Board of Governors of the Federal Reserve System

Modeled Loss Rates

Corporate Loan Model

Modeled Loss Rates on Pools of Corporate Loans

The output of the corporate loan model is the expected loss on each loan. As described above, estimated corporate loan loss rates depend on a number of variables. This section groups loans according to three of the most important variables in the model: sector (financial and nonfinancial), security status (secured and unsecured), and rating class (investment grade and non-investment grade).⁹¹ Categorizing corporate loans reported on schedule H.1 of the FR Y-14Q as of the fourth quarter of 2017 by sector, security status, and rating class results in eight groups of loans:⁹²

1. Financial, secured, investment grade
2. Financial, secured, non-investment grade
3. Financial, unsecured, investment grade
4. Financial, unsecured, non-investment grade
5. Nonfinancial, secured, investment grade
6. Nonfinancial, secured, non-investment grade
7. Nonfinancial, unsecured, investment grade
8. Nonfinancial, unsecured, non-investment grade

The remainder of this section reports summary statistics and modeled loss rates for these eight groups of corporate loans.

Table 20 reports summary statistics for the eight groups of loans. The summary statistics cover a wide set of variables that capture important characteristics of the loans and borrowers in the loan groups.

Tables 21 and 22 show the modeled loss rates for the eight groups of loans for the DFAST 2018 supervisory severely adverse and supervisory adverse scenarios, respectively. Each entry in the table shows the portfolio-level (average) estimated loss rate for the loans in one of the eight groups, as well as the median and 25th and 75th percentiles of the estimated loan-level loss rates.

Certain groups of loans generally have wider ranges of losses than other groups. Although the loans are grouped according to the most important characteristics in the model, other loan characteristics in the model also affect loss rates, albeit in a more limited manner. Differences in these other characteristics within each loan group are responsible for the range of loss rates shown in the tables. Greater variation in these other characteristics within a group will generally lead to larger ranges of loss rates. For example, among secured, non-investment grade loans, the range of loan-level loss rates is 10.6 to 15.2 for financial firms, compared to 3.6 to 14.4 for nonfinancial firms, which include a wider variety of industries (table 21). Secured, non-investment grade loans to nonfinancial firms are predominantly loans to firms in the manufacturing, transportation, and technology sectors but also include loans to firms in other sectors like education and utilities (table 20).

 

Table 20. Summary statistics of selected variables in the corporate loan data grouped by loan and borrower characteristics

Table 21. Projected portfolio loss rates and 25th and 75th percentile ranges by loan and borrower characteristics, 2018:Q1-2020:Q1, DFAST 2018 severely adverse scenario

Table 22. Projected portfolio loss rates and 25th and 75th percentile ranges by loan and borrower characteristics, 2018:Q1-2020:Q1, DFAST 2018 adverse scenario

Portfolios of Hypothetical Loans and Associated Loss Rates

The effect of loan and borrower characteristics on the losses estimated by the corporate loan model can also be illustrated by the differences in the estimated loss rate on specific sets of hypothetical loans. This section contains descriptive statistics from three portfolios of hypothetical loans (table 24) and the modeled loss rates for the three portfolios under the DFAST 2018 supervisory adverse and supervisory severely adverse scenarios (table 25).

The Federal Reserve has designed the portfolios of hypothetical loans to have characteristics similar to the actual loans reported in schedule H.1 of the FR Y-14Q. The Federal Reserve provides three portfolios containing 200 loans each, designed to capture characteristics associated with

1. typical set of loans reported in the FR Y-14Q,
2. higher-than-average-risk loans (in this case, non-investment grade loans), and
3. lower-than-average-risk loans (in this case, investment grade loans).

The portfolios of hypothetical loans include 12 variables that describe characteristics of corporate loans that are generally used to estimate corporate loan losses (table 23).⁹³

Table 24 contains summary statistics for the portfolios of hypothetical loans in the same format as table 20. The portfolios of hypothetical loans are constructed to capture characteristics of certain sets of loans but are not fully representative of the population of loans reported in table 20. Table 25 contains the loss rates for the portfolios of hypothetical loans calculated under the DFAST 2018 supervisory severely adverse and supervisory adverse scenarios. The portfolio of higher-risk loans has higher loss rates under both the severely adverse and adverse scenarios and is also more sensitive to changes in macroeconomic conditions (loss rate of 5.5 percent in the adverse scenario and 9.7 percent in the severely adverse scenario) than the portfolio of typical loans (loss rate of 3.9 percent in the adverse scenario and 6.8 percent in the severely adverse scenario). Conversely, the portfolio of lower-risk loans has lower losses under both scenarios and is less sensitive to changes in macroeconomic conditions (loss rate of 1.2 percent in the adverse scenario 1.9 percent in the severely adverse scenario).

