As every lender knows, the current environment is one of sustained depressed levels of credit quality, and naturally increasing competition among lenders for the least risky borrowers. Bank managers continually ask themselves, Where are the opportunities for growth in this market?
As lenders consider how to move beyond recession-based management strategies and intelligently re-enter the world of originations and portfolio profit maximization, they can take comfort in the fact that deeper insight about consumer credit behaviors can identify profitable opportunities and expose segments that require increased risk mitigation.
More specifically, growth opportunities come from predicting which borrowers in a portfolio will — and which will not — pose new risks and which ones are poised to improve their creditworthiness.
With that in mind, an important arrow in a lender's quiver is a segmentation process that uses a credit score in conjunction with consumer financial management behaviors (available on the consumer credit files) to go beyond indicating the likelihood of default.
VantageScore Solutions used segmentation strategies to demonstrate score migration on a macro level and found that more than 60 million borrowers are creditworthy today and will likely either improve their credit score or remain stable over a 12-month period.
Within these 60 million consumers, VantageScore identified 10.6 million whose overall credit quality is improving and whose risk profile is consequently very attractive. Beyond the 60 million, another 11 million consumers were identified who are likely to drop in credit quality over a 12-month period.
While these figures may appeal to a lender's drive for growth, it's the concepts and methodologies used to arrive at these numbers that lenders need to consider more carefully.
In other words, a lender needs to ask whether it is possible to predict which borrowers in a portfolio will trend upward and downward when they have nearly identical credit scores.
Based on our analysis, the answer is yes, but lenders need to dig deeper than the score and use information in a credit report to garner value — added insight and then apply that information to portfolio optimization strategies.
Based on VantageScore's analysis, consumers considered to be superprime who are predicted to be stable are identified as having 15% fewer inquiries on their credit report, 21% more real estate trades and 22% fewer real estate delinquencies.
Consumers with prime credit scores who are considered stable exhibit specific behaviors in their credit profiles when compared with the average prime-credit-quality consumer, including fewer trades, fewer inquiries, lower bank card utilization and fewer auto and real estate trades.
Consumers with lower inquiries and older loans are signaling that they need less credit and have kept their loan products in better shape for longer, underscoring that they can handle their debts more effectively.
Extending this logic to all credit tiers, more than 50 million consumers were considered stable, with strong credit scores, representing 74% and 62% of the prime and superprime scoring bands, respectively. Among these 50 million, the risk for those in the prime category was 0.1% (a tenth of 1%) or less, as determined by the average 90-day-plus delinquency rate in the most recent 12 months.
This risk level for the "stable, prime" consumer was approximately 75% lower than the average risk level for the prime scoring band overall.
In the superprime category, the risk among those with stable credit improves to an average of 0.001%.
In addition, VantageScore identified 10.6 million consumers whose overall credit quality is improving and whose risk profile is consequently very attractive.
The study suggests that if lenders can predict score migrations, then they can potentially extend credit where they may not have otherwise, thus potentially improving profit and loss ratios.
This strategy can work in reverse as well.
Using segmentation strategies, VantageScore determined 11 million consumers whose credit quality is declining. Of these 11 million, more than 8 million are currently considered prime and superprime quality when reviewed using credit scoring methods alone.
The deteriorating population can be identified by segmenting those prime borrowers who have 14% more recently opened trades and 65% higher bank card utilization — among other things — when compared against all other behavior categories.
These borrowers are signaling potential distress, and are obviously pockets of risk in their portfolios that lenders may not recognize.
The purpose of a credit score is to predict the likelihood that a consumer will default on a loan, defined as being more than 90 days overdue. The score is an interpretation of information in a consumer's credit report. These truisms notwithstanding, just because the score is based on a consumer's credit report doesn't mean those data points cannot be used for strategic portfolio optimization.
Segmentation strategies, in conjunction with prudent underwriting, can help lenders succeed in a challenging economic environment.