The Newsletter on Credit, Data and Analytics

Reeling In New Business

WITH ADDED COMPETITION AND TIGHTER REGULATIONS, LENDERS RESTORE MARKETING METHODS FOR GROWTH - P4

SPRING 12

U.S. INCHES CLOSER TO ADOPTING CHIP CARDS - P3 EXECUTING EFFECTIVE VALIDATION IN 2012 & BEYOND - P6 HOW ONLINE ACCOUNT OPENING INFLUENCES RISK - P10 WITH A DIRECTOR IN PLACE, CFPB RAMPS UP - P11

Welcome

Dear reader, Im sure you are familiar with that over-used phrase to describe what most pundits believe is the single greatest factor that impacts Presidential elections. Of course Im referring to the axiom that its the economy stupid that will, in large part, drive which candidate voters choose. As I write this, the current headline in most newspapers is that the jobless rate in the U.S. is at a three-year low and that for the second straight month the economy added more jobs than expected. Consumer credit risk is also materially improving. Default rates for the major consumer loan categories (mortgage, auto, RV, marine and credit card) are on the decline. To wit, according to a VantageScore Solutions study, in 2008 the overall default rate stood at 7.7 percent. In 2010, the rate increased to 10.3 percent. Last year showed improvement as the overall default rate dipped back down to 9.0 percent. Even the mortgage origination market, which admittedly faces many hurdles and challenges, is improving. In a recent study, we found that the likelihood that a borrower will become 90 or more days past due after a mortgage origination was 2.5 percent in 2011, far lower than in 2009 where it hovered at 7 percent. Thats an improvement of more than 60 percent a signal to mortgage finance companies that it is now time to increase originations. I will leave the guess work to the pundits as to the question of how economic conditions will impact the Presidential election, but the broader point is that there are reasons to prepare for a period of growth with cautious optimism. This issue of TradeLines aims to arm you with some new tools to do just that. Included are articles about how a new examination manual issued by the Consumer Financial Protection Bureau could impact providers of consumer financial products and services. Also included is a story about new chip and PIN technologies available for debit cards, and an interesting piece on marketing strategies for targeting consumers with differentiating default risks. Our trend piece centers on the risk profile of online versus branch depositors and Im also delighted that our very own Sarah Davies, who heads research, analytics and product development at VantageScore Solutions, has contributed a how-to article for executing a model validation in light of recent new guidelines from the Office of the Comptroller of the Currency. Im sure you will find the content interesting and relevant. Thank you for your interest in reading TradeLines. All the best, Barrett Burns, President/CEO VantageScore Solutions, LLC
P.S. To insure that you continue to receive TradeLines, please register for your complimentary subscription by visiting www.vantagescore.com/TradeLinesRequest or by sending your mailing information to tradelines@vantagescore.com.
TradeLines is published by Royal Media Group on behalf of VantageScore Solutions, LLC. For more information about VantageScore, e-mail info@vantagescore.com or visit www.vantagescore.com. Royal Media Group can be found at www.royalmedia.com. 2012 VantageScore Solutions LLC.
Register for your complimentary subscription to TradeLines by visiting www.vantagescore.com/TradelinesRequest or by sending your mailing information to tradelines@vantagescore.com

CARD PLAYS:

As Security Concerns Mount, U.S. Issuers Are Taking EMV More Seriously

REELING IN NEW BUSINESS:

Lenders Strive to Up Originations by Reviving Marketing Efforts

PERFECTING THE MODEL:

Executing Effective Validation In 2012 & Beyond

DIGITAL DEVELOPMENTS:

With Digital Channel Usage Growing, Credit Risk Questions Arise

THE NEW RULES:

How the appointment of a CFPB Director Shifts Risk Assessments

3 4 6 10 11

Cards

Card
BY LAURI GIESEN

As Threat of Payment Fraud Mounts, U.S. Inches Closer to Adopting Chip Cards with PIN Numbers

