Risk Rating Model Overrides: Supporting evidence
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We are developing unified PD and LGD model overrides framework for an entity that is in the process of merging multiple legacy banks. In doing this work, we have identified categories and sub-categories on what constitutes an override. The categories are meant to represent what is a pre-selected override reason, while the “Other” bucket would be a free-text response – see below for the full list.
Ask for this group: Could you provide color on what additional supporting evidence should be uploaded to justify an underwriter’s decision to override a PD and/or LGD grade? How have you seen the required documentation vary between pre-selected override reasons and the “Other” bucket?
Appreciate your guidance on this topic.
PD or LGD?
Category
Description
Sub-category
PD
Change in interim financial performance
Override reason used in instances where:
- The prior year financials are believed to not be representative of the forward-looking cash flows (typical as evidenced by more recent performance)
- An alternative financial statement (e.g., rolling 12 months) is not used (as this will be captured outside of overrides)
Cash flow (+/-)
Liquidity (+/-)
Other balance sheet strength (+/-)
Other (Free text required)
Obligor specific non-financial factors not captured in the model
Override reason used for non-financial factors that were neither captured in the model nor as warning signals (i.e., prescriptive rules)
Change in management quality
Extraordinary event (e.g., lawsuit)
Performance relative to pre-existing benchmarks (e.g., construction timelines)
Other (Free text required)
Systemic risk events
Override reason used for downgrades or upgrades associated with non-obligor specific (e.g., industry, geography) risk factors that would not have been present in the prior year financials
Industry-specific demand fluctuation
Industry-specific supply fluctuation
Price fluctuations in key direct costs
Geographic risk
Operational risk
Other (Free text required)
Other
Used for all other override reasons, including strength or weakness in financial variables that were not included in the model (note – assuming robust models with testing of a wide variety of variables, this should be used sparingly)
Free text required
LGD
Unforeseen disruption to collateral value (typically market level)
Override attributed to external factors such as systemic risk events as well as changes in legal and regulatory environments
Deprioritized as part of this phase
Abnormal expected appreciation / depreciation due to borrower / facility characteristics
Override reflecting idiosyncratic factors with the specific attributes of a range of similar facility loans
Change in recoverability patterns
Override driven by either changes in the liquidity of the collateral or the timing associated with recoverability
Other
Override reason used for considerations that are not captured within the initial LGD, as part of the structural adjustments or other override reasons; requires details/justification to allow for approval and monitoring of usage***