10/5/2012. How to Avoid Student Loan Defaults. PSL Credit, Data and Analytics. Credit Underwriting and Default. Loan Environment

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1 Credit Underwriting and Default Management in Today s Private Student Loan Environment MASFAA October, 2012 Contact Info: Michial Thompson Managing Director, Credit Risk Management First Marblehead mthompson@fmd.com How to Avoid Student Loan Defaults To determine how to prevent defaults, let s look at what the main drivers of default are: Credit Policy: Lenders make loans they expect to be paid back Collection Agency Management: Ensure maximum performance when DQ loans are placed for collections Data & Analytics: Performance projections, reporting and collections placement streams driven by data analytics Student Loan Idiosyncrasies: Deferment, youth, cosigners Underwriting PSL Credit, Data and Analytics HISTORICAL Loans to (almost) anyone at (almost) any school with (almost) any cosigner. First Marblehead Student and cosigner both evaluated, and much more rigorously Quality of school considered Credit scores Primarily cosigner FICO FICO of both student and cosigner used, and much higher values required. Many other credit attributes reviewed Custom scorecards Collections Student loan specific Due diligence check the box style, modeled after federal program. Agencies compensated for carrying out tasks, not for performance. Not much customization of credit policy or collections Especially complicated asset class to understand: Deferment, forbearance, young borrowers. Large unsecured personal loan. Driven by data and analytics Custom treatment streams driven by credit risk Similar to other asset classes credit cards Rigorous (micro)management of agencies and performance Products custom designed with credit and portfolio management in mind Data, analytics, reporting and collections are custom designed to deal with student loan idiosyncrasies Analytical techniques specifically tailored for PSL s Data Very few have data needed to understand credit and performance $17B in originations and performance data over 20+ years Comprehensive and frequent credit bureau refreshes Robust data set of loans across multiple lenders, marketers, school lists, economic periods and credit policies 1

com How to Avoid Student Loan Defaults To determine how to prevent defaults, let s look at what the main drivers of default are: Credit Policy: Lenders make loans they expect to be paid back

2 CREDIT POLICY Credit Policy Appropriate Assessment of Risk at Time of Application Beyond just FICO More granular credit bureau attributes Evaluate both student and cosigner Over-borrowing/loan amounts School types/programs Ability to repay Credit Policy: Skeletons in the Closet All of these are cosigned loans with cosigner FICO > 750. The bars show what happens to defaults when we further segment these by student FICO. The student (skeleton in the closet) weighs heavily on the performance of the loan. Overall cosigned loans with cosigner FICO > 750 default at a higher rate than non-cosigned loans with student FICO > 750. Cosigner vs. CWS Student FICO on Cosigned (>750) Loans 2

The bars show what happens to defaults when we further segment these by student FICO. The student (skeleton in the closet) weighs heavily on the performance of the loan.

3 Credit Policy: Lend to Quality Schools Dropouts are twice as likely to default as graduates School, school type, and program of study are strong predictors of graduation rates Clearly graduates are more likely to get a higher paying job that will allow them to pay back the loan Credit Policy: Lend to Quality Schools 200% Default Rates by School Type 100% 0% 2 year school 4 year school K 12 school For profit school Credit Policy: Control Over- Borrowing School certification greatly reduces overborrowing compared to DTC Loan amount requested should be considered in credit decision Capacity metrics (such as DTI) further assess ability to repay and prevent excessive loan amounts 3

School Type 100% 0% 2 year school 4 year school K 12 school For profit school Credit Policy: Control Over- Borrowing School certification greatly reduces overborrowing

4 FMC Private Student Loan Scorecard: Updated Score Further Separates Risk 100% To Remove 75% of Defaults Eliminate worst 55% using FICO Eliminate worst 35% using FMD1 90% Eliminate worst 26% using FMD2 80% % of Defaults Captured 70% 60% 50% 40% 30% 20% 10% Worst 15% assigned by FMD Score Version 2 (Extant) captures 58% of defaults Worst 15% assigned by FMD Score Version 1 captures 50% of defaults Worst 15% assigned by FICO Score captures 35% of defaults Cosigner FICO FMD Score Version 1 FMD Score Version 2 (Extant) 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100% Percent of Applications AGENCY MANAGEMENT Aggressive Agency Management Approach Define Strategy Define the agency type (experience, client base, management, etc) Performance drives future volume placements Incentive plan must be meaningful to agency to align performance Develop Network Optimizing number of agencies per segment to foster competition Continuous refresh of agencies based on results Robust bullpen for quick change-out for performance or client need Manage Goals and volume forecasts clearly communicated Monitoring in place for outcomes; activity monitoring progressing Mutual transparency into operations Deep dives on root causes of performance gaps Volume shift algorithms for Recovery agencies Agencies now know they are being watched 4

defaults Worst 15% assigned by FICO Score captures 35% of defaults Cosigner FICO FMD Score Version 1 FMD Score Version 2 (Extant) 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85%

5 DATA & ANALYTICS Data and Analytics NOT one-size-fits-all Collectability scorecard Origination, monthly performance, refreshed credit bureau data Probability of a delinquent loan curing Strategies driven by data When to place a file vs. leaving it with servicer Which collection agency to place with How long to leave loan at a given collection agency Which strategies (FB, MGRS, etc) available per customer Test-and-learn approach Data and Analytics Agency level Daily, weekly, monthly Performance by batch, by risk segment, by placement stream/strategy Transparent view of competition Agent level Daily, weekly, monthly Keep track of what happens to top performers 5

leaving it with servicer Which collection agency to place with How long to leave loan at a given collection agency Which strategies (FB, MGRS, etc) available per

6 Data and Analytics Data Dialer data Daily details of every call Skip-tracing Refreshed credit bureau data Phone, cell phone data USPS (and others) data to track relocations Data and Analytics: Example Agent level reporting Prevent best performer migration Plans for lower performers Resulted in 3 better supervisors transferred in They know we are watching Data and Analytics: Example Test-and-Learn Mailing Strategy Test Cure Rates (to less than 30) Timing of communications strategy Borrower vs. Cosigner Delivery / Channel options Agency integration / talking points No Cosigner With Cosigner 6

better supervisors transferred in They know we are watching Data and Analytics: Example Test-and-Learn Mailing Strategy Test Cure Rates (to less than

7 STUDENT LOAN IDIOSYNCRASIES Student Loan Idiosyncrasies Deferment does not build a habit of making payments Credit policy should encourage cash-flowing loans Early Awareness Program Reach out to both student and cosigner before repayment , phone, mail package Most loans need a cosigner utilize this early and often Contact cosigner at any sign of trouble Include cosigner in all communications Require cosigner participation in FB or similar decisions Student Loan Idiosyncrasies: Example Deferment 7

phone, mail package Most loans need a cosigner utilize this early and often Contact cosigner at any sign of trouble Include

8 RESULTS: A CASE STUDY Case Study: FMD reduced delinquencies and defaults for one major bank s PSL portfolio by 50% After taking over, delinquencies immediately improved. Within 6 months, annualized monthly charge-off rates were cut in half. 8

taking over, delinquencies immediately improved.

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