hile the rest of the world has been speeding toward the implementation of chips in credit cards, the United States has been in the slow lanes but that could be changing soon in the U.S. because of mounting security concerns. Europe and some nations on other continents now require that financial institutions that issue credit cards adopt the Europay MasterCard Visa (EMV) standard, a chip card specification. While the U.S. has thus far resisted adoption of EMV cards, there have been significant efforts to indicate that, however slowly, the U.S. is moving toward use of chip cards with personal identification numbers because the payment method is more secure. Use of chip cards has dramatically reduced fraud risk in many other countries by eliminating the ability for fraudsters to produce counterfeit cards. And the use of PINs, instead of signatures, to validate the identity of the the card user, can also reduce fraud by improving authentication, fraud experts say. Without the heightened security of EMV, the U.S. will increasingly be targeted with fraud. A lot of people believe that if the rest of the world is taking strong measures to prevent fraud that will make the U.S. more vulnerable to fraudsters and drive up the fraud rates here, says Paul Tomasofsky, president of Montvale, N.J.-based Two Sparrows Consulting. That threat is likely to put pressure on the U.S. to adopt chip cards with PINs. Furthermore, in the past year, Visa has announced incentives for both financial institutions that issue credit cards and merchants that accept them to move toward chip cards. MasterCard also recently rolled out its EMV roadmap too. Now, some banks are looking to chips for the future. We are committed to the adoption of the EMV standard and we have begun to develop our roadmap, says Eric Schindewolf, product manager of EMV cards for Wells Fargo Bank. But while the maps may be in hand, few banks have gotten on the highway yet. Only a handful have announced issuance of any chip cards at all, including Wells Fargo, JP Morgan Chase, Bank of America, and U.S. Bancorp. Furthermore, most of these banks have only issued them to international travelers to use overseas, which is in response to complaints from some Americans who cannot use magnetic-stripe cards abroad. The new cards include both mag-stripes for U.S. use and chips for use overseas.

That said, the base of customers with chip cards is expected to expand. The State Employees Credit Union, for example, initially issued debit cards with chips only to customers who traveled internationally, but then later converted all of its debit cards to chips about 1 million cards. We want to be prepared for the future, says Leanne Phelps, senior vice president of card servicers. The credit union wants to convert its mag-stripe cards over to chip as soon as its processor can accommodate the conversion, Phelps adds.

RETAILER RELUCTANCE
Similarly, Wells Fargos efforts to expand its base of chip cards have so far been stymied by U.S. merchants who refuse to install terminals that can read chips. We want to migrate toward chips, but we can only move at a speed that is appropriate with merchant acceptance, Schindewolf says. Incentives and mandates announced by Visa last August are expected to prompt greater merchant acceptance of chips. Visa is requiring that merchant processors support chip-based transactions by April 2013. Also, Visa has shifted the liability for fraudulent transactions made on counterfeit cards. Card issuers have always been liable for such transactions, but now, if a fraudulent transaction is made on a counterfeit card that had a chip, but the chip could not be read by the merchant, the merchant is liable. Still, despite the chip incentives, not everyone is convinced the U.S. market will move in that direction quickly. David Porter, general manager of Chase Card Services, says bank efforts to accommodate card transactions made from cell phones could divert attention away from EMV. Such programs for near-field contact payments made from mobile phones will involve chips, but the chips will be in phones, not cards. Mobile transactions cloud the position the U.S. will take toward EMV as the platform developed for mobile payments may not be the same as EMV, Porter says. But others believe mobile and EMV will be compatible. There is a great opportunity for financial institutions to lay the infrastructure now for emerging payments so that both contactless and EMV can be accommodated, says Jennifer Fischer, head of Visas U.S. payment risk team.

Spring 2012

TradeLines

Reeling In
With Added Competition and Tighter Regulations, Lenders Restore Marketing Methods to Recruit New Customers
now competitively while you look at the mail volume, mail volume is returning dangerously close to sort of where it used to be. And by the way, that doesnt even show that a lot of the marketing has moved to the internet. Though Capital One declined an interview on precisely how it markets to consumers across the credit spectrum, a spokesman tells TradeLines that the company relies on its internal data to help determine which course to take. We are a full spectrum lender and use multiple marketing channels, leveraging our proprietary information-based strategy to make offers based on a variety of factors, he says. Those marketing efforts appear to be on an upswing for industry players. Discover Financial Services also recently clued players into an intensifying marketplace. I do feel like many of our competitors who cut way back on their marketing have restored a lot of that marketing, and I dont think the marketing intensity is or is likely to go as high as it was before the great downturn and the consolidation in the industry, said David W. Nelms, chief executive, during the companys fourth quarter 2011 earning call. But I think were back to the new normal, if you will, in terms of competitive intensity, and our marketing, I would say, is the same.

Marketing

BY MARY WISNIEWSKI

CREDIT CARD CRAZY

n the wake of the credit crisis, lenders are striving to acquire more business, with credit cards capturing the eyes of some issuers as one such product to help them achieve growth.

