An Australian Firm Wants To Head Off Another Subprime Crisis With Data-Driven Risk Assessment

Investors traditionally rely on black-box models from rating agencies such as Moody’s, S&P and Fitch to assess residential mortgage-backed securities, but the US subprime crisis highlighted just how dangerous that can be.

The finance industry’s sudden realisation that mortgage books were riskier than previously thought triggered a chain of failures that culminated in the global financial crisis of 2008.

Central banks have since demanded that securities issuers supply more clean, usable data about their products than ever, and investment banker-turned-entrepreneur Graham Anderson wants to turn that into a transparent, objective rating system to complement rating agencies’ “opinions”.

Anderson has been working on a commercial rating algorithm since 2009, and formed joint venture MARQ Services with Perpetual Corporate Trust and Oliver Wyman in August last year.

MARQ is a cloud-based data analytics service that allows clients to upload de-identified mortgage data and crunches it to produce a “MARQ score” of between 0 to 1500, with higher scores denoting a greater risk of default.

For each loan in a mortgage pool, MARQ takes in 23 variables including the loan-to-value ratio, borrower’s residency status and credit history, employment type, property characteristics and loan period and type to produce a score. MARQ then produces a weighted average of scores for the entire pool.

MARQ profile of the mortgage pool of a sample major bank. Credit: MARQ Services

Anderson told Business Insider Australia that MARQ scores of less than 200 described low-risk mortgages. Scores of 200-400 came with some risk of a default, scores of 400-600 were classified as “sub-prime”, and those with scores above 600 were likely to default.

“A rating is language. Most people don’t understand what AAA means at all – they don’t have to but they can communicate about AAA,” he explained.

“What we’re doing with MARQ is providing open-book analysis which produces a score that you can both use to communicate and also, if someone wants to understand all the underlying parameters, they can do that as well.

Rather than competing with rating agencies, Anderson positioned MARQ as a complementary service that was “open, granular and technically consistent”. Its methodology is publicly available here.

“The credibility of rating agencies has suffered hugely [since the GFC] but they’re still a cornerstone of the market,” he said.

“Because people have investment rules around credit ratings, even though they’re self-made rules, the rating agencies are relevant … but there needs to be tools that are an alternative.”

MARQ currently has five “major clients”, including Suncorp, and three regional banks that can’t yet be named. Anderson expects to have as clients most regional and second-tier banks in “months”.

The firm will then target mutual funds before marketing to larger banks and central banks – including the European Central Bank and the Reserve Bank of Australia – by 2015.

“The whole of the western world, in terms of secured debt, is going to what we call transparency,” Anderson said, speaking of the effect of the GFC.

“For the first time, we’re having central banks legislating data provision requirements to the central banks as well as publicly so anyone lending money or taking risk on the securities can analyse the risk and not just rely on rating agency opinions.

“The Reserve Bank doesn’t want to just rely on rating agencies; it wants to be able to receive data that it can analyse and understand the securities at once, and it wants the market to be able to do that as well.”

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