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Evaluating single vs. dual rating systems

September 22, 2017
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This post was authored by Alison Trapp, Director of Client Education at Abrigo.

When a lending institution establishes its risk rating system it has to decide whether it will require analysts to risk rate the borrower or the loan -- or both. Said another way, it has to decide between a single or dual rating system. There are benefits to each. On one hand, a single rating system is simple. On the other, the dual rating system allows for more distinction in risk grades, which could be beneficial to the institution. The answer to the question as to which is better for a lending institution is the same as many questions in credit risk: it depends.

A dual rating system has one rating that captures the overall creditworthiness of the borrower and a second at the facility level. Differences between the two ratings are generally because of secondary support factors such as collateral, guarantees or letters of credit that would impact a single facility and not the borrower’s overall condition. In other words, being secured by a building is not likely to change whether a borrower defaults but it does mitigate the chargeoff. Often loans that are unsecured or structured as cash flow loans will have a facility rating equal to the borrower rating because there is limited hard collateral or additional credit support to improve the facility rating. A concordance table maps the risk ratings to the regulatory risk classification system of Special Mention and classified asset levels.

The OCC and NCUA explain that while many institutions have moved to a dual rating system over the last 15-20 years, the regulatory agencies do not require institutions to do so. Smaller, less complex institutions may find that a single rating system is sufficient. What is important is that the risk rating system capture consistently, accurately, and timely “the ability and willingness of the obligor to repay and the support provided by structure and collateral.”



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Typically, the benefits of using a dual rating system are tied to loan pricing, the allowance for loan and lease losses and capital requirements. For example, an analyst knows intuitively that two loans to the same borrower - one unsecured and one secured by a marketable piece of equipment - will have different levels of risk. Systematically distinguishing between these allows the institution to reflect this difference in risk consistently in pricing, capital requirements, etc.

Two factors are combining to make dual rating systems more prevalent even at smaller institutions: 

1. Available software and other information systems make it relatively easy to capture and retrieve data. 

2. Regulatory expectations are not likely to retreat on issues of safety and soundness. 

The discipline of considering how secondary sources of repayment and structural protections may improve the recoverability of one loan vs. another to the same borrower is part of strong risk management.

Alison Trapp is a former Senior Consultant with Sageworks' Advisory Services team and is focused on credit. Today, Alison serves as the Director of Client Education at Abrigo. Alison joins Abrigo after spending 17 years on the commercial credit risk team at GE Capital and a year consulting with mid-sized commercial banks. She has particular expertise in credit administration and policy implementation.

About the Author


Raleigh, N.C.-based Sageworks, a leading provider of lending, credit risk, and portfolio risk software that enables banks and credit unions to efficiently grow and improve the borrower experience, was founded in 1998. Using its platform, Sageworks analyzed over 11.5 million loans, aggregated the corresponding loan data, and created the largest

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