Direct and HSBC credit card portfolios as vehicles for strengthening and expanding its card activities. Theres opportunity to gain share, said Chief Financial Officer Gary Perlin on the call, according to a Seeking Alpha transcript. You can get a chance to build these annuities that last a long, long time. And so I would characterize the card market right

The card business has gone relatively wild lately, says Jim Marous, senior director of marketing services at Harland Clarke Marketing Services and author of the Bank Marketing Strategy blog. Translation: Issuers are somewhat relaxing underwriting criteria. [Issuers] are starting to lower the bar ever so slightly in whom they are approving in

Take Capital One Financial Corp., for example. During its third quarter 2011 earnings call, the lender gave airtime to its credit card business, citing pending acquisitions of ING

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Spring 2012

Marketing
order to expand the customer base, says Bill Hardekopf, chief executive of LowCards. com. Its a very heated area for good or excellent credit. But credit cards arent the only product for which lenders are reviving marketing efforts. Indeed, Experian has been observing an expanding lending universe. Lenders that are in the subprime space are learning to expand their share into the near-prime spectrum, whereas typically prime lenders are dipping into a slightly riskier portfolio, says Michele Pearson, Experians vice president of prospecting and scores. Expansion of loans is somewhat agnostic to the product category, too. Weve started to see even some mortgage lenders start at their growth efforts, she adds. But that does not mean the subprime space is moving back to pre-recession days. Indeed, Experian says there is very little activity in lending credit in the subprime space, unless a lender is already specifically in the vertical. Take bankcards, for example. Experian data shows that 29.1% of originations were nonprime in the second quarter of 2011, down from 40.8% in the same quarter of 2007. buys Product A and Product B, the model would show the likelihood of buying Product C, Cox says. His goal is to apply that formula to the financial services environment. Using activity-based modeling sets BBVA Compass somewhat apart from its peers, because most banks use geography and clustering-based segmentation, Cox says. Activity-based modeling is a lot more accurate and telling, he says. But its a lot more difficult to do... Were trying to evolve into consumer needs versus the product needs, he says. Post recession, keeping the customer more in mind has been key to lenders strategy, with many choosing to market financial responsibility within their selling efforts. Ally Bank, for one, touts the message, No nonsense just people sense, while also emphasizing its 24/7 customer service portal as a primary marketing message, Beth Coggins, director of public relations and community relationships, tells TradeLines. Ally declined to comment on its marketing budget or whether it has a metric in place that measures cost per customer. Though details were scarce, the direct lender has no intentions of making any significant changes from the past in 2012, Coggins says. Ally might be the exception. As the credit crisis has left plenty more consumers with less solid credit, some lenders marketing strategies have had to change with the times. The biggest difference is over the last five or six years, [a lender] could do a blast marketing campaign and had confidence that it would generate tolerable risk levels, says Harlands Marous. These days, such blanket blasts would catch consumers in foreclosures or in other non-creditworthy situations, and as such, banks are shying away from the practice. Instead, according to Marous, banks are mostly fighting for the wallets of better credit consumers. Banks are dying for loans, he says. The biggest challenge is looking for unique pockets out there.

One way to search for new customers? Staying tuned to people who have recently moved to a new home. New movers have a desire for loans, Marous says. As lenders start thinking about marketing to consumers in the subprime turf, meanwhile, touting consolidation and lowering the cost of credit becomes a major marketing message theme, Marous says. Beyond the actual message, the delivery method should reflect the credit tier, too. Though with regard to credit risk nothing is vanilla, the channels lenders use to market to consumers should depend on consumers creditworthiness, especially subprime consumers, says Steven Kietz, general manager and executive vice president of strategic partnerships at EDO Interactive. Indeed, the lowest end of the credit spectrum identifies best with text messages and point-of-sale messaging. Theres been a big growth in text messaging for the 550-and-lower credit scores, he says. The group is harder to reach because its members tend to be transient, Kietz says. Its more complicated for a marketer to reach those consumers. You cant get an address for someone sleeping on an aunts couch.

MARKETING WAYS
Marketing across the credit spectrum depends on the lender, but ultimately, most strive to ensure that marketing messages resonate with their needs at any given moment. There are lots of different ways to tailor messages in terms of assessing past behavior, Pearson says, adding that communication segmentation isnt necessarily based on a consumers risk band as much as it is based on characteristics like attitude and behavior. BBVA Compass, a Birmingham, Ala.-based financial institution, is working to apply an activity-based modeling approach to grow its business, along with building a worldclass campaign management system. Thats a huge undertaking, says Emmett Cox, senior vice president of consumer and business intelligence at BBVA Compass. One of the big to-dos for the lender? Taking a look at the next best sell, next best offer for customers, says Cox. Such an approach mimics retailers modeling sensibilities. In the retailer environment, if a consumer

But I think were back to the new normal, if you will in terms of competitive intensity, and our marketing, I would say, is the same.
David W. Nelms, chief executive at Discover Financial Services, on his fourth quarter 2011 earnings call

