January *For full copies please contact Peggy Doss at CEB TowerGroup CONSUMER LOAN ORIGINATION SYSTEMS MARKET UPDATE

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1 January 2014 THE LENDING EVOLUTION: PREPARING FOR SUSTAINABLE CONSUMER LENDING GROWTH An International View on Consumer Loan Origination Systems Market Update Abstract* *For full copies please contact Peggy Doss at CEB TowerGroup

2 EXECUTIVE SUMMARY Stepping out from the shadows of the recent financial crisis, lenders are now seeing a sharp rise in long-term interest rates from absolute lows one year prior. Growth and opportunities for consumer lending are largely driven by emerging market economies, yet tempered by demands associated with increased compliance requirements. In order to ready systems for expected lending volumes and unexpected regulatory change, CEB TowerGroup recommends banks take the following actions: 1. Leverage Advanced Analytics Capabilities: Identify additional lending opportunities and optimize pricing while minimizing risk by aggregating alternate data sources and creating more custom consumer risk profiles. 2. Extend Mobile Banking Capability into Retail Lending: Understand the potential ROI of mobility for lenders and improved service for borrowers by identifying the most important mobile lending use cases. 3. Modify LOS for Continuous Regulatory Change: Integrate new data, analytics, workflow and reporting capabilities for ongoing regulatory change given new legislation, as well as accessibility demands by business users. KEY MARKET TRENDS POSITIVE OUTLOOK FOR US GROWTH DESPITE HEADWINDS While the economic picture has not been entirely rosy over the past half-decade, the US consumer-driven economy is improving. The IMF projects that real GDP growth in the US will accelerate to 2.6% in 2014 from an estimated 1.6% in. Although the unemployment rate still remains above average, it has fallen to 7.0% from a high of 10.0% in Median household income also rose by a healthy 2.7% to reach its highest point since 2008 (Fig. 1). The US housing market, one of the worst-affected sectors of the financial crisis, is gaining traction in terms of home price growth (Fig. 2), and home sales are low but growing. However, recent new lending volume growth was driven by refinancing of existing mortgages, and this financing is plummeting as interest rates increase. Lenders are trying to replace this lost business in two key areas: First, automobile lending remains the healthiest and strongest growing segment of consumer lending heading into Second, home equity lending (second lien mortgages) has begun to grow slowly again as home price growth increases available equity for homeowners to borrow against. Figure 1 US Median Household Income Median Income for a Family of Four in USD, 2009 $52,000 = 2.7% $51,404 Figure 2 US Composite Housing Prices of 20 Metro Areas Indexed at Year 2000 = 100, Q Q $51, $50,000 $49,000 $48,000 $50,054 $49,777 $49, Q Q Q1 145 Q Q3 Q4 Q1 Q2 Q3 Source: US Census Bureau,. Source: S&P Case-Shiller Index,. 2

