General Session V D&B and FICO: Risk Management …...4. Calculate lender-level expected 12 month dollar purchase rate by dividing total expected purchase amount from Step 3 by total

General Session V D&B and FICO: Risk

Management – Now and What’s on the Horizon

Grand Ballroom Salons 1-4 2:15 pm – 3:15 pm

Thank you to our Alliance Partners

• Steve Gregg, Senior Leader, Data & Analytic Solutions Dun & Bradstreet • Adrianna Rockford, Analytical Lead Dun & Bradstreet • David K. Smith, Lead Consultant, Originations FICO • Linda Rusche, Director, Office of Credit Risk Management U.S. Small Business Administration • Paul Kirwin, Supervisory Financial Analyst, Office of Credit

Risk Management U.S. Small Business Administration • Catherine Riddle, Chief Financial and Technology Officer CDC Small Business Finance Corporation

Speakers

D&B FICO Risk Ratings

What is on the Horizon

May 2016

NADCO Spring Summit

Washington D.C.

SMALL BUSINESS RISK PORTFOLIO SOLUTION (SBRPS) SCORE

LENDER RISK RATING/LENDER PURCHASE RATING (LRR/LPR)

SMART LENDER RISK FRAMEWORK

SBA’s Current Risk Rating Tools

3

Small Business Risk Portfolio Solution (SBRPS) Score*

• Built jointly by D&B and FICO, SBRPS predicts the likelihood that a borrower will become severely delinquent (60+ days past due), including bankruptcies and charges offs, within the next 12 to 24 months

• SBRPS uses D&B business credit data (firmographic, financial payment, and public records), as well as TransUnion (TU) consumer credit data (consumer credit bureau report application and internal) and does not rely on the SBA loan performance to assess the borrower’s risk

• For the last 13 years, SBA has successfully used SBRPS to monitor the performance of small businesses and to provide early warnings of future risk

• SBRPS scores are updated and validated, through the data warehouse quarterly processing, as discreet scores on each loan and are available as historical scores for a five year period

* Commonly called by the SBA SBPS

4

Automatic Approve/Reject

Establish Credit Terms

Set Credit Limits

Price For Risk

Risk Mitigation

Monitoring & Benchmarking

Updating Credit Lines

Compliance and Forecasting

Collections Prioritization

Credit Application Evaluation

PortfolioManagement

While Portfolio Management is only one stage of the credit life-

cycle, it could be the most important one, given the suppressed

demand for credit in Financial Services

Sales & Marketing

PreScreen

PreApproval

Small Business Risk Portfolio Solution (SBRPS) Score

5

D&B and FICO combine their respective strengths to put forth the industry-leading

portfolio management blended score

Well-respected

Have high brand recognition

Share a common approach to model development

Dedicated to financial services small business risk assessment

Two Market Leaders That Are…

D&B Adds…

Traditional strength in trade credit origination and financial services

Powerful commercial information

Highly predictive commercial score

Highly experienced batch delivery organization

FICO Adds…

Traditional strength in financial services

Expertise in small business analytics and decisioning

Proficient in building consumer and blended scorecards for small business


6

Model Definition “Bad” defined as 60+ days delinquent

Predicts performance over 18-24 month period

Suite of 15 Models (Version 6.0)

Model selected based on data available

Model selection logic based on the product type (Term Loan, LOC, Commercial Card), absence/presence of derogatory consumer information, and file thickness (presence of commercial and consumer tradelines)

Unique Features

Score driven by consumer bureau data on up to two principals

Up to four adverse action codes identify top reasons driving down score, plus derogatory commercial public records indicator

Powerful predictive modeling techniques transform data into useful information


7

SBPS - Blended Data produces most predictive results

SBPS 7.0 Scoring Solution

SBRPS Bureau Based Score

Consumer Bureau

Data

DNB Report Data

SBRI Data

SBRPS Behavioral

Score

Behavioral Data

Business financial

obligation 1

Business financial

obligation 2

Business financial

obligation 3

Behavioral Data:Current and historical information associated with the one financial

obligation being reviewed

8

Our lending customers have been successfully using the SBRPS solution to support a wide range of Portfolio Management efforts

• Early warning risk indicators

• Loan loss forecasting

• Compliance management

• Credit Line management

• Expedited renewals process


9

Lender Risk Rating / Lender Purchase Rating

• What is the Lender Purchase Rating (LPR)?

• The Lender Purchase Rating (LPR) leverages BASEL III recommendations and industry best practices, and predict each active loan’s 12 month probability of purchase on a quarterly basis

• The models then aggregate the loans’ probability of purchase to a lender-level metric as a measure of overall lender risk and a numeric value - 1 (Low Risk) to 5 (High Risk)

• The loan-level predictive scoring used by the LPR system allows the models to make use of loan attributes such as firmographic and summarized trade data from D&B’s Credit Score Archive Database (CSAD), more granular trade data from D&B’s Detailed Trade Database, the D&B and FICO loan level risk score (SBRPS), macro-economic indicator variables, and SBA’s loan performance data

• Assists in assessing the risk of an SBA Lender’s SBA loan performance on a uniform basis and identifying those SBA Lenders whose portfolio performance demonstrates the need for additional SBA monitoring or other action.

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Lender risk level assessment done in 5 steps:

1. Predict loan-level probability of purchase across all loans using statistical modeling.

2. Multiply predicted probability of purchase from Step 1 by the outstanding balance (exposure) for each active loan in the lender’s portfolio.

3. Sum up values from Step 2 across all loans in the portfolio to arrive at the total expected purchase dollars for the lender in the next 12 months.

4. Calculate lender-level expected 12 month dollar purchase rate by dividing total expected purchase amount from Step 3 by total outstanding amount in the portfolio.

5. Map lender-level expected purchase rate from Step 4 to (1-5) risk categories.


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Model Segmentation

1. Current: Account with current payment status

2. Non-Current: Account without current payment status

Model Variables:


Independent Predictors Data Source Short Description Increase (+) or Decrease (-)

Odds of PurchaseGreater # of Accounts D&B sourced – Detailed Trade # of Accounts on Database Last 4

Months

-

Higher % of Accounts Past Due D&B sourced – Detailed Trade Pct of Accounts Past Due -Last 4

Months

+

Higher % accounts 31+ Days Past Due D&B sourced – Detailed Trade Pct of Dollars 31+ Past Due -Last

3 Months

+

Higher SM % Current D&B sourced – CSAD Pct Current - Long Term Trend -

Age in Business D&B sourced – CSAD Average years in Business -

Higher SBPS score D&B and FICO sourced Average Small Business

Predictive Score

-

Increasing Levels of Current Delinquency SBA sourced Average Status - Months

Delinquent, Catch Up, Deferment

+

Months on Book SBA sourced Number of Months On Books -/+/- (U-shaped)

Increases in Housing Prices Macroeconomic data Year Over Year Housing Price

Ratio

-

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SMART Lender Risk Framework

Objective:

Provide a risk framework for lenders with attribute benchmarks that

• are consistent, accurately measure lender risk, systematic, easy to understand, and on par with industry standards;

• identify the higher risk lenders to assist SBA Office of Credit Risk Management (OCRM) in resource allocation;

• and help lenders identify areas to improve and understand their target ranges and the metrics on which SBA will score their performance.

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SMART Lender Risk FrameworkThe SMART score is calculated from 12 benchmarks, which are classified into five categories.

• Solvency and Financial Condition, Management and Board Governance, Asset Quality and Servicing, Regulatory Compliance and Technical Issues and Mission.

Each of the 12 benchmarks is assigned a score.

• The sum of all 12 benchmark scores equals the lender’s overall SMART score.

—The score will be periodically updated, with an overall score range of 12 - 60.

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• One benchmark scorecard is established for all 504 lenders/CDCs.

• A“20/60/20” rule is used to establish the higher risk (+5), moderate risk (+3), and lower risk (+1) thresholds.

• The “Lower risk” threshold uses the best 20th percentile of 2005 lender performance data.

• 2005 was a period of time when the overall economy was stable and the 504 program was essentially subsidy neutral (net cash yields close to zero) and thus is the preferred state of performance.

• The “Higher Risk” threshold is defined with the worst 20th percentile of current 2013 lender performance data.

• This approach enables SBA to encourage lenders to minimize risky behavior, while still taking into account the residual effects of the economic recession.

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5 Year Cumulative Net Yield > -1% ≥ -3% AND ≤ -1% < -3%

12 Month Default Rate 0% > 0% AND ≤ 5% > 5%

5 Year Default Rate 0% > 0% AND ≤ 5% > 5%

Lender Purchase Rating (formerly LRR) 1, 2 3 4, 5

High Risk Origination Rate 0% > 0% AND ≤ 13% > 13%

Loans in Purchase Status Over 3yr Rate 0% > 0% AND ≤ 27% > 27%

Stressed Loan Rate < 3% ≥ 3% AND ≤ 10% > 10%

Recovery Rate (Over last 5 years) > 33% ≤ 33% AND ≥ 6% < 6%

Early Problem Loan Rate 0% > 0% AND ≤ 4% > 4%

( + 5 )

< 4

Average Portfolio SBPS (weighted for $) > 197 ≤ 197 AND ≥ 188 < 188

Top Industry Concentration Rate < 13% ≥ 13% AND ≤ 28% > 28%Technical Issues

Management and Board

Governance

Asset Quality and

Servicing

Regulatory Compliance Minimum Level of 504 Loan Activity

Highest Risk

(+ 5)

Solvency and Financial

Condition

( + 1 )

≥ 4

SMART Category AttributeLower Risk

(+ 1)

Moderate Risk

(+ 3)

SMALL BUSINESS LENDING LANDSCAPE

MACRO-ECONOMIC

REGULATORY

ALTERNATIVE LENDING

DATA, TOOLS & TACTICS

Trends in Risk Rating and Management

in the Industry (not SBA specific)

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• While payment behaviors have significantly improved over the past few years, lenders are still on the lookout for tools to help refine their risk mitigation, while seeking growth opportunities

• Payment behaviors of all businesses had worsened significantly during the contraction, but are now almost near their pre-recession levels

Source: Federal Reserve Board, Dun & Bradstreet

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

Delinquency (Cycle 3+) Rates on Small Business Credit Card Accounts

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Delinquency Rate on Business Loans

Delinquency Rate on C&I Loans: All Businesses

Cycle 3+ Delinquency Rate on Small Business Loan Accounts

The Current Small Business Lending Landscape: Macro-economy

Trends in Risk Rating and Management in the Industry (not SBA specific)

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• Changing patterns can be seen among geographies, with respect to both business growth and risk, and lenders need to target appropriately

Small Business Employment Growth by State: 2014-16

Data Source: SBFE Data™ and Dun & BradstreetAnalytic Source: Dun & Bradstreet

Rankings are based on the Feb 2016 D&B SBFE Score which predicts the probability of serious delinquency within the next 12 months on a business financial services account



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• Beyond that, which cities and sectors need to be watched?

Industries with the highest risk

• Rankings are based on the Feb 2016 D&B SBFE Score which predicts the probability of serious delinquency within the next 12 months on a business financial services account

MSAs with the highest risk

Rank MetroplitanStatisicalArea

1 LasVegas,NV

2 Laredo,TX

3 Miami,FL

4 Riverside-SanBernadino,CA

5 McAllen-Edinburg-Mission,TX

6 Brownsville-Harlingen,TX

7 FtLauderdale-Hollywood,FL

8 ElPaso,TX

9 Orlando,FL

10 JerseyCity,NJ



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• Which macro-economic attributes can add value to your origination and portfolio management models? Regulatory agencies have raised the requirements.

Establishment Openings and

Closings by State

Housing Indicators by

State

Personal Income by State

Retail Sales

Job Losses and Gains by State

S&P 500 IndicesEnergy Prices by

State

Industrial Production

Indices

Loan Delinquency

Rates

The Current Small Business Lending Landscape: Regulatory


21

Portfolio Stress Testing: Scenarios applied to a Risk Score

• The macro-economic factors that significantly affect Risk Scores are Unemployment Rate, and the Dow Jones Industrials Average

• Portfolio Stress Tests manifest how the portfolio will act under various economic scenarios or fluctuations in various economic factors.

• From our experience with stress testing we know that in good economic conditions, with robust Labor and Capital markets, risk scores are expected to climb higher on an average, while inching downwards in periods of slack.

• However, risk scores generally react to macroeconomic changes with some lag.

Scores react to economic

changes with a lag

896.0

900.0

904.0

908.0

912.0

916.0 Scenarios applied to Risk Score

Actual Best Baseline

Adverse Severely Adverse Worst

The Current Small Business Lending Landscape: Regulatory


2222

With the arrival of FinTechs and Alternative

Lenders, the marketplace has changed

Market Place Lenders (MPLs) –

• Relatively new option to traditional bank loans

• Both Personal and Small Business Loans

• Some backed by the SBA

• Alternative to banks – strong use of Alternative data

• Fundation and Kabbage were early pioneers on peer-to-peer lending – back to 2009

• Lending Club and Prosper originally focused on debt consolidation

• OnDeck and Funding Circle emphasized small business lending

• SoFi and CommonBond started in student loan refinancing

• Partnerships have begun – Fundation/Regions, OnDeck/Chase, Lending Club/Citi

The Current Small Business Lending Landscape: Alternative Lending


2323

• Credit quality ranges from subprime to superprime which leads to APRs of ~5.9% - 30%.

• Generally short-term credit – 3-9 months, but some as long as 48 mths

• Some have state lending licenses, others use bank partners

• One common characteristic of MPLs is that they aren't banks —they don't collect deposits and they don't have national lending licenses

• The MPLS don’t yet fall under bank regulatory oversight!

• What is the future?

• More players and other companies like Amex, Amazon, Square, and Paypal getting into merchant lending

Alternative Lenders: Characteristics & Partnerships“Can’t Get a bank Loan –

the Alternatives are Expanding”

The New York TimesJuly 29, 2015

“Banks are Only Hurting Themselves By Shunning

Alternative Lenders”

American BankerAugust 25, 2015

The Current Small Business Lending Landscape: Alternative Lending


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Organizations usually begin their analytical transformations with one of four high-value initiatives

Grow and Retain and

Satisfy customers

Increase Operational

efficiency

Transform Financial processes

Manage risk, fraud & regulatory

compliance

• Identify/Grow best prospects• Reduce Attrition• Personalization/relevancy• Drive profitable growth

• Optimize Expenses• Automate decisioning• Personalization/relevancy

• Increase Cash Flow - Net Profit• Customer Lifetime Value • Strategic Drivers• Staying ahead of competition

• Risk/Fraud mitigation• Premium assignment strategies• Regulatory due-diligence• Vendor Risk mitigation

Data, Tools, and Tactics


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• Optimized decision making is driven through analytics

Analytics Infused Data

Standard Scores and Predictors

Advanced Analytics Services

• Custom models and scorecards

• Joint Strategic Engagements

• Analytics Sandbox for R&D

• Composite Risk Score• D&B Viability Rating• D&B Delinquency Score• D&B Total Loss

Predictor • Global Business

Ranking• Material Change™ • Decision HQ

• Detailed Trade• Inquiry Data• Global Activity Data• Small Business Financial

Exchange (SBFE®)• Small Business Risk Insight



26

Financial Institutions have begun to utilize innovative data assets which provide significant lift, giving tremendous new insights into business behavior

UNIQUE, PROPRIETARY ANALYTIC INFUSED DATA

DETAILED

TRADE

PAYMENT

DATA

LABOR

MARKET/

JOB

POSTINGS

MACRO

ECONOMIC

DATA

INQUIRY &

MATCH

DATA

BUSINESS

ACTIVITY

DATA &

SIGNALS

PURCHASE

AND

SPEND

DATA



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Lenders can improve the bottom line with innovative commercial insights and analytics

across the customer lifecycle

Business

Impact

Work Flows

Analytical

Capabilities

Origination &

Underwriting

Account Mgmt

& Portfolio MonitoringCollections & Recovery

Standard &

Custom Models

Standard &

Custom Models

Custom

Collections

Model

Maximize New Applicant

Profitability or Approval

Rates

Risk Mitigation &

Profit Optimization

Maximize $$

Collected &

Efficiency

Line Assignment Decision,

Segmentation Strategies

Recovery Analytics,

Segmentation Strategies

Score Cutoff &

Approval Rate AnalysisEarly

Warning

Third Party Outsourcing

Analytics

Activation and Balance

Build, Segmentation

Strategies

Most Profitable

Prospecting &

Targeting

Standard & Custom

Models

Maximize net approval

rates, Find “fresh/hot”

prospects

Acquisition

Risk knockout ,

Profitability Models,

Segmentation



3:30 PM – 5:00 PM • General Session VI – Briefing from the Office of

Credit Risk Management Grand Ballroom Salons 1-4 5:30 PM – 7:00 PM • PAC Reception Sonoma Restaurant & Wine Bar In Honor of: Congresswoman Judy Chu (CA-27) Ranking Member House Small Business Subcommittee on Economic Growth, Tax and Capital Access

What’s Up Next?

Documents

General Session V D&B and FICO: Risk Management …...4. Calculate lender-level expected 12 month dollar purchase rate by dividing total expected purchase amount from Step 3 by total