Spring 2012

TradeLines

Modeling Risk

Perfecting
BY SARAH DAVIES
Senior Vice President of Analytics, Research, & Product Management at VantageScore Solutions

Executing Effective Validation in 2012 & Beyond

ne of the key components to successfully utilizing risk management models and decision analytics is an effective validation. When executed properly, model validations verify that models are performing according to expectation within their original design and purpose. Effective validations also confirm that models remain sound, even amidst changing environments, while identifying and measuring the impact of any potential limitations or errant assumptions. Regulators are also stressing the importance of model validation. In April 2011 the Office of the Comptroller of the Currency (OCC) expanded long-existing guidelines about model validation in response to the lending industrys increasing reliance on models to drive decision making. As part of its guidance, the OCC explicitly recommends that financial services firms utilizing predictive models and decision analytics perform regular validations to gauge model efficacy. The OCCs guidelines apply both to lenders that utilize proprietary models and, importantly, those that use vendor generated models where there might not be the same transparency and understanding in terms of how the model was built. VantageScore Solutions recently completed its own validation of VantageScore 2.0, the models second version, and enhanced its validation execution in accordance the OCCs expanded guidelines. A webinar was then hosted in conjunction with American Banker to discuss the results and help risk managers perform their own validations in light of the OCCs guidance on model risk management. The webinar is available online at www.VantageScore.com/research. A synopsis of the event is presented here.

applications. Such treatment affords cleaner processes that allow the validation team within organizations to operate objectively. A trend among larger institutions is to acknowledge the seniority of the role responsible for model validation and the importance of that person having access to the chief executive officer and the board. These individuals and teams will routinely examine whether risk-management models and processes are fair, transparent, and appropriately used in the context of a lenders business. Many of these institutions have created roles such as chief model compliance officer or chief risk officer. Most smaller institutions are still trying to work through how to develop and identify the appropriate resources for model compliance. While there is no prescribed method for analyzing risk, validation teams can follow several generally accepted principles. Materiality is a significant issue as a starting point. What is the organizations risk appetite? In a statistical sense, how much mis-estimation can be tolerated? Whats the appetite for financial risk? When does too much risk within the business model really impact P&Ls? And what is the reputational risk? These are critical questions to address before the validation is begun.

EFFECTIVE VALIDATION
An effective validation can focus on three major themes: (1) conceptual soundness, (2) ongoing monitoring, and (3) outcome analysis. Validation teams need to be intimately familiar with the architecture of the segmentation, the actual data that was developed and synthesized to feed the model, and the initial developments performance. This occurs organically when a lender has developed its own model, but for those using third-party developed models it is incumbent upon lenders to conduct due diligence to understand how each model they use is designed. Much of the necessary information can be provided by the vendor. Upon receipt, understanding the models assumptions is important.

ASSESSING RISKHOLISTICALLY AND ROUTINELY

One of the flagships of the OCCs validation guidelines is the idea of having effective challenge, which is the notion that lending institutions should treat validations as an independent function outside of model development and even outside of model

TradeLines

Spring 2012

Modeling Risk
Are the assumptions intuitively correct? Is there sufficient transparency in terms of why the model is performing the way it does? Veiled answers are unacceptable. Secondly, the concept of ongoing monitoring can be built into the process. This includes routinely drilling down into the performance of the model ensuring that the model is rank ordering within the right markets and on the right products. Questions to ask include whether there are various consumer or product segments performing in the appropriate ways and if it is possible to create better reporting systems. Ideally this will include dedicated resources, which underscores the OCCs desire that validations become a priority level function. The goal is to understand how and where a models potential errors are exposing a business to unexpected risk as well as the impact of those errors. Thirdly, the meat of the validation is in its testing, or outcome analysis. The OCC describes effective outcome analysis to include the following: Backtesting, which analyzes whether the model predicted what actually happened; Benchmarking, which compares a models performance with other models in the marketplace; Stress testing, which looks at how the model performs in high-risk areas; and Sensitivity analysis, which evaluates the impact of small changes in the input data. VantageScore Solutions performs these tests as a matter of routine and provided here is a roadmap that risk managers can use to shape their validation procedures. Keep in mind that implicit in the OCCs guidelines are recommendations to drill down to understand the details behind the outcomes. Unexpected results should trigger analysis of what has happened and whether the model is still performing within the organizations tolerance. VANTAGESCORE 2.0