3 US CREDIT GROWTH WILL REMAIN SLOW While the more stable economic environment has encouraged consumers to take on fixed loans to finance home purchases, renovations, cars, and other durable goods, they continue to avoid or pay down higher interest rate revolving debt. Data from the Federal Reserve shows that although outstanding nonrevolving consumer credit balances have risen by 17% to $1.97 trillion since 2010, revolving credit balances have actually fallen by 3% to $816 billion(fig. 3). Results from the Fed s fourth quarter Senior Loan Officer Survey also show that demand for auto loans far outpace the demand for credit cards, mortgages and other consumer credit. On the one hand, this trend could be viewed as welcome news, reflecting the new American consumer s more sensible purchasing decisions and paydown of high debt levels. On the other hand, this deprives lenders of higher margin, though often riskier, credit products. Figure 3 Outstanding Consumer Credit In Billions USD, 2010 Q YTD $0 $500 $1,000 $1,500 $2,000 $2,500 $3,000 $1,682 $1,773 $1,922 $1,974 Non-Revolving Source: US Federal Reserve,. $841 $843 Revolving $846 $816 Ironically, because of the unexpectedly strong recovery of the economy, this era of robust growth for US lenders may soon be slowing down. With the US economy gaining momentum, the Federal Reserve will likely tighten easy monetary policy by ending Quantitative Easing (QE), and raise benchmark interest rate targets in response to heightened inflationary expectations. Even though the Fed has not moved yet, anticipation of action has already caused rates to rise (Fig. 4). Figure 4 Selected Loan Interest Rates Annual Averages in Percent Source: Federal Reserve; Mortgage Bankers Association; CEB analysis. 7% 6% 5% 4% 3% 2% 1% E 2014P New Car Loans 10-Year Treasury 30 Year FRM Prime Rate REACHING THE BOTTOM IN EUROPE In the European Union, vigorous growth is elusive. Moreover, it is uncertain as to whether the most acute chapters of the Sovereign Debt Crisis have finally passed for many countries. Recent figures released by Eurostat show that the European Union as a whole officially exited recession in the second quarter of, and in the third quarter eked out a 0.1% gain when compared to the previous period in. The worst-affected countries such as Greece, Ireland, Portugal and Spain remain mired in turmoil, and while many of the continent s largest economies have bottomed out, conditions are still far from improved. Recent revisions to the OECD forecast cut global economic growth to 0.5%, 2.7%, and 3.6% for, 2014, and 2015 respectively, despite a more positive forecast in May. The OECD concludes that this weaker outlook for coming years is a direct result of an expected slowdown in large developing economies in preparation for the eventual reduction in the US Federal Reserve s stimulus plan. The IMF s GDP forecasts for the EU s largest members indicate that the fund expects the recession to end across all five of the largest EU economies by 2014, leaving some member states with slightly warmer outlooks. However, these figures overall are low by global standards for a bloc of 500 million people with a combined GDP of $17.3 trillion, and a dozen EU countries remain mired in recession. 3

4 A LONG ROAD TO RECOVERY FOR EUROPEAN DEMAND Prospects for growth in consumer lending in Europe remain dim. Although economies as a whole may be expanding, many consumers still struggle to maintain ever-slipping standards of living. The chief issue that EU member states must handle is the severe unemployment crisis. Even with the nascent recovery in some countries, unemployment rates continue to rise, reaching 12.1% in the euro zone (Fig. 5). In some countries such as Spain, unemployment rates have reached Depression levels, topping 20%. Meanwhile youth unemployment across Southern Europe nears 50%. Across the continent, governments are finally introducing structural reforms to improve labor flexibility and increase employment. The future economic prospects for the EU will ultimately depend on the passage of these reforms and resolving the sovereign debt crisis. Consumer finance growth is also constrained by the weak capital position of many financial institutions due to delinquent sovereign debt. This limits institutions ability to increase retail lending relative to commercial and sovereign lending. Figure 5 Euro Area Unemployment Rate Average Rate per Year, 2010 YTD EMERGING ECONOMIES: SHIFTING INTO LOWER GEARS Brazil, Russia, India, China and South Africa, together known as the BRICS, are five of the largest emerging market economies. These countries have been increasingly stronger engines of global economic growth over the past decade-and-a-half. Yet now, as developed world growth is increasing, these emerging markets are faltering. Some of the slowdown is purposeful, as in the case of China, which is rebalancing its investment-driven economy toward domestic consumption. This bodes well for consumer loan growth and financial institution investment in lending systems. In India, the slow progress of political and economic reforms, challenges modernizing infrastructure and a falling local currency have reduced growth. Although their prospects are somewhat diminished, emerging markets still offer the greatest potential to lenders seeking to new customers. The rewards will be rich if they can simultaneously manage higher political, economic, and social volatility. Figure 6 Annual GDP Growth Trends for BRICS Countries 2011 (P) 2014 (P) 12% 11.4% 12.1% Brazil 2.7% 0.9% 2.5% 2.5% Russia 4.4% 3.4% 1.5% 3.0% 11% 10% 10.1% 10.2% India 6.3% 3.2% 3.8% 5.1% China 9.3% 7.7% 7.6% 7.3% 9% YTD South Africa 3.5% 2.5% 2.0% 2.9% Source: ECB September Source: World Economic Outlook October, IMF. 4

