Quantify your portfolio risk



Score migration: a way to monitor portfolio performance
Times are changing for financial institutions. With a double-digit national unemployment rate, a severe recession and new credit lending laws that took effect in February, institutions need to be more vigilant in how they manage, optimize and collect on their current account holders. By understanding credit risk, how credit scores can change over time and how those scores will impact performance, financial institutions can better address their account holders throughout the credit life cycle.



Credit risk trends

The chart below shows the VantageScore® distribution from Q1 2004 to Q3 2009 from a sample of the Experian database.


VantageScore* is the first credit score developed cooperatively by Experian and the other national credit reporting companies. The scores used in the analysis were the valid score from 501 to 990.

The chart shows that the average VantageScore reached its peak in Q1 2006 and remained fairly consistent through Q3 2008. There may be questions as to why the VantageScore remains fairly stable until Q3 2008 if the recession began in December 2007. The reason is that economic factors have a delayed impact on credit scores. When economic times are harsh, credit scores will start to decline after the main bad economic news already has been reported. They will follow a positive trend only after good economic news already has been reported.

The next section of this article shows how individual consumer score migration has been affected by the economic climate and how financial institutions need to handle the changes to their portfolio.

Individual score migration
Financial institutions will be faced with the following score migration trends and each will require a distinct action:

  • Positive trend: The score moves in a positive direction. Account holders in this group are paying all of their obligations on time and represent a low-risk group. Financial institutions will need to reward these account holders with cross-sell or up-sell opportunities, provide them with lower rates or develop ways to better assist them because these account holders will be the target of other institutions.
  • Neutral trend: The score changes minimally in either a positive or negative direction or remains constant. Account holders in this group are paying most of their obligations on time, keeping stable balances and represent a medium-risk group. Financial institutions will need to monitor these accounts and be proactive if their payment patterns change.
  • Negative trend: The score moves in a negative direction. Account holders in this group are not paying their obligations on time, are maxing out their limits and represent a high-risk group. Financial institutions will need to develop strategies that will prevent account holders in this group from constituting losses for the institution.

A sample of accounts with valid scores from the Experian database was used to show the impact of a credit score migration policy. The analysis consisted of looking at the change in VantageScore over two time periods. The first period was from Q3 2007 to Q3 2008; the second occurred from Q3 2008 to Q3 2009. The purpose of using these time periods was to capture the economic changes that have been occurring since December 2007.

For the purposes of the analysis, the following terms were used. (Note: The 50-point scale used for the analysis is for hypothetical purposes. To some it might be too loose and to others too strict.):

  • Positive change: The account’s score increased by 50 or more points during the time period
  • No change: The account’s score increased by no more than 49 points or decreased by no more than 49 points during the time period
  • Negative change: The account’s score decreased by 50 or more points during the time period

The first step of the migration analysis was to examine accounts to see how their scores changed from Q3 2007 to Q3 2008. The chart below shows the results:


As you can see from the chart, almost 77 percent of the accounts experienced limited change in their VantageScore, while 11 percent experienced a large negative change and 12 percent experienced a large positive change. At first glance, a financial institution might not be alarmed by such a change. However, the analysis becomes more useful with an examination of the migration using a second time period.

The second step of the migration analysis involved looking at the same accounts used in the first step to see how their scores changed from Q3 2008 to Q3 2009. The chart below shows the results. The exclusion score includes accounts that did not receive a score in the second period.

Dark green represents accounts that experienced a positive shift in their score during the two time periods examined. Accounts in this group are your best group and should be offered a cross-sell/up-sell opportunity or a lower rate because they are high targets for competitors.

Light green represents accounts that experienced a small or large positive score change during the second period. Accounts in this group changed their payment patterns and met their obligations in a timelier manner. These accounts need to be monitored to determine if the positive score change indicates the future performance of these accounts or if it is a random occurrence.

Light blue represents accounts that have stabilized their payment pattern. Accounts in this group need to be watched and medium-level collections strategies should be applied if these accounts go delinquent.

Dark blue represents accounts that remained consistent during both time periods. Accounts in this group need to be watched and low- to medium-level collections strategies should be applied if these accounts go delinquent.

Orange represents accounts that are paying their obligations in a less timely manner compared with the previous period. Accounts in this group need to be watched and medium- to high-level collections strategies should be applied if these accounts go delinquent.

Red represents accounts that experienced a large negative change in their score in the second time period. Accounts in this group have multiple obligations that they cannot pay. The group consists of the worst group (accounts that had two 50-point or more drops in their score during the time periods) and probably the most troubling group (accounts that had a 50-point positive change in the first period and a 50-point negative change in the second period). Proactive actions should be developed for accounts in this group to reduce their loss potential.

Score migration policies create many opportunities for financial institutions, including the ability to evaluate a portfolio’s health via data analysis, to determine if account acquisition strategies need adjustment, and to modify their risk-based pricing strategies to allow for growth opportunities and to better serve account holders.

Geographic score migration
During these tough economic times, it is very important to understand how credit scores are changing among individual account holders and within different geographic regions. From a competitive standpoint, financial institutions should identify how scores are changing, then adjust strategies to minimize risk and maximize profit.

Using the same sample as the individual analysis, the following are results for the geographic score migration analysis:

  • The overall state average VantageScore decreased by four points per person.
  • Residents of Arizona, Nevada and Florida experienced a decrease of more than 13.5 points per person.
  • Residents of California experienced a decrease of more than 12 points per person.
  • Connecticut, Vermont and Alaska were the only states where residents had an increase to their VantageScore. The highest increase was among residents of Alaska, with a five-point per-person increase.

By understanding state-level changes, financial institutions will be better prepared to handle the different stages of the credit life cycle, from account acquisition to collections.

Financial institutions that proactively understand how changes to a credit score affect their individual account holders and their geographic footprint will be in a better position to develop strategies that will keep their portfolio healthier now and in the future.

VantageScore® is owned by VantageScore Solutions, LLC.


 

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