KOLMOGOROV-SMIRNOV MEASUREMENTS
EXISTING ACCOUNTS
100% 100%

NEW ACCOUNTS
Cumulative % of Consumers
80% 60% 40% 20% 0%

Cumulative % of Consumers

80% 60% 40% 20% 0%

50

KS=60.73

KS=55.48

70

50

911-9 50 951-9 90

70

711-7 50

751-7 90

711-7 50

631-6 70 671-7 10

631-6 70 671-7 10

751-7 90

871-9

551-5

Score Range Cumulative % Good Cumulative % Bad

551-5

Score Range Cumulative % Good Cumulative % Bad

ROC-CURVE TEST RESULTS

EXISTING ACCOUNTS
100 80 60 40

NEW ACCOUNTS
100 80 60 40

Cumulative % of Bads

Cumulative % of Bads

C=0.88
20 0 0 20 40 60 80 100 Cumulative % of Goods

C=0.86
20 0 0 20 40 60 80 100 Cumulative % of Goods

INDUSTRY
OVERALL BANKCARD FINANCE REVOLVING INSTALLMENT AUTO RETAIL REAL ESTATE DEPARTMENT STORE CREDIT UNION

NEW ACCOUNTS
55.45 63.99 40.89 58.54 49.54 46.92 51.62 55.80 52.26 45.90

EXISTING ACCOUNTS
60.73 63.02 49.44 63.06 49.75 51.30 63.17 59.68 64.95 58.54

BACKTESTING
Numerous metrics may be employed for backtesting, which might surprise some risk managers that are accustomed to the industry mainstay: the Kolmogorov-Smirnov (KS) statistic. A KS measurement looks at the cumulative percentages of good consumers and bad consumers (defaulting and current borrowers) and identifies the point at which theres the greatest separation of those two distributions. However, its also important to go beyond an examination of a single point on a credit score models range so that the validation affirms there is proper separation throughout the distribution. Supplementing the KS measurement is the trade-off curve, or ROC curve. It measures the quality of the distribution. Within this tool, risk managers examine the C-statistic, whereby a score of 1 equates to perfection and .5 equates to complete randomness. When used in conjunction with one-another, these back tests provide tremendous confidence in how a credit score model is performing, both in terms of identifying goods and bads in an absolute fashion but also along the entire distribution. The following charts demonstrate how these two measurements were utilized when a validation was performed on the VantageScore 2.0 model.

As demonstrated, the KS values show that the model is doing an excellent job of pulling the goods to the top of the distribution and the bads to the bottom, which allows lenders to more effectively manage risk, and the trade-off curve demonstrates the models separation across the entire distribution. Across all industries, the model is performing similarly, as demonstrated by the KS results above.

BENCHMARKING
The next question to address is whether the model provides the absolute best results available. This is where benchmarking may be employed. In the credit scoring industry, benchmarking determines how a model performs against other competitive models, both in-house, proprietary models and those provided by third parties. For example, VantageScore 2.0 is measured against the best credit score models from each of the three largest credit reporting companies (CRCs). As the chart below shows, for mortgage originations, there
Continued on page 8

Spring 2012

TradeLines

871-9

911-9 50 951-9 90

791-8 30

791-8 30

30

10

30

90

501-5

831-8

501-5

90

831-8

591-6

591-6

10

Modeling Risk
in geographic regions of the country that experienced varying degrees of unemployment and home price depreciation. The yellow bar represents regions that have both high unemployment and high rates of home price depreciation, which is where accurate predictive performance can be harder to achieve due to volatility. The KS results for VantageScore 2.0 remain strong across the high and low stress regions. This test can be tailored to a risk managers own business. For example, instead of geographic regions one might test certain products where the risk may vary.

Continued on page 7

is exceptionally strong performance, with VantageScore 2.0 outperforming the CRC models in a range from eight percent to 12 percent. The average range of outperformance is three percent to four percent across the board for most of the key industries.

NEW ACCOUNTS 2009-2011

VANTAGESCORE 2.0 KS VALUE IMPROVEMENTS
VantageScore % Improvement INDUSTRY VantageScore 2.0 CRC1 CRC2 CRC3 Min Max

SENSITIVITY ANALYSIS
54.4 63.3 39.9 56.9 48.9 43.9 49.1 52.0 49.3 43.1 54.0 63.3 38.5 56.8 48.8 43.5 48.6 49.8 48.6 43.0 54.1 63.1 39.4 56.9 49.1 43.9 48.6 51.5 48.4 43.3 2% 1% 3% 3% 1% 7% 5% 8% 6% 6% 3% 1% 6% 3% 2% 8% 6% 12% 8% 7%