5 FEATURE AUDIT SCOPING VENDOR OFFERS Retail banks benefit from more informed decision making. Banks looking to expand lending portfolios and improve loan pricing and decisioning are turning to loan origination systems that incorporate more data into the origination process. More information, used in the right way, can lead to informed decision making and accurate, real-time pricing of loans. Data combined and analyzed in a time-efficient manner helps banks to individualize pricing per loan and per borrower, rather than in groups. Additionally, the ability to process multiple loan types on a single system represents a market-leading system feature. CEB TowerGroup expects advanced risk scoring and analytics to play an important, forward-thinking role in loan origination technology, so we suggest focusing on investing in those key complementary attributes. Standard Native Feature Premium Native Feature Premium Third-Party Feature Not Offered FICO FICO Origination Manager Percent of Vendors Offering as a Standard Native Feature Automated Decisioning 75% Automated Task Assignment 88% Business Intelligence Tools 100% Collateral Management 100% Credit Risk Scoring 73% Document Generation 100% GUI for BPM 94% Islamic Lending 88% KYC/AML Tools 75% Lead Generation 69% Loan Pricing 69% Management Dashboards 50% Multi-Channel Origination 88% Multi-Currency 88% Multi-Language 94% Operational Reporting 81% Prequalification 81% Rate Quotes 94% 5

6 FAIR ISAAC CORPORATION (FICO ORIGINATION MANAGER) KEY STATISTICS Founded: 1956 Company Type: Public Headquarters: San Jose, California FY Revenue: $743.4 million Full-Time Employees: 2,500 FIRM OVERVIEW Fair Isaac Corporation (FICO) offers predictive analytics solutions to more than 5,000 businesses worldwide with offices in 12 countries. In the past two years, FICO made four major acquisitions, including Entiera, Adeptra, CR Software, and Infoglide. These acquisitions add new capabilities to FICO s product suite, including mobile customer engagement and risk intervention, cloud-based open-source PaaS, social link analysis, and collections and recovery. PRODUCT OVERVIEW FICO s Origination Manager contains four modular components which clients can choose from depending on their infrastructure. The four modules include an application processing module (APM), decision module (DM), data acquisition module (DAM), and analytic module (AM). Together, the modules facilitate the process of submitting a credit application, gathering additional data, and applying automated credit policies to evaluate a prospective customer and make a final decision. Origination Manager targets Tier 1, 2, and 3 lenders. RECENT UPDATES FICO Origination Manager 4.5, released October, builds upon open source technologies and extends the Application Processing Module (APM) beyond Websphere to include the RedHat technology stack. The new FICO Application Studio (a rapid application development platform) delivers an intuitive design environment enabling creation and management of the system s User Interfaces, Workflows and Data Model. Additionally, the automated build and staging processes across environments reduces errors, allows faster change cycles using one click deployment, as well as offers performance management and system monitoring. CEB TowerGroup View FICO s recent acquisitions and product enhancements have increased its stature as a software developer and innovator. The enhanced workflow capabilities and modular design will appeal to many large and medium-sized institutions, while the new mobile and cloud capabilities will appeal to institutions of all sizes. In our full Consumer Loan Origination Systems Technology Analysis, FICO received two Best-in-Class achievements in the Loan Decisioning and Enterprise Support categories. CUSTOMER SUCCESS STORY FICO s client, a top 10 US bank, needed to adapt to the market shift in the consumer and small business lending space post To do so would require an integrated set of decisioning and analytic capabilities to provide value to the customer. Prior to implementing the solution, the bank made quarterly policy adjustments which could lead to costly mistakes. FICO s Origination Manager helped ensure real-time customer responses to credit products offered, with capabilities to adjust policies week-by-week. The solution also granted the bank the ability to deploy policies, score models, and pricing offers as a set of business rules. The system had access to internal and external data sources, creating a learning loop that helps users execute the changes in a volatile market. Through the implementation, acquisition volume increased three-fold. Cross-sell penetration within the bank s customer base improved by 15% and the bank additionally observed an increase in credit card usage, with overall balances up by 8%. GLOBAL COVERAGE CUSTOMERS BY SERVICE MODEL 10% ASP/Hosted Source: FICO 80% Installed Covered Not Covered 10% SaaS/Cloud 6

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