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Confidential. This presentation is provided for the recipient only and cannot be reproduced or shared without Fair Isaac Corporation's express consent. © 2013 Fair Isaac Corporation. Understanding Credit Worthiness Small Business Lease Credit Assessment Methodology Mary Du Pont Principal Consultant Global Business Consulting October 11, 2013
Confidential. This presentation is provided for the recipient only and cannot be reproduced or shared without Fair Isaac Corporation's express consent. © 2013 Fair Isaac Corporation. © 2012 Fair Isaac Corporation 2 The Re-Evolution of Small Business Lending New opportunities, new risks
© 2013 Fair Isaac Corporation. Confidential. 3 SME Lending Today A transformed landscape requires new perspectives Small business lending has taken a disproportionate hit from the financial crisis The comeback has been slow, but lenders must move fast or lose out to more nimble competitors Equalizers (just a few!) Credit risk requirements tightened Regulations (FCRA, owner data, CFPB impact) Capital requirements (e.g., lending caps for CUs) Model monitoring and validation According to a July 2012 PRMIA survey, 86% of those polled expect to lend more to small businesses – with zero respondents actually saying they would decrease lending to this sector
© 2013 Fair Isaac Corporation. Confidential. 4 The View Through an SME Lens Emerging from a very long, dark tunnel 27.5MM total businesses in the US (according to SBA) 99.9% are businesses of < 500 employees Employ half of all US workers Create 65% of all net new jobs As of Q2 2012, small businesses were tentatively optimistic Reported a net difference of +37% on future expectations for their financial condition (up 8 points from Q1) More small businesses (sales $100K–<$10MM) reported an improvement vs. deterioration in financial condition during the last 12 months American Recovery and Reinvestment Act (ARRA) Small businesses are adding banking relationships Q3: Expanding businesses outnumber contracting businesses for the first time since 2007
Confidential. This presentation is provided for the recipient only and cannot be reproduced or shared without Fair Isaac Corporation's express consent. © 2013 Fair Isaac Corporation. © 2012 Fair Isaac Corporation 5 Understand Credit Worthiness The Five C’s of Credit
© 2013 Fair Isaac Corporation. Confidential. 6 Understanding Credit Worthiness »Today’s objective »Dissect the factors that contribute to risk assessment. »Understand how and why scores are used in the assessment process. »Discuss how lenders decide what risk level to approve. »What is the lessor trying to accomplish? »Accurately predict the future!!!
© 2013 Fair Isaac Corporation. Confidential. 7 Prediction »What is the lessor trying to predict? »Who will pay the lease in a timely manner »Why does this matter? »Cost of funds »Limited funds to lend »Cash flow requirements »Cost of management “Prediction is very difficult, especially if it's about the future” Niels Bohr
© 2013 Fair Isaac Corporation. Confidential. 8 Balance Minimize Pre payment What is the right lease amount and price for my customers? Control Risk Maximize Take-up Reduce Operational Expense Use Exposure Wisely Maximize Profit Control Losses
© 2013 Fair Isaac Corporation. Confidential. 9 Origination Decision Importance Risk mitigation Identify 80% of risk at the point of origination with model usage The remaining risk over the life of the lease comes from Economic conditions Account management practices Competition
© 2013 Fair Isaac Corporation. Confidential. 10 How to Choose? »5 C’s of lending »Credit History- how loans, lines, trades and other debt has been used and paid in the past »Collateral - what is securing the lease »Capacity to Pay – the ability to make the required payments »Character – the willingness to repay »Capital – the liquid assets available to contribute to payments should circumstances warrant
© 2013 Fair Isaac Corporation. Confidential. 11 How Do You Put Together a Winning Hand? »No one card/data element assures a winning hand »It’s the combination that counts »Many ways to put together a winning hand Cre dit Hist ory Cap ital Cap acit y to Pay Coll ater al Cha ract er
© 2013 Fair Isaac Corporation. Confidential. 12 »Historical information about how the applicant has paid others on loans, cards, leases, lines, and trades »How does applicant manage past obligations? »Due to complexity and various sources of data the industry relies on scores to summarize this risk » Removes complex decision rules based on hundreds of potential data elements How Do You Put Together a Winning Hand?
© 2013 Fair Isaac Corporation. Confidential. 13 Other Data Sources »Consumer credit bureau on business owner »Highly predictive »99% hit rates »Traditional business bureau »B2B trade credit performance, public records, firmographics »80-95% hit rates, sometimes no trade lines »Emerging business bureaus »Business credit performance with Financial Services
© 2013 Fair Isaac Corporation. Confidential. 14 160 180 200 140 Scores are Designed to Rank-Order Risk Good Account Bad Account »One of every X »Not which one of the X
© 2013 Fair Isaac Corporation. Confidential. 15 Predictive Characteristics Library of 800+ characteristics Core group of 40 most predictive characteristics
© 2013 Fair Isaac Corporation. Confidential. 16 FICO ® Score Ingredients Consumer Credit Tradelines Inquiries Collections Public Records Age Address Employment Income Gender Business Trade Credit CONSIDERED NOT CONSIDERED
© 2013 Fair Isaac Corporation. Confidential. 17 Bureau Snapshot Scoring date Bureau Snapshot Performance date Development Data 2 years
© 2013 Fair Isaac Corporation. Confidential. 18 FICO ® 8 Score Segmentation Enhanced Core System 4 3 2 1 NoYes Presence of Serious Delinquency/ Derogatory Items ? Return Final FICO ® 8 Score 8 Non-Derogatory Scorecards Return Final FICO ® 8 Score 4 Derogatory Scorecards Thickness of file Age of file Recency of new openings 8 7 6 5 4 3 2 1 Public record Worst rating Credit Bureau File
© 2013 Fair Isaac Corporation. Confidential. 19 Five Categories of FICO ® Score Predictive Characteristics 1. Payment History 35% 5. Credit Mix 10% 4. Pursuit of New Credit 10% 3. Credit History Length 15% 2. Outstanding Debt 30%
© 2013 Fair Isaac Corporation. Confidential. 20 1. Payment History Key Factors »How recent is the most recent delinquency, collection or public record item? »How severe was the worst delinquency—30 days, 90 days? »How many credit obligations have been delinquent? 1. Payment History 35%
© 2013 Fair Isaac Corporation. Confidential. 21 Payment History Example Months Since Most Recent Major Delinquency High Low 0–11 24–3536–47 48–High No Delq Risk 12–23
© 2013 Fair Isaac Corporation. Confidential. 22 2. Outstanding Debt Key Factors »How much does the consumer owe creditors? »What percentage of available credit card limits is the consumer using? »What percentage is outstanding on open installment loans? 2. Outstanding Debt 30%
© 2013 Fair Isaac Corporation. Confidential. 23 0-19%40-59%60-79%80-99%100+%20-39% High Low Ratio of Total Balances to Total Limits on Revolving Accounts Risk Outstanding Debt Example
© 2013 Fair Isaac Corporation. Confidential. 24 3. Credit History Length Key Factors »How long have accounts been established—average number of months accounts have been open »New accounts—number of months since most recent account opening 3. Credit History Length 15%
© 2013 Fair Isaac Corporation. Confidential. 25 0–2324–4748–7172–119120+ High Low Risk Number of Months Since Oldest Revolving Account Opening Amount of Credit History Example
© 2013 Fair Isaac Corporation. Confidential. 26 4. Pursuit of New Credit Key Factors »Inquiries: Number of recent inquiries (12 months) »New accounts—number of trade lines opened in last year 4. Pursuit of New Credit 10%
© 2013 Fair Isaac Corporation. Confidential. 27 Pursuit of New Credit Example 234–High 01 Young/Thin filesMature/Thick files High Low Risk Number of Inquiries
© 2013 Fair Isaac Corporation. Confidential. 28 Types of Inquiries »FICO ® Scores only consider consumer-initiated inquiries for credit posted in the last 12 months »FICO ® Scores do not consider the following inquiries: »Promotional inquiries »Account review inquiries »Consumer disclosure inquiries »Insurance inquiries »Employment inquiries
© 2013 Fair Isaac Corporation. Confidential. 29 »Lack of bankruptcy or liens or public records »This is still common knock out criteria » Separate minor from major issues » Amounts and source vary by organization (i.e., do not count a mechanical lien less than $400) Credit History
© 2013 Fair Isaac Corporation. Confidential. 30 Credit History »Guarantor FICO 8 score »Ranges from 650 to 680 »Various ways to use multiple guarantors » “At least one with” » Use of best or worst » Method must be validated with analysis »Some still require guarantors regardless of business type » Becoming less competitive especially for corporations or professional groups »Business scores »MDS » 600 to 650 or higher »SBSS »Commercial Intelliscore »Etc.