 

Table 23. List of variables included in portfolios of hypothetical loans

Table 24. Summary statistics of selected variables in the portfolios of hypothetical loans

Table 25. Projected portfolio loss rates, 2018:Q1-2020:Q1, DFAST 2018 scenarios

 

Credit Card Model

Modeled Loss Rates on Pools of Credit Card Accounts

The output of the credit card model is the expected loss on each account. As described above, the Federal Reserve uses the credit card model to project losses on domestic bank cards and domestic charge cards, and estimated credit card loss rates depend on a number of variables. This section groups domestic bank card accounts (credit card accounts) according to their commercially available credit score, which is one of the most important variables in the model. FICO® Scores are the most widely used commercially available credit scores in the historical data used to estimate the model.⁹⁴ Accounts are grouped into four segments. Categorizing credit card accounts reported on schedule D.1 of the FR Y-14M report as of the fourth quarter of 2017 by FICO® Score results in four groups of accounts:⁹⁵

1. Accounts with FICO® Score under 650
2. Accounts with FICO® Score from 650 to 699
3. Accounts with FICO® Score from 700 to 749
4. Accounts with FICO® Score above 750

The remainder of this section reports summary statistics and modeled loss rates for these four groups of credit card accounts.

Table 26 reports summary statistics for the four groups of credit card accounts. The summary statistics cover a wide set of variables that capture important account characteristics.

Tables 27 and 28 show the modeled loss rates for the four groups of accounts under the DFAST 2018 supervisory severely adverse and supervisory adverse scenarios, respectively. Each entry in the table shows the portfolio-level (average) estimated loss rate for the accounts in one of the four groups, as well as the median and 25th and 75th percentiles of the estimated account-level loss rates.

Certain groups of accounts generally have wider ranges of losses than other groups. Although accounts are grouped according to one of the most important characteristics in the model, other account characteristics in the model also affect loss rates, albeit in a more limited manner. Differences in these other characteristics within each account group are responsible for the range of loss rates shown in the tables. Greater variation in these other characteristics within a group will generally lead to larger ranges of loss rates. For example, the account-level loss rates shown in table 27 range from 27.0 percent to 57.6 percent for accounts with a FICO® Score below 650, a category in which other account characteristics vary widely, but range from 3.9 percent to 12.3 percent for accounts with a FICO® Score above 750, a category in which there is less variation in other account characteristics.

Table 26. Summary statistics of selected variables in the consumer bank card data by credit score

Table 27. Projected portfolio loss rates and 25th and 75th percentile ranges by credit score, 2018:Q1-2020:Q1, DFAST 2018 severely adverse scenario

Table 28. Projected portfolio loss rates and 25th and 75th percentile ranges by credit score, 2018:Q1-2020:Q1, DFAST 2018 adverse scenario

Portfolios of Hypothetical Accounts and Associated Loss Rates

The effect of account characteristics on the losses estimated by the credit card loss model can also be illustrated by the differences in the estimated loss rate on specific sets of hypothetical accounts. This section contains descriptive statistics for three portfolios of hypothetical accounts (table 30) and the modeled loss rates for the three portfolios under the DFAST 2018 supervisory adverse and supervisory severely adverse scenarios (table 31).

The Federal Reserve has designed the portfolios of hypothetical accounts to have characteristics similar to the actual accounts reported in schedule D.1 of the FR Y-14M. The Federal Reserve provides three portfolios containing 200 accounts each, designed to capture characteristics associated with

1. typical set of accounts reported in the FR Y-14M,
2. higher-than-average-risk credit card accounts, and
3. lower-than-average-risk credit card accounts.

The portfolios of hypothetical accounts include 12 variables that describe characteristics of credit card accounts that are generally used to estimate credit card losses (table 29).⁹⁶ .

Table 30 contains summary statistics for the portfolios of hypothetical accounts in the same format as table 26. The portfolios of hypothetical accounts are constructed to capture characteristics of certain sets of accounts but are not fully representative of the population of accounts reported in table 26. Table 31 contains the loss rates for the portfolios of hypothetical accounts calculated under the DFAST 2018 supervisory severely adverse and supervisory adverse scenarios. The portfolio of higher-risk accounts has higher loss rates under both the adverse and severely adverse scenarios and is also more sensitive to changes in macroeconomic conditions (loss rate of 20.4 percent in the adverse scenario and 26.8 percent in the severely adverse scenario) than the portfolio of typical accounts (loss rate of 13.3 percent in the adverse scenario and 17.7 percent in the severely adverse scenario). Conversely, the portfolio of lower-risk accounts has lower losses under both scenarios and is less sensitive to changes in macroeconomic conditions (loss rate of 4.8 percent in the adverse scenario and 7.2 percent in the severely adverse scenario).