OVERALL BANKCARD FINANCE REVOLVING INSTALLMENT AUTO RETAIL REAL ESTATE DEP. STORE CREDIT UNION

55.5 64.0 40.9 58.5 49.5 46.9 51.6 55.8 52.3 45.9

Another test useful for an effective validation is determining model sensitivity to differentiating data inputs. For a third-party credit score model, sensitivity analysis can be viewed in two ways: 1. The impact from small differences in consumers credit files at the three CRCs. 2. The impact from changes in consumer payment behaviors that have occurred since a model was developed. Exposing a third-party consumer credit scoring model to small data variances in consumer credit files among the three CRCs is an important way to measure sensitivity. If the test results in wide variance among scores, then a portfolio may be exposed to hidden risk because the model has potentially become unstable. The VantageScore model uses a single algorithm with leveled characteristics across all three CRCs, which limits score variance. Model stability across the multiple data sets is proven by KS results, which show consistent accuracy in predicting performance, regardless of which CRC the data is pulled from. The graph below shows the percentage of consumers whose score difference is less than 40 points between the CRCs when VantageScore 2.0 is employed. The scores generated are highly predictive and highly accurate across the three CRCs, thus allowing lenders to have the confidence that a consumer will fall under the same risk bracket regardless of the data source.

By and large, when lenders are comparing their models to others, its important to conduct enough benchmarking to feel confident theyre getting the best possible results from the best available tools.

STRESS TESTING
Ensuring a model doesnt break down in the most volatile conditions is very important as well, especially as the lending industry emerges from just such an environment. As part of the validation exercise for VantageScore 2.0, the model was exposed to stress testing. Demonstrated below, the validation examined performance

SENSITIVITY ANALYSIS: CONSISTENCY

CONSISTENCY WITHIN A 40-PT RISK BAND
100% 90%

GEOGRAPHY - EXISTING VS. NEW ACCOUNTS

VALIDATION STRESS TEST
65 60

80% 70% 60% 50% 40% 30% 20% 10%

KS Results

55 50 45 40 35 Exis ng GEOGRAPHIC KEY: Home Price Deprecia on

High (>15%) Low (<15%)

New Unemployment
High (>9.5%) Low (<9.5%)

0%
CRC1- CRC2 CRC2- CRC3 CRC1- CRC2

H-H H- H L-H

H-L L-L

Development 2006-2009

2008-2010

2009-2011

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Spring 2012

Modeling Risk
Sensitivity measurement can also show patterns over time. An interpretation for users of third-party consumer credit scoring models is its ability to remain predictive over a time period where payment behaviors may have changed. This chart shows VantageScore 2.0s performance improvement over the past two years versus its performance at development. While some deterioration in the auto lending sector occurred, credit card and mortgages have improved 14 percent and 16 percent respectively.

The real estate industry also is experiencing a shift. In the case of the most current timeframe, data shows that there was over a 60 percent reduction in defaults as compared to the original development window. Moreover, the total number of credit inquiries is reduced by about one-third, and there also was one-third fewer opened bank cards with a significant reduction in bank card balances. Consumers appear to be contracting or reducing their credit footprint, suggesting that they are now more likely living within their credit footprint. Intuitively, consumers are now living within their credit or cash profile and not extending themselves into risky situations. Fundamentally thats driving lower risk and more stable behavior. Based on the results of the validation and the tightening of credit markets, the chart below suggests it may now be time to expand lending strategies in order to capture more borrowers that have behaved conservatively. The dotted-green line exemplifies how the development default rate was higher than the validations default rate, signaling to lenders an optimal pool of prospective borrowers.

SENSITIVITY ANALYSIS: ACCURACY

DEVELOPMENT VS. 2010 & 2011
70 60

KS Result

50 40 30 20 10

REAL ESTATE VALIDATION

VANTAGESCORE 2.0
50% 45%
10%

90+Days past due rate

0
OVERALL BANKCARD AUTO REAL ESTATE

Development 2006-2009

2008-2010

2009-2011

35% 30% 25% 20% 15% 10%

6% 4% 2% 0% -2%

DRILL DOWN
As the VantageScore validation team engaged these tests, key findings included that the model is more accurate overall and particularly in the credit card and mortgage industries. Additional findings reflected statistically insignificant drops in performance. Rank ordering remained effective throughout. An assessment of the input data reveals there has been a significant shift in the composition of the marketplace, which gives some context to the performance. The volume of subprime originations in the auto finance industry is increasing. Offsetting this is an overall improvement in default rates. The chart below demonstrates a reduction in default rates in the subprime score band in particular, thus there is little likelihood of a material impact to a portfolios P&L ratio.

5% 0%
-4%

CONCLUSION
Clearly, validations are becoming a much larger priority for the lending community as the OCCs guidelines are taken to heart. It will take some getting used to. Budgets and priorities will be shifted. For small lenders its a whole new world. Central to the guidelines is the quest to continually ensure risk models are accurate, fair, and transparent, and that actionable results are reviewed by those with the power to affect change. Much more on this topic is available in the web seminar online at www.VantageScore.com/research.

