qualities - just the absolute level of arrears represented by 100% will differ.

Loans enter arrears at a pretty steady rate month by month, as a function of the credit quality of the loan book. Hence the first few months are a straight line. As the loan book matures, you find people coming out of arrears, and getting loans back on track, and the loan starts to flatten.

At some point, you get approximately the same number of borrowers entering arrears, as you do leaving, and the curve becomes relatively flat.

Eventually, delinquent loans get written off. When this happens is determined by the credit policies of the loan manager, but is typically 3 - 6 months after the missed repayment. This means that there is a considerable delay between the loan delinquency curve and the loan write off curve. It also means that most write offs occur towards the end of the loan term. For example, on a 3 year loan book, the write off chart will principally be over years 2 and 3.

By this late stage, many good borrowers have repaid their loans early (The average amount of time a good repayer holds a 3 year loan for is 18-24 months) and you’re left with an increasingly ‘bad’ book of loans - those that are in and out of arrears (pay one month, miss the next, pay up again etc.), and those who are already deep in arrears.

It is possible to project likely write offs from delinquent loans based on ‘roll rates’. These show what percentage of loans in a certain stage of arrears more to the next stage. For example, a typical set of roll rates for unsecured loans would be:

  • 15 days to 1 month: 30% (i.e. 30% of loans that go 15 days late will move to being 1 month late)

  • 1 month to 2 months: 50%

  • 2 months to 3 months: 60%

  • 3 months to 4 months: 75%

  • 4 months to write off: 90%

You can multiply these through to calculate the final write off - for example, if £100 of loans are 1 month late, £20.25 is estimated to end up being written off (£100 x 50% x 60% x 75% x 90%) - so Zopa’s current level of arrears (c. 0.05%) is actually about 5 x the amount we’ll finally write off from the delinquent loans. Which we’re pretty happy with!

Happy to answer questions - either in the comments, or the discussion board.

Tags: credit score

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