What might happen if sold-derogatory trades — credit-speak for bad debts in which consumers have charged off an account with a lender, and the lender then sold those trades to an external collection agency — were wiped from a consumer’s credit score? Would it improve it? And would lenders be subject to increased risk as a result?
No – and no.
In discussing the results of VantageScore’s recent study — “Impact of Sold-Derogatory Trade Lines on VantageScore 3.0 Credit Scores” — Sarah Davies, SVP of Product Management & Analytics at VantageScore Solutions, tells MPD CEO Karen Webster that “sold-derog” debts carry something of a “‘black box’ aura around them.”
This subject is not just a hypothetical. As Davies explains, there are a number of reporting and compliance concerns related to sold-derogatory trades. For example, if a consumer had gotten the debt from a sold-derogatory trade dismissed through a bankruptcy, that debt is not one that should be reported to the credit files, leaving lenders wondering if they are getting all of the right and relevant information in making a lending decision.
“The net of that,” says Davies, “was that a number of large lenders started to stop reporting on [sold-derogs]. So the rest of the industry then began asking the question, ‘What’s going to happen to the credit score? Is it valid now that such an important piece of negative information (i.e., derogatory) has been removed from the credit file?’”
To address this issue, VantageScore ran an analysis, using a sample of 4.3 million consumers, to determine how the score was impacted if all of the sold-derogatory trades were removed from a consumer’s credit files.
“What we found was that about 4.9 percent of the sample had at least one sold-derogatory trade on their account,” Davies explains. “When we removed that, we actually only ended up removing about 4.06 percent of the trades from the sample. It ended up being — albeit a very small set of data — very important data from the negative expression.”
The next step for VantageScore was to rerun those consumers’ credit scores and find out what they looked like. The hypothesis going in was that the scores would improve.
That turned out, however, not to be the case.
The scores “did not change very much at all,” Davies reveals. “In fact, about 60 percent of consumers’ scores didn’t experience any change whatsoever.”
In hindsight, the reason is obvious. Most consumers with a sold-derogatory trade on their accounts also had a number of delinquencies, which are similarly negative in terms of the impact on the score. Removing one bad debt — the sold-derogatory trade — did not offset the overall negativity of the consumer’s scores created by the other bad collection trades.
In fact, Davies says that their survey found that consumers with one sold-derogatory trade had an average of five collection trades on their account. “That was at least 92 percent of that population,” she adds.
Webster observes that where there’s smoke (one really bad debt), there’s fire (more of them). Consumers with sold-derogs seem to have a history of being chronically late in paying their bills.
Davies agrees, noting that there are exceptions. Sometimes sold-derogs are in the area of medical collections, for example, “where sometimes there is absolutely a population that has [experienced] a one-time, very unfortunate life event.”
“You wouldn’t want to see those consumers unnecessarily or inappropriately penalized,” she adds.
The consumers that VantageScore dealt with in its study, on the other hand, Davies says, constitute “a population that is absolutely challenged when paying their debts, and are impacted on any number of them.”
Given their findings — removing bad data makes no real difference — Davies makes it clear that she is “in no way an advocate of removing negative data.”
“I wouldn’t advocate that lenders begin to subjectively determine which information to remove and what to not. In this particular case, this is a population that is challenged on many fronts,” she explains.
The takeaway for reporting agencies and lenders from VantageScore’s investigation, Davies attests, should not be a broad-stroke decision to disregard sold-derogatory debts. What the study shows, however, is that — if that tact is taken — it’s not going to impact the risk profile of the particular borrower and therefore will not put the lender at risk.
Another element that VantageScore tested for in the study was to determine if the credit score with the sold-derogatory trade removed would continue to be accurate in its predictions of good versus bad performance.
“For this particular population, given this far broader context of collections information for these consumers,” explains Davies, “there was no impact on the score’s performance in terms of rank ordering, and very minimal impact on consumer scores.”
“Lenders can take away the fact that the score is continuing to be accurate,” she tells Webster. “It’s continuing to represent good versus bad performance appropriately. They don’t need to consider a major revision of their strategies in-house.”
For consumers, Davies believes that “the key here is that the score continues to accurately represent how they’re managing their debts — which any consumer should really want.”
As Webster and Davies begin to wrap up their discussion, Davies shares that VantageScore has “a few interesting analyses” on its agenda toward supporting the efficacy of credit scoring.
She says that VantageScore is hoping to move beyond just the “mechanics” of scores, for one. “We have some insights coming up around secured card; that’s a product that’s coming back into the marketplace as lenders are opening up their universe and wanting to find ways to begin to give new-scoring consumers — people who weren’t traditionally scored — access to products that get them into mainstream credit.”
Another area that VantageScore is looking at is score migration, addressing how consumers’ scores are shifting and what the debt profile or risk profile might be behind that.
Thirdly, VantageScore will be analyzing “new-scoring consumers in general,” says Davies. “I think all of the credit scoring companies are trying to find ways to accurately score those consumers. Given that those consumers often have not had access to credit, what’s the story behind them? What’s their demographic insight?”
The analyses of those areas, Davies tells Webster, will be coming up in the next one to two quarters.
To download VantageScore’s full report — “Impact of Sold-Derogatory Trade Lines on VantageScore 3.0 Credit Scores” — click here.
Sarah Davies, SVP Product Management & Analytics at VantageScore Solutions
Sarah Davies is senior vice president of analytics, research and product management at VantageScore Solutions LLC, a company owned by the three national credit reporting companies (Equifax, Experian and TransUnion) to provide credit grantors a highly predictive, universal credit scoring model. As the leader of the team responsible for developing VantageScore Solutions’ credit scoring models, Davies and her team are credited with a number of important industry breakthroughs such as a “scorecard” designed specifically to deliver a highly accurate credit score to those with sparse credit histories, and the elimination of paid third-party collection accounts.
In addition to leading the product strategy, she engages with numerous government regulatory agencies and the secondary market to provide insights on consumer financial trends, credit and risk analytics. She is recognized as a national expert on credit scoring technologies, model governance, decision-analytics and is a frequent speaker to the financial service industry and the media on these topics.
She has nearly 25 years of leadership experience in strategy, analytics and information sciences in the financial service industry. Prior to joining VantageScore Solutions, she served as Chief Analytic Officer for iQor Holdings Incorporate, a global customer service and receivables management outsourcing business.