Credit risk assessment : the new lending system for borrowers, lenders, and investors PDF
Preview Credit risk assessment : the new lending system for borrowers, lenders, and investors
(continued from front flap) ABRAHAMS Credit $49.95 USA/$59.95 CAN (cid:127) How a CCAF connects borrowers, lenders, and PRAISE FOR ZHANG investors—with greater transparency Credit Risk Assessment C (cid:127) The current fi nancial crisis and its implications (cid:127) The root cause to weaknesses in loan The New Lending System for Borrowers, Lenders, and Investors r Risk underwriting practices and lending systems e (cid:127) The main drivers that undermine borrowers, “Clark and Mingyuan start with an insightful and comprehensive description of how mar- d lenders, and investors Credit Risk ket participants contributed to the current crisis in the residential mortgage markets and (cid:127) Why a new generation of lending systems is needed the root causes of the crisis. They then proceed to develop a new residential mortgage i Assessment t Assessment (cid:127) Market requirements and how a comprehensive lending system that can fix our broken markets because it addresses the root causes. The risk assessment framework can meet them most impressive attributes of their new system is its commonsense return to the basics of R traditional underwriting, combined with factors based on expert judgment and statistics (cid:127) The notion of an underwriting gap and how it The New Lending System for and forward-looking attributes, all of which can be updated as markets change. The whole affects the lenders’ underwriting practices i Borrowers, Lenders, Investors process is transparent to the borrower, lender, and investor.” s and (cid:127) Typical issues associated with credit E —Dean Schultz, President and CEO, Federal Home Loan Bank of San Francisco k scoring models New Lending System (cid:127) H ow improper use of credit scoring in under- The xisting credit risk assessment methods writing underestimates the borrower’s credit risk “The credit market crisis of 2008 has deeply affected the economic lives of every American. A have put too much of an emphasis on Yet, its underlying causes and its surface features are so complex that many observers and even Borrowers, past loan performance and historical (cid:127) The ways in which the current lending system policymakers barely understand them. This timely book will help guide nonspecialists through s for market conditions and not enough on borrower fails to address loan affordability the workings of financial markets, particularly how they value, price, and distribute risk.” s Lenders, capacity, new mortgage product risk character- (cid:127) How mortgage and capital market fi nancial —Professor William Greene, Stern School of Business, New York University e and istics, and economic cycles. According to indus- innovation relates to the crisis try practitioners Clark Abrahams and Mingyuan s Investors Zhang, the housing market bubble boom and Whether you are a borrower, a lender, or an “This book is a well-timed departure from much of what is being written today regarding investor, Credit Risk Assessment enables you to s burst and the subsequent financial crisis could the current foreclosure and credit crisis. Rather than attempting to blame lenders, borrowers, have been prevented had these underwriting gaps better understand the weaknesses in today’s loan and/or federal regulators for the mortgage meltdown and the subsequent impacts on the m been properly addressed. underwriting and to better cope with fi nancial financial markets, Clark and Mingyuan have proposed a groundbreaking new framework weaknesses toward fostering a new generation of to revolutionize our current lending system. The book is built on the authors’ deep under- e Credit Risk Assessment: The New Lending System credit models that possess greater transparency. standing of risk and the models used for credit analysis, and reflects their commitment to for Borrowers, Lenders, and Investors equips you n solve the problem. What I find most profound is their passion to develop a system that with an effective comprehensive credit assess- CLARK ABRAHAMS is Chief Financial will facilitate new and better investment, especially in underserved urban markets that t ment framework (CCAF) that can provide early Architect at SAS, where he leads business and have been disproportionately impacted in the current crisis. I applaud the authors for this warning of risk, thanks to its forward-looking important work, and urge practitioners and theorists alike to investigate this new approach.” pexropdeuricetn dcee vienl othpem feinnta.n Hciea lh saesr voivceers tihnidrutys tyreya wrsi tohf —John Talmage, President and CEO, Social Compact BorNThe athnea lypsaesst tdheatte rdmoi nneos t threel yf uotnu ret.h eR epvreeamlinisge hthoawt r corporations including Bank of America and Fair oe an existing credit underwriting system can be ww Isaac Corporation. “In the wake of the credit crisis, it is clear that transparency is the key to not repeating e L extended to embrace all relevant factors and busi- MINGYUAN ZHANG, PHD, is Principal hInisvteosrtoy.r sI,n C Clarrekd iAt bRriaskh