Looking for new borrowers with only the best credit isn't enough to help lenders forge a recovery — there simply aren't enough to go around. This is leading to a slew of new scoring products to help locate diamonds in the rough on both the consumer and business side.
The latest scoring product on the business side comes from Experian, whose new financial stability risk score is designed to identify accounts with the highest probability of business failure, a tool the firm envisions being used to segment risky yet economically palatable businesses from non-starters.
The new score accompanies existing Experian products that gauge the likelihood of an account falling 91 days or more behind on payments and guide the size of credit packages.
"The missing piece of the scoring pie was the ability for lenders to figure out, 'Am I ever going to get paid?'" says Adam Fingersh, a senior vice president at Experian. "Before, we could say a prospective borrowing firm would be slow to pay, but we could not say who would not pay at all."
Fingersh says that for the new score, the firm accesses sources of data on payment trends, such as a history of delinquencies; credit utilization, including any derogatory actions such as liens or judgments; and firmographics, which is jargon for corporate demographics — information such as line of business, geography, and number of employees.
Other data sets, which Experian would not disclose in detail, are sourced to determine the likelihood of stress that will result in difficulty paying. This data is run through an internal analytics engine to produce numerical predictions of future credit health.
Lenders and other targeted firms such as utilities can use the information to fast track some credit applications while delaying others for a review, screen out the highest risk accounts, and hone credit risk resources toward the higher-risk accounts. "Clients can further segment portfolios of commercial customers and treat those accounts appropriately. It's also useful in determining what types of deposits or upfront payments need to be made [commensurate] with the risk of a particular business," Fingersh says.
The scores range from 1 to 100 — the higher the number, the better the credit. Firms are also ranked from one to five, with one being the lowest risk.
In testing its new scoring model, Experian says it's found that in the lowest 20 percent of scores, 74 percent of the businesses failed within a year. "In this segment, you have to absolutely get a deposit up front or have a higher rate, more collateral or a 'cash on delivery' billing system," Fingersh says.
Deeper credit metrics for businesses have also been popping up at other scoring firms. Equifax recently introduced a new suite of risk scores that use data accessed from the Small Business Financial Exchange, a nonprofit organization including most of the country's small business lenders. The suite includes a business delinquency score, which predicts the likelihood of severe delinquency on an account and the business delinquency financial score, which determines likelihood of severe delinquency on financial accounts. It's also added a business failure score, which uses much of the same data elements as the delinquency scores to predict the likelihood of failure within 12 months. Equifax is mining new data, which includes pre-recession, recession, and post-recession historical information; minimum scoring criteria to validate the legitimacy of a business and verify application data for potential fraud; and scorecards that can be applied automatically based on business size.
FICO's new Small Business Origination Scores 6.0 includes 66 models, allowing lenders to divide borrowers into more segments and further separate good and bad risks. The models are aimed specifically at start-up businesses. A credit offer helps lenders measure a business's capacity to pay. FICO and Equifax did not return requests for comment.
Experian's new scoring models aren't necessarily aimed solely at startups or small businesses, yet new companies are a high risk segment that provides fertile ground for credit modeling.
Fingersh notes a counterintuitive trend during economic downturns: as employment at large firms decreases, startups increase. It's a trend that results when workers — particularly in fields such as technology and retail — get laid off and use that chance to start their own business. That heightens both the opportunity and risk for lenders, and the opportunistic moves by the scoring firms. "Starting a new business can be an option of last resort," Fingersh says.