In this economy, credit unions are justifiably conservative in their lending practices. From declining performance of credit cards and loans over the past few years to sweeping government regulations, the pressure felt by these institutions and their stakeholders has caused constriction across the board.
Although the market shows some signs of stabilization, a number of recent studies point to the fact that we are still operating in a high-risk environment. FICO recently conducted a study of a bank card lender, taking a proxy of the U.S. population that found significant score movement over time. The study showed that 27% of consumers scores change plus or minus 20 points over a three-month period; almost 40% of consumers see a score shift of plus or minus 20 points over a six-month time period. For credit unions, this means that even your best customers may not be risk-averse, warranting stricter account management processes to help identify early delinquency issues before they become unrecoverable.
Recent FICO score trend data, gleaned from the FICO Score Trend Service, demonstrates that the relationship between the FICO score and risk has changed substantially over the past few years with the population in general become more risky overall. In the most recent period a smaller shift has been observed than has been seen in prior years. While the FICO score remains the same, in 2009, to achieve the same level of risk as used to be identified at a score of 700 in 2005, a lender would need to look at candidates with a near 740. The change in this relationship has become more varied by region and product type in the most recent periods, as to be expected given pockets of more volatile real estate markets.
Together with a changing credit-risk landscape, the recent passage of the CARD Act has affected credit unions in two ways. First, new regulations which lowered profit potential, are forcing lenders to shift business strategies to stay profitable. Second, with rising interest rates at traditional card issuers, credit unions are offering credit cards with more attractive terms to members. An increase in the number of accounts is generally positive-but credit unions must also be mindful to select customers who, despite various income levels, represent the lowest levels of credit risk.
How can credit unions serve their members without taking on an inordinate level of risk? In essence, it's time for a fundamental overhaul in risk-management concepts and practices. New technologies, no longer the purview of only large lending institutions, can provide a critical difference to credit unions caught between hyper-caution and long-term risk.
Strike a balance with risk-assessment tools and quality underwriting. Most credit unions have a strong desire to serve their members and grant every opportunity for them to obtain credit. However, with higher default rates, credit unions must also rely on more precise risk-assessment tools to understand the risk represented by a given borrower. With widespread adoption, new analytics, updated and tuned to changing environments, credit unions are able to more accurately pinpoint less risky customers at the time of origination. Decisions made at this point-to accept or decline the borrower, for which products and at what price-affect more than 80% of the measurable risk over the lifetime of the account. In fact, improved risk assessment through newly developed scores can help lenders approve more loans without increasing risk.
Extend appropriate credit but don't overextend. Many consumers are pulling back on the use of credit as saving levels are rising nationwide. However, credit unions must still take care to only extend the amount of credit that a member will safely be able to manage. To do that, they must examine the ability to pay as well as risk. This is a requirement for card lending, as prescribed by the CARD act. However, responsible credit unions will take this requirement one step further by looking to analytics that are more predictive than income estimators and self-reported income, the minimum required by new legislation. Using both verified income and analytics that predict which consumers will be more able to manage additional credit will yield positive results both for the credit union and the borrower.
Assist members with early intervention. Given the volatility of unemployment and other economic shifts, it's more important than ever for credit unions to more frequently assess risk across their accounts. By pulling credit scores more frequently (quarterly, for example), segmenting member populations for special treatments and running standard risk-analysis reports, credit unions will be able to provide early intervention and assistance for members exhibiting signs of early delinquency, even if that behavior is happening outside of the credit union's walls.
Track and analyze for successful lending. By leveraging standard credit-risk management reporting, credit unions can more accurately assess the success of their strategies, score cutoffs, delinquency rates and override policies.
Moving forward, even with market conditions improving, credit unions will still have to deal with increased risk, competition for best performing borrowers and harsher compliance restrictions. New analytics and best practices allow credit unions to put technology to good use so that they may serve their members with quality lending in a highly dynamic marketplace.
Robert Duque-Ribeiro, vice president/general manager for scores at FICO. He can be reached at 415-446-6000 or info@fico.com