AUTO VALIDATION
VANTAGESCORE 2.0
35%
4.0%

90+Days past due rate

30% 25% 20% 15% 10% 5% 0%

2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0%

O/U Rate Dierence

Score Range Development Valida on O/U

3.5% 3.0%

The VantageScore model leverages the collective experience of the industrys leading experts on credit data, credit risk modeling and analytics to provide lenders and consumers with a more consistent, highly predictive credit score. Developed as a joint venture among the three major credit reporting companies (CRCs) Equifax, Experian and TransUnion, VantageScore marks the first time that the three companies joined forces by combining cutting-edge, patented and patent-pending analytic techniques with an intuitive scoring scale, producing a model that offers more consistency across all three CRCs and has the ability to score more people. The entire web seminar, including many more graphs and participant questions, is available online at www.VantageScore.com/research

Spring 2012

TradeLines

O/U Rate Dierence

40%

Score Range Development Valida on O/U

8%

10

Online Banking

Developments
BY MARY WISNIEWSKI
You never get a second chance to make a first impression. Thats why BBVA Compass decided to roll out a new online banking platform in January. Eighty percent of consumers who buy [financial services] will come to the site first, says Jennifer Wilson, BBVAs senior vice president and director of the online channel. Not only that, but theres a growing trend of consumers coming online to open accounts, she adds. Though the online effort means BBVA is missing out on face time with its new customers, the quality of consumers opening accounts online has been high for the institution, which bodes well for credit risk. They are younger, more affluent customers coming through the channel, she says. BBVA Compass is not alone in its findings. Andera Inc., an online account opening and customer acquisition vendor, published research that showed online banking account openers are 70% to 90% more likely to be in the 18-to-24 and 25-to-34 age brackets when compared with the full population of those within the same geographic footprint. Additionally, the May 2011 research culled from 500 financial institutions showed that online account openers are 20% to 40% more likely to earn more than the overall population. Novantas LLC takes the research a step further. In analyzing virtualdomiciled consumers defined as those who have eliminated branch visits from their daily banking activities the consultancy found that the group exhibits average or better-than-average profitability and product ownership than their peers. Though that seems to imply lower risk for the bank, the firm has yet to delineate whether online account openers credit risk trends better than in-branch openers. A report on the subject is due soon. Meanwhile, financiers continue to rely on web-based banking platforms. The online channel is very important to us, says Hal Coxon, vice president of sales and marketing at Waukegan Ill.-based Consumers Credit Union. In fact, the credit unions goal is to lower its in-branch deposit account openings to 40% by 2013. To date, half its customers open deposits through its six branches. In 2011, 39.5% of its accounts were opened online, compared with 17.7% in 2010. To mitigate risk from online deposit openers, Coxon says the credit union approves and reviews aspects of applications manually. With plans to start issuing credit this year, the credit union first must gain some comfort in granting loans digitally and adjust underwriting accordingly. It would be foolhardy to underwrite properties in areas you are not familiar with, he says. Nonetheless, debuting more robust online services is crucial, as each generation becomes less tethered to a physical facility, Cox says. As digital channels become more widely used, lenders must stay tuned to possible new risks. Novantass Partner Kevin Travis, for one, has already noticed that online banking customers typically maintain different attitudes toward their institutions. They tend to be more likely to switch banks because of service issues versus product or pricing, Travis says. This dynamic could affect how lenders underwrite that population, as financial institutions make more money when consumers remain on their books longer. When it comes to online banking services, community banks face a greater business opportunity than do larger institutions simply because the technology allows them to tap into a wider applicant pool. That opportunity comes with additional portfolio risks as the customer pool expands. Technology puts people on an even playing field, says Travis. In turn, banks must stay tuned to the fact that offering digital channel services means the additional risk of losing direct consumer contact, which may eliminate data points gleaned from personalized relationships. There is a degree of risk that comes with that, says Marc Schwanhausser, senior analyst multi-channel financial services at Javelin Strategy & Research, a consultancy. On the other hand, Travis of Novantis contends, knowing consumers in person is somewhat irrelevant to credit risk. Were long past that, he says. Identity today is documentation. I am who I am because I have the documents to prove it. Though banking professionals agree that physical branches provide some benefit for new depositors and for underwriting certain loans, they also know institutions cant go without the online service, says Javelins Schwanhausser. Consumers will come to the online channel thinking they should be able to do most of the stuff they do at a branch. For banks like BBVA, physical branches enhance the brand. The branch network is a huge factor in how well customers know us, Wilson says. The greatest percentage of applicants online comes from Texas, the state in which BBVA Compass has the most physical branches. But that connection might not always be true. Travis, for one, expects consumers to become more ambivalent about the availability of multiple locations simply because they arent frequenting physical branches and banks cant afford non-trafficked presences. If a branch is an $800,000 billboard, thats a pretty expensive billboard for most places, says Travis. Fundamentally, theres a huge shift going on.

