SCORING MODELS PRO S, CON S, AND LEGAL CONSIDERATIONS

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1 SCORING MODELS PRO S, CON S, AND LEGAL CONSIDERATIONS December 11, 2014 CRAIG COMBS, President KYR Financial LLC Business: (805) SCOTT E. BLAKELEY, ESQ. 2 Park Plaza, Suite 400, Irvine, California V. (949) F. (949) seb@blakeleyllp.com Orange County Los Angeles New York San Francisco Delaware Washington D.C. INTERNET: VIRGINIA SODERMAN, Vice President, Credit Ventura Foods, LLC 40 Pointe Drive Brea, CA Business: (714) Fax: (714) vsoderman@venturafoods.com

2 Craig Combs is the President of KYR Financial Services LLC. KYR Financial Services LLC is an Industry Leader in providing credit scoring modules (Credit Wizard) designed to provide today s Credit Manager with tools to help improve the credit review process, manage their credit risk while reducing costs associated with performing credit reviews. Craig has over 20 years of experience in the Credit Profession and has been designing credit scoring modules for over 10 years. Scott Blakeley is a partner in the California law firm of Blakeley & Blakeley LLP, where he advises companies around the country regarding creditors rights, commercial law, e- commerce and bankruptcy law. He was selected as one of the 50 most influential people in commercial credit by Credit Today. He is contributing editor for NACM s Credit Manual of Commercial Law, contributing editor for American Bankruptcy Institute s Manual of Reclamation Laws, and author of A History of Bankruptcy Preference Law, published by ABI. Credit Research Foundation has published his manuals entitled The Credit Professional s Guide to Bankruptcy, Serving On a Creditors Committee and Commencing An Involuntary Bankruptcy Petition. Scott has published dozens of articles and manuals in the area of creditors rights, commercial law, e-commerce and bankruptcy in such publications as Business Credit, Managing Credit, Receivables & Collections, Norton s Bankruptcy Review and the Practicing Law Institute, and speaks frequently to credit industry groups regarding these topics throughout the country. Scott holds a B.S. from Pepperdine University, an M.B.A. from Loyola University and a law degree from Southwestern University. He served as law clerk to Bankruptcy Judge John J. Wilson. Virginia Soderman is the Vice President responsible for Credit and Accounts Receivable with Ventura Foods, LLC, headquartered in Brea, California. Ventura Foods, LLC is a national manufacturer of edible oil related products that are distributed to the Retail, Food Service and Industrial segments of the food chain. Virginia has been with Ventura Foods, LLC for over 25 years and has had the opportunity to participate in the company s significant growth over that time period. In addition, Virginia has served on the Board of Directors for the local NACM affiliate: CMA Business Credit Services. She has also served as the Chairman of the National Suppliers to Food Processors Credit Group and the National Food Service Manufacturer s Credit Group. She received her CCE designation in 1991 and has been certified as an Expert Witness in the area of Preference Actions in Bankruptcy. 2

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4 SCORING MODELS 1. SCORING CONCEPTS a. A statistical technique used to determine whether to extend credit and in what amounts. b. To develop a credit scoring model, a creditor may analyze a sample of customers or credit seekers to determine what factors have the most effect on credit worthiness. Once the factors and their relative importance are established, a model is developed or purchased to measure those factors. Relative values are assigned in order to create a score c. Define what you are trying to accomplish and what resources you have available to you. d. Scoring done based on an internally developed model or based on a purchased model. It can be done internally or there are vendors available that will generate scoring for you. 2. SCORING USES IN COMMERCIAL SETTINGS a. Scoring can also be used to make a credit decision or to be the basis for forming a credit decision. In the consumer arena, credit scoring is often used to determine the amount of credit that will be granted. b. Generally in commercial settings, scoring is used as the platform for building the overall view of the customer. c. Most commercial credit grantors allow flexibility for non-credit oriented data, such as market share, market trends, customer base, etc. This is where the art of credit granting is a major factor. d. Scoring can provide the objective component of the decision process. e. Scoring can also be used as a knowledge transfer mechanism for example, a model can be adjusted to replicate a seasoned credit grantor s decision making process. The model then embodies that process and can be shared with new staff members. 3. PROS AND CONS OF SCORING FROM A CREDIT POINT OF VIEW a. Once you have a sense of what is most important to you and your company, you will want to identify the important traits and ratios that measure those values. For example: i. Payment predictability 4

5 ii. Ultimate solvency/insolvency iii. Identify traