High-Performance Scorecards. Best practices to build a winning formula every time

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1 High-Performance Scorecards Best practices to build a winning formula every time

2 Will your team win or lose? Scorecards drive financial decision making For decades, your organization has used the predictive power of analytic scorecards to help manage every aspect of its business from deciding which applicants are creditworthy to determining regulatory capital requirements. But are your scorecards really in top gear? If you re asking any of these questions Is our bank holding the right amount of required capital, or can it be reduced? Why are credit card delinquencies higher than we expected? Are we in compliance with the latest regulations? Why can t we analyze mortgage applications in the context of an applicant s entire relationship with our bank? you could probably benefit from using scorecard best practices from FICO, the global leader in applying predictive analytics Fair Isaac Corporation. All rights reserved. 2

3 The customer relationship: Influencing every turn More than ever, banks and other financial institutions are focused on three goals: Checking account Savings account Optimizing the customer experience to make every interaction a positive one New customer Credit card Building long-term customer loyalty Maximizing the value of every relationship by providing the right mix of financial products across the customer lifecycle Delinquency Line of credit Mortgage Consumer loan High-performance analytic scorecards can make all the difference in achieving these goals. They help institutions to make the right strategic decisions and move nimbly in individual customer interactions to provide highly personalized service. Across all retail products, financial organizations use FICO s scorecard expertise to: Understand the risks associated with onboarding new customers, and determine the best offers to apply to existing customers Analyze unstructured data, such as collection agents notes, to predict which accounts will go delinquent Trace unanticipated changes in defaults back to specific marketing campaigns And much, much more Fair Isaac Corporation. All rights reserved. 3

4 Data sources: High-octane fuel to maximize predictive power Data is data, right? Not when it comes to developing scorecards. FICO has decades of experience in understanding how data quality affects scorecard results and downstream business performance. FICO can help your financial organization benefit from best practices to: Learn which types of data can be predictive, and which types can skew scorecard results Combine data from disparate systems to create a customer view that spans all products, and rewards loyalty FICO consultants are experts in shaping data into scorecards with FICO Model Builder and building analysis frameworks with FICO Blaze Advisor business rules management system. Equally important, your in-house team will have access to FICO s unmatched analytic technology and expertise, applying these resources to your scorecard engagement. Have our highly trained consultants validate extracted data, and highlight any potential issues the validation process reveals many of which may be previously unknown Incorporate unstructured data, such as key words and phrases from call center agents notes, into scorecards to extract its predictive element 2014 Fair Isaac Corporation. All rights reserved. 4

5 Characteristic generation: Capturing customer behaviors that impact results FICO s intellectual property includes a suite of over 1,000 behavior characteristics and their cross-characteristic relationships. This extraordinary asset, coupled with FICO analytic expertise, can help you pinpoint the specific characteristics that influence scorecard outcomes. Performance indicator: Income Income level is an important scorecard characteristic. Most scorecards look at the amount the more income a customer deposits into his or her checking account on a regular basis, the more positive a predictive factor it is. Or is it? And we can do it with predictive accuracy that is truly unique. Although FICO s behavior characteristics repository is built on years of experience, we continue to push the limits of scorecard analytics. For example, today we re using text mining to detect predictive characteristics in unstructured Big Data. In addition to the vast library of behavioral characteristics FICO offers, we can generate new characteristics from your raw data, adding even more value to your scorecard efforts. Not necessarily. Instead of defining income data as a raw monetary value, FICO analytics look at the stability of the income how consistent is the amount that is deposited each month? Does it vary significantly from month to month? Instead of scoring average income over a six-month period, as a best practice, FICO recommends looking at the six-month range of income variance. In fine-tuning this characteristic, this is just one of the ways FICO can extract more value from your organization s data Fair Isaac Corporation. All rights reserved. 5

6 Development exclusions: What s left out of the race can win it When developing a scorecard, the data that is left out can be just as important as the data utilized. Put another way, incorporating the wrong data into scorecard development can bias analytic results. You won t be predicting exactly what you think you are, and that can have severe business repercussions. For example, let s look at the performance of a credit card portfolio to predict which accounts may go into default. Candidates for default might be defined as customers who have missed two or more payments within the last 18 months. The population that would be analyzed includes all customers but, by the definition above, would also include inactive customers: those who have accepted the credit card offer, activated their cards, but never made a purchase. These customers have never missed a payment because they ve never had to make one. By default, these customers are rated as good, even though they really haven t been proven to be good, diminishing the predictive power of the scorecard. FICO can help your organization develop best practices in choosing the right data exclusions, to help maximize any scorecard s predictive accuracy. Compliance alert Including certain characteristics in scorecards can be discriminatory a major regulatory breach when using the results to make credit decisions on products such as loans and mortgages. Myriad characteristics can be discriminatory if improperly used. These include race, language spoken, religion, occupation and even postal code. FICO can help your organization to ensure regulatory compliance, in whatever regions it operates, drawing from our global knowledge base and regional expertise Fair Isaac Corporation. All rights reserved. 6

7 Performance definition: Why the default benchmark isn t always best The 107% rule In the financial world, Basel performance definitions can be analogous to Formula 1 racing s 107% rule sometimes Basel provides the proper benchmark, but sometimes not. Basel definitions allow regulators to use a single method to compare performance across banks to understand capital requirements. In anticipation of regulatory review, some organizations use Basel defaults when developing scorecards. During the first phase of qualifying, any driver who fails to set a lap within 107 percent of the fastest Q1 time will not be allowed to start the race. However, in exceptional circumstances, which could include a driver setting a suitable time during practice, the stewards may permit the car to start. 1 adjusting the standard For example, one of the Basel standards used to predict default (90+ days past due) is a customer missing any 3 payments over the next 12 months. This standard may be appropriate for some products, like personal loans, but not others. For example, a customer with a newly activated high-limit credit card might take 18 months to build up a large balance and be classified, incorrectly, as high-risk for 18 months afterward. The high balance is used as a predictor of missed payments and thus default. Many scorecards would not incorporate the nuance of how slowly the balance was built, a signal of financial stability. FICO has best-practice expertise in all aspects of performance definitions. Using them correctly for each scorecard can greatly improve predictive accuracy and, ultimately, the appropriate level of capital reserves. 1 Source: Formula 1 The Original F1 Website, Fair Isaac Corporation. All rights reserved. 7

