Mitigating Credit Risk For “Thin File” Customers

The Great Recession created a new mantra for lenders: When it comes to data on a would-be borrower, “more is better.” In other words, according to a recent whitepaper by VantageScore, the thicker the file on a consumer, the easier it is to gauge risk — especially if there has been a troubled credit history, with, say, a bankruptcy in place.

But is such “qualitative” analysis enough? VantageScore says it isn’t, and in the paper, titled “Maximizing the Credit Universe,” such a strategy can have a damaging, twofold effect: 1) Origination risk may not in fact be adequately reflected, and 2) the actual pool of accessible lending prospects (i.e., “safe” new business) may actually be reduced.

In reference to the total eligible credit universe — and winnowing things down by adopting several prisms — VantageScore’s paper uses the 2010 census, which estimates an adult population of 237 million at 18 years of age or older. That population has a 220 million to 230 million person “potential” lending pool with data from at least one of the three national credit reporting companies (CRCs). That rather large sample in turn can be segmented into:

"Mainstream" consumers, which can be defined as “typical” credit users, all 160 million of them, with at least three credit accounts that receive frequent updates. Then there are the “upsiders” that, across 20 million consumers, have one or two credit accounts, with frequent updates of at least every six months, and another 13 million consumers with any number of accounts that are updated less frequently because they do not often use credit. Finally, there are the “minimalists” who use credit sparingly, but represent, according to VantageScore, “good loan candidates.” The minimalist segment also has an additional 13 million adults, so classified because they have only “derogatory” information on their credit reports.

VantageScore says that the very composition of a consumer’s file can vary across all three CRCs. That’s because lenders report different information to the bureaus at different times and may not even report to all three CRCs. The result is that a credit file on a consumer, and the attendant score, can vary across the CRCs. As an example, VantageScore said that about 78 percent of consumers had “mainstream” status universally across all three CRCs.

There is also evidence of “churn” as consumers scale up and down across the three tiers of mainstream, minimalists and upsiders. Some 5 million consumers, by dint of reducing both their need and use of credit, drop out from the mainstream designation.

Such staggered reporting data and churn, as noted above, can have a significant impact on how credit risk is assessed and who is in fact deemed eligible. Under the most onerous qualitative guidelines, VantageScore’s research shows, the “accessible universe” can be cut almost in half.

Viewed in this light, VantageScore notes, the conventional or current models can be erroneous in process and results. The paper utilizes a case study, in which a mortgage originations strategy took into account both “traditional” and qualitative thresholds and the VantageScore 3.0 risk scoring model (which takes into account data that includes, say, utility payments or telecom bills).

In a “typical design,” the credit scoring model would have a mainstream designation with at least three trades with updates within the last six months and a score of at least 620. The mainstream audience shakes out to about 173 million consumers, in which 128 million exceeded the 620 cutoff. Those criteria have an impact in that they “drop” an additional 54 million possible borrowers who do not have the mainstream designation.

People with just one CRC file, or a single credit score, have higher risk levels – even with a score of 620, the default rate can be as high as 13 percent.

But, according to VantageScore, using a program like its 3.0 software and dropping the mainstream threshold, allowing anyone with a valid credit score to be considered boosts the “lendable universe” by as much as 27 percent, or 47 million consumers. Adding in the 620 cutoff point still expands the universe significantly, by about 14 percent, VantageScore says, with a new pool of possible borrowers that the firm brands as “New Opportunity.” In the end, the risk profile that comes from using a quantitative model rather than solely the traditional, “thick file” method results in an expanded lending pool marked by relatively more attractive default risk.




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