© 2013 Fair Isaac Corporation. Confidential. 31 Consumer Credit Questions »Commercial credit card are not reported to the big three national credit repositories? True False »Carrying a lot of debt won’t lower my credit score as I have high income? True False »That charged off credit card was the fault of my business partner, so it won’t affect my score. True False »Most lenders don’t place a lot of weight on my personal credit when making small business lending decisions. True False »Being several days late on my personal credit payments now and then is ok and won’t have much impact on my credit score? True False
© 2013 Fair Isaac Corporation. Confidential. 32 Personal Credit and FICO ® Score Matters »It’s predictive »Most small business owners have a credit history/FICO Score »It’s convenient, easy to access and provides the lender with a “common” measurement »Lenders may access and use it as a “stand alone” evaluation tool or incorporate it with other information about your business Impact of Data Sources on Predicting Small Business Credit Risk
© 2013 Fair Isaac Corporation. Confidential. 33 A Complete Picture »Check your personal FICO Score and credit profile frequently at www.myfico.com to ensure data accuracy and to understand what areas need focus to increase your FICO ® Score www.myfico.com »Understand what information is contained on your business credit profile, take action to build it up and monitor it overtime »These actions can help your present the most complete picture of your credit risk to lenders and facilitate the loan application process
© 2013 Fair Isaac Corporation. Confidential. 34 Value of Data Sources Varies Depending on Size of Business High Business Personal Size of Business Low Data Value Small Large
© 2013 Fair Isaac Corporation. Confidential. 35 »Principal Data »Application »Consumer Credit Report »Traditional Business Data »Application »Financials »D&B, Experian Reports »Deposit, Other Bank Relationships »Small Business Repositories »Loans, Leases »Lines »Cards Total Score “170” SBSS Scores
© 2013 Fair Isaac Corporation. Confidential. 36 Judgmental Review »Why review applications for some scores and not for others?
© 2013 Fair Isaac Corporation. Confidential. 37 Credit History »Supplement to guarantor scores »Thin files, low data volume »Minimum trades 2-5 »Time in file similar to Time in Business »Don’t try to “confirm” the score with credit history rules unless analytically determined to add predictive lift for your book of business, e.g.: »Count and severity of derogatory rating »Revolving utilization »Inquiry counts »Guarantors will generally have lower FICO 8 scores than average consumers »Blended use of personal and business credit leads to higher balances, higher utilization, more frequent mild delinquency
© 2013 Fair Isaac Corporation. Confidential. 38 Capacity to Pay »Examination of the cash flow to determine if there are funds available after current obligations »Bank statement »Tax returns »Full financials used as credit enhancements »Audited financials used for larger tickets » Comparable trades still used, but biased against growing businesses or new business and can be replaced with financials » Bank balances stated or verified over several months » Cash flow limits in the 1.2 to 1.5 range
© 2013 Fair Isaac Corporation. Confidential. 39 Collateral »What is the equipment worth today? »What is the fair market value? »If it had to be sold tomorrow what would it be worth? »If it had to be sold in 3 years what would it be worth »What is morale hazard and how can it be avoided? »In economic theory, a moral hazard is a situation where a party will have a tendency to take risks because the costs that could incur will not be felt by the party taking the risk. In other words, it is a tendency to be more willing to take a risk, knowing that the potential costs or burdens of taking such risk will be borne, in whole or in part, by others.
© 2013 Fair Isaac Corporation. Confidential. 40 Sample Policy Construction Time in BusinessMinimum of 7 years SBSS ScoreMinimum of 180 FICO Score700 or higher Bank BalancesLast 3 months, medium 5 figures Collateral RequirementsNo more than 20% after market items Loan to Value Ratio80% What does this policy really require? 1.Credit History? 2.Capacity to Pay? 3.Capital? 4.Collateral? 5.Character?
© 2013 Fair Isaac Corporation. Confidential. 41 How Can You Help? »Ask for and understand your Lessor’s requirements »Complete information »True legal name of business »Fully explain the deal »Your lessors want to approve as many leases as possible »Within their risk tolerances »With the needed return on investment »In a manner that creates results that can be forecasted
Confidential. This presentation is provided for the recipient only and cannot be reproduced or shared without Fair Isaac Corporation's express consent. © 2013 Fair Isaac Corporation. 42 THANK YOU Mary Du Pont Principal Consultant FICO Global Business Consulting firstname.lastname@example.org October 11, 2013
Confidential. The material in this presentation is the property of Fair Isaac Corporation, is provided for the recipient only, and shall not be used, reproduced,
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