8 Interpreting the past: The benefits of reject inference Past events often affect those in the future. With scorecards, this is particularly true when developing scorecards for originations to determine which future applications will be accepted or rejected. Most originations scorecards are based on the historic account performance of existing accounts customers whose applications, obviously, were previously accepted. But including only current account data introduces bias into the decisioning model. This bias can have significant downstream impact, including additional capital requirements for your institution, and an increase in bad debt. Predicting future performance To make the best originations decisions, you want the scorecard to accurately assess all new applicants. Therefore, when building an originations model, it s important to address the question, How would the model perform if the applicants from the past, who did not become customers, had? That s a complicated hypothesis, requiring the scorecard to incorporate not one, but two unknown populations: the applicants who were rejected, and the applicants who were approved but chose not to take up the offer. FICO has deep experience with performance inference and scorecard development. We can combine a number of approaches, including variations used by your financial institution, to create a best-practice approach for reject inference Fair Isaac Corporation. All rights reserved. 8

9 Will it crash? Best practices in probability of default methodologies Under Basel regulations, banks need to calculate, for every single account, the probability of each moving into default within the next 12 months. For this reason, many banks build scorecards based solely on a probability of default definition. Forecasting a payment holiday Forecasting delinquency is part of day-to-day operations, too, and can be a powerful tool in managing specific cardholder populations. But a scorecard based on a probability of default definition is rarely the best one to use when making other decisions about active accounts, such as whether to allow credit limit increases, approval of over-the-limit transactions and more. Properly administered, these decisions can be a big factor in the customer experience and customer satisfaction. As a best practice, FICO can build the scorecard based on a best performance definition, and then also align the result to the Basel probability of default. In this way, the scorecard meets regulatory requirements and provides more accurate predictive insight to manage the card portfolio, day to day. For example, to a customer group that appears to be heading toward delinquency, a bank can make a special offer of a payment holiday, which allows the customer to skip a month or two of payments. Alternatively, the card issuer may offer to restructure this endangered debt with a lower interest rate. All of these measures can boost customer satisfaction and loyalty, while at the same time preventing endangered accounts from going into default Fair Isaac Corporation. All rights reserved. 9

10 Meeting performance expectations: Scorecard Monitoring Services Best practices for scorecard development include periodic monitoring, to make sure that underlying assumptions remain as expected, and true. Any number of forces can impact scorecard outcomes. For example, a marketing campaign directed at new college graduates can cause the percentage of a card issuer s underage-25 population to spike from, say, 10% to 30% within weeks. A year later, defaults also may have risen dramatically. Periodic scorecard reviews can detect if a card portfolio is no longer performing as expected, and if any scorecard changes or strategy adjustments need to be made. Similarly, in both developed and emerging markets, rapid economic changes can impact scorecard assumptions within weeks or even days. The Great Recession of 2008 in the US, and multiple European governmentdebt crises in the years following, quickly affected consumers financial health and habits. Monitoring performance To help ensure that scorecards are performing as expected, FICO Consulting offers Scorecard Monitoring Services on a monthly or quarterly basis. Importantly, FICO can link scorecards from multiple product portfolios to view the health of entire customer relationships. This can help banks to both improve the customer experience and maximize the value of total customer relationships Fair Isaac Corporation. All rights reserved. 10

11 FICO Model Builder: Accelerating the modeling lifecycle FICO Model Builder gives your organization the power to explore and analyze data of any size and complexity, informing your business decisions with insight into future outcomes. By better predicting behaviors, you can increase the precision of your data-driven scorecards, and substantially impact your bottom line. With FICO Model Builder, you can: Quickly develop analytics with timesaving features and extensibility Extract business insights from your Big Data assets including very large and unstructured data Engage new team members with an approachable graphical user interface Design solutions using intuitive wizards, then generalize for repeated use with automatically generated scripts Use industry-leading FICO scorecard technology that combines analytic science and business expertise Collaborate easily using consistent logic, common methodologies, reusable libraries and templates, and robust model documentation FICO Model Builder offers a rich graphical interface to prepare and explore analytic data, and interactively develop complete predictive models Fair Isaac Corporation. All rights reserved. 11

12 Make FICO part of your team For decades, FICO has provided powerful custom analytics and analytic consulting, earning a reputation for excellence in the many industries it serves. FICO can help your organization to maximize the value it derives from analytics, with engagements ranging from model development to full analytic partnerships. To speak with a FICO representative about how FICO can help your organization build a winning scorecard practice, please contact FICO today. Learn more Download the white paper on this topic: Building Powerful, Predictive Scorecards Check out our blog: Banking Analytics Blog For more information north America toll-free latin America & Caribbean europe, Middle East & Africa Asia Pacific (0) info@fico.com LAC_info@fico.com emeainfo@fico.com infoasia@fico.com FICO and Blaze Advisor are trademarks or registered trademarks of Fair Isaac Corporation in the United States and in other countries. Other product and company names herein may be trademarks of their respective owners Fair Isaac Corporation. All rights reserved. 4003BK 5/14 PDF