Table 29. List of variables included in portfolios of hypothetical accounts

Table 30. Summary statistics of selected variables in the portfolios of hypothetical accounts

Table 31. Projected portfolio loss rates, 2018:Q1-2020:Q1, DFAST 2018 scenarios

Explanatory Notes on Model Disclosures

The model disclosures in this document focus on the design of and projections from specific models, whereas the disclosures of supervisory stress test results include projections aggregated to the portfolio level. In most cases, those portfolio-level aggregates contain outputs from multiple supervisory models.⁹⁷ As such, the results shown in the two different disclosures will be different.

This document includes disclosures of loss rates on loan and account segments and on hypothetical portfolios of loans and accounts. These loss rates differ from those included in the stress test results disclosures in that they do not include accounting and other adjustments used to translate projected credit losses into net income. In the supervisory stress test results disclosure, the Federal Reserve makes certain accounting adjustments to translate supervisory model estimates into provisions and other income or expense items needed to calculate stressed pre-tax net income. These adjustments often depend on factors that vary across participating firms, such as write-down amounts on accounts purchased with credit impairments.

In addition, the Federal Reserve incorporates material changes in a firm's business plan--such as a planned merger, acquisition, consolidation, or divestiture--in its supervisory projections.⁹⁸ The process for incorporating material business plan changes in projections is specific to the nature of submitted business plan changes and is not described in this document.

 

References

 

 91. Financial loans have a NAICS category ("naics_two_digit_cat") of 52; all other loans are marked nonfinancial. Secured loans are defined as loans with lien positions ("lien_position_cat") marked as "first-lien senior"; all other loans are marked as unsecured. Investment grade loans are defined as loans with a credit rating ("rating") higher than and including BBB; all other loans are marked as non-investment grade. Return to text

 92. The set of loans on which loss rates are calculated excludes loans held for sale or accounted for under the fair value option, loan observations missing data fields used in the model, lines of credit that were undrawn as of 2017:Q4, and other types of loans that are not modeled using the corporate loan model (e.g., loans to financial depositories). Return to text

 93. The sets of accounts are available for download on the Federal Reserve's website: higher-than-average-risk accounts, https://www.federalreserve.gov/newsevents/pressreleases/files/corporate-high-risk-2019.csv; typical-risk accounts, https://www.federalreserve.gov/newsevents/pressreleases/files/corporate-typical-2019.csv; lower-than-average-risk accounts, https://www.federalreserve.gov/newsevents/pressreleases/files/corporate-low-risk-2019.csv. Return to text

 94. FR Y-14 reporters are not required to report a particular credit score. For the purposes of making projections using a model estimated with FICO® Scores, the Federal Reserve maps scores reported on the FR Y-14 to FICO® Scores. Return to text

 95. The set of accounts presented in this table excludes accounts held for sale or accounted for under the fair value option, observations missing data fields used in the model, and accounts with 0-1 percent utilization rate as of 2017:Q4. Return to text

 96. The sets of accounts are available for download on the Federal Reserve's website: higher-than-average-risk accounts, https://www.federalreserve.gov/newsevents/pressreleases/files/cards-high-risk-2019.csv; typical-risk accounts, https://www.federalreserve.gov/newsevents/pressreleases/files/cards-typical-2019.csv; lower-than-average-risk accounts, https://www.federalreserve.gov/newsevents/pressreleases/files/cards-low-risk-2019.csv. Return to text

 97. See Board of Governors of the Federal Reserve System, "Mapping of Loan Categories to Disclosure Categories," Dodd-Frank Act Stress Test 2018: Supervisory Stress Test Methodology and Results (Washington: Board of Governors, June 2018), 51, https://www.federalreserve.gov/publications/files/2018-dfast-methodology-results-20180621.pdf. Return to text

 98. The inclusion of the effects of such expected changes to a firm's business plan does not--and is not intended to--express a view on the merits of such proposals and is not an approval or non-objection to such plans. Only divestitures that had been completed or contractually agreed to prior to April 5 of the year of the stress test exercise are incorporated in supervisory projections. Once balance sheet components are adjusted to account for the material business plan change, assets are assumed to grow at the same rate as the pre-adjusted balance sheet. Return to text