aAmssse assnmde Mnt:i nTghyeu Nane wZ hLaenngd idnegs cSryisbtee ma nfoerw B olernrodwinegrs ,f rLaemnedweros rakn tdh at rs, Lend nrieskss caonndt edxrtisv ein aolrl dterra ntosa acctciounras teinly ac latsrsainfysp carreednitt Consultant at SAS. He has over ten years of ein einxgp eericeonncoem iicn fodreevcealsotpining,g daantad miminpinlegm, eanntd- scmeueesklttosd mtoowe rcnso’, ntrnhiseekc Atp boalrtlae hnthatiema lps. /lAaZyshe tarhns egi n fli entnhadeni cnleigan lm dsieonrdgv eicclh ecase irinnt adainundslyt rp yor forfevecirdso evs oearm sm efor noreem wh t ofhloeios tmdic of ovrrtieg twahg oeou fg ht ndersg Sys mthaen fnaecrt,s . Credit Risk Assessment clearly lays out financial risk management solutions for the to laymen and professionals alike.” , a te This well-timed book explores how your company financial services industry. nd m can improve its current credit assessment system —Maria Bruno-Britz, Senior Editor, Bank Systems & Technology magazine In fo to balance risk and return and prevent future vr e fi nancial disruptions. Describing how a new s to and comprehensive lending framework can r s achieve more complete and accurate credit risk assessment while improving loan transparency, The Wiley and SAS Business Series presents books that help senior-level affordability, and performance, Credit Risk Assess- managers with their critical CLARK ABRAHAMS MINGYUAN ZHANG ment addresses: management decisions (continued on back flap) ffffiirrss..iinndddd vvii 22//2266//0099 1111::2299::4477 AAMM Credit Risk Assessment ffffiirrss..iinndddd ii 22//2266//0099 1111::2299::4455 AAMM Wiley & SAS Business Series The Wiley & SAS Business Series presents books that help senior-level managers with their critical management decisions. Titles in the Wiley and SAS Business Series include: Business Intelligence Competency Centers: A Team Approach to Maximizing Competitive Advantage, by Gloria J. Miller, Dagmar Brautigam, and Stefanie Gerlach Case Studies in Performance Management: A Guide from the Experts, by Tony C. Adkins CIO Best Practices: Enabling Strategic Value with Information Technology, by Joe Stenzel Credit Risk Scorecards: Developing and Implementing Intelligent Credit Scoring, by Naeem Siddiqi Customer Data Integration: Reaching a Single Version of the Truth, by Jill Dyche and Evan Levy Enterprise Risk Management: A Methodology for Achieving Strategic Objectives, by Gregory Monahan Fair Lending Compliance: Intelligence and Implications for Credit Risk Management, by Clark R. Abrahams and Mingyuan Zhang Information Revolution: Using the Information Evolution Model to Grow Your Business, by Jim Davis, Gloria J. Miller, and Allan Russell Marketing Automation: Practical Steps to More Effective Direct Marketing, by Jeff LeSueur Performance Management: Finding the Missing Pieces (to Close the Intelligence Gap), by Gary Cokins Performance Management: Integrating Strategy Execution, Methodologies, Risk, and Analytics, by Gary Cokins For more information on any of the above titles, visit www.wiley.com. ffffiirrss..iinndddd iiii 22//2266//0099 1111::2299::4466 AAMM Credit Risk Assessment The New Lending System for Borrowers, Lenders, and Investors Clark Abrahams Mingyuan Zhang John Wiley & Sons, Inc. ffffiirrss..iinndddd iiiiii 22//2266//0099 1111::2299::4466 AAMM Copyright © 2009 by SAS Institute. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-646-8600, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, or online at http://www.wiley.com/go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifi cally disclaim any implied warranties of merchantability or fi tness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profi t or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993 or fax 317-572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our Web site at http://www.wiley.com. Library of Congress Cataloging-in-Publication Data: Abrahams, Clark R., 1951- Credit risk assessment: the new lending system for borrowers, lenders, and investors/Clark Abrahams and Mingyuan Zhang. p. cm.—(Wiley & SAS business series) Includes index. ISBN 978-0-470-46168-6 (cloth) 1. Credit—Management. 2. Consumer credit—Management. 3. Bank loans—Management. 4. Risk management. I. Zhang, Mingyuan. II. Title. HG3751.A27 2009 332.7—dc22 2008054910 Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 ffffiirrss..iinndddd iivv 22//2266//0099 1111::2299::4477 AAMM To Judy, Brad, Candice, and my lifelong mentor, Estella Hunter. —Clark Abrahams To Lily, our parents, and Amy, Larry, and Gary. —Mingyuan Zhang ffffiirrss..iinndddd vv 22//2266//0099 1111::2299::4477 AAMM ffffiirrss..iinndddd vvii 22//2266//0099 1111::2299::4477 AAMM Contents Preface ix chapter 1 Unpacking the Financial Crisis 1 chapter 2 The Case for a Comprehensive Credit 41 Assessment Framework chapter 3 The Lender and the Underwriting Gap 107 chapter 4 The Borrower and Loan Affordability 161 chapter 5 The Investor and Financial Innovation 207 chapter 6 Crisis Intervention and Prevention 255 Index 301 vii ffttoocc..iinndddd vviiii 22//2266//0099 1111::3366::2244 AAMM ffttoocc..iinndddd vviiiiii 22//2266//0099 1111::3366::2255 AAMM
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