Technology puts people on

Kevin Travis, Partner, Novantas

TradeLines

Spring 2012

Regulation
ith Richard Cordray now in the directors chair, the Consumer Financial Protection Bureau (CFPB) gains enforcement power of the Supervision and Examination Manual it released last October. For lenders, the new oversight will translate to a shift in how risk is assessed. Previous legislation protected investors, but the CFPB aims to protect the consumer. Its a twist that forces them to look at risk differently than in the past, says Michael Zwall, director of mortgage services for SourceHOV, a business processing outsourcing firm. Specifically, the examination manual is divided into three parts. The first part describes the supervision process. The second part contains examination procedures, including instructions for determining compliance with specific regulations. The third part presents templates for documenting information about supervised entities, including examination reports. CFPB examiners will scrutinize lenders policies on issues like referrals, fee sharing, kickbacks, and steering, says Barry Hester, an associate in the financial institutions practice at Bryan Cave International Consulting LLC. Examiners will ask things like: Does the consumer have a meaningful choice for the service provider? Those are the questions that are certainly coming, Hester says. The examination manual also focuses on unfair, deceptive, or abusive acts or practices, commonly referred to as UDAAP. Using those guidelines, forms will be reviewed to see which could be deemed confusing, and products will be analyzed to determine which might be misleading or unfair to consumers. Already the CFPB has created a forum for credit card customers to lodge complaints. The web portal prompts consumers to tell their stories of deceptive lending practices and propose preferred resolutions. The credit card site, for instance, includes more than 30 complaint categories. A similar mortgage site was launched in December 2011, and David Anthony, partner at Richmond, Va.-based law firm Troutman Sanders, expects a comparable auto finance portal to debut next. These CFPB complaint sites will force lenders to be proactive in their responses to consumers, Zwall says.

11

Th The New The he

With Director in Place, CFPB Can Crack Down on Compliance
BY CHRISTINA HABERSTROH
regulations, implement new processes, and hire the necessary employees. As a result, theyre closing up shop. I dont think they are fully prepared, Anthony says. For example, a smaller business may lack the resources to deal with consumer complaints, provide a corporate manual for fair practices, and gather information from complaints to provide recommendations to the CFPB. Its a big deal, he says. Similarly, Hester has seen companies pull the plug due to fears of being unable to comply with regulations. They say their product is going to require compliance they just cant afford, he says. For some payday lenders and others that provide services to lower income consumers, the CFPB requirements make it too risky to stay in business, he says. Among mortgage servicers, the CFPB mandates acknowledgement of a qualified written request (QWR) of complaint in five days, as opposed to 20 days previously. The new reforms require mortgage servicers to reexamine their business processes and technology infrastructure to ensure they have the flexibility to adapt to changing conditions, Zwall notes. For companies that intend to stick it out through the new regulatory era, the critical factor is to put practices in place quickly. Though companies would rather avoid spending more money to hire new employees or improve compliance efforts, many need support. Anyone who is worth their salt has had to look at [the examination manual] knowing there will be a significant change as to how they are going to do business, says Anthony of Troutman Sanders. Some are just putting it off. Brian Caves Hester, though, has a different perspective. He has seen clients, especially bank clients that intend to exceed the $10-billionin-assets mark, hiring compliance staff left and right, he says. They are cleaning house, putting real dollars into the effort, and ultimately delivering products in a more friendly way. In the end, banks and nonbanks will have to make changes to deal with the tougher regulatory environment. Its just a matter of time before [the CFPB] gets everyone covered, Anthony says. I think 2012 is going to be a busy, busy year.

A HEAD START FOR BANKS

The CFPB will initially use the manual to supervise the nations more than 100 large banks, thrifts, and credit unions with at least $10 billion of assets. It is uncertain which non-depository consumer financial services companies will fall under the agencys purview as the agency fleshes out its regulatory responsibilities. As such, nonbank lenders are trying to get their ducks in a row, Anthony says. Among smaller companies like payday lenders and debt collectors, some are finding that it would be too difficult to comply with new

THEY ARE GETTING TO THE UNDERBELLY OF LOOKING AT HOW THE Consumer Financial Protection Bureau MARKET WORKS TO ATTACK WHAT IS BAD ABOUT IT.
Barry Hester, Associate, Bryan Cave International Consulting LLC

Spring 2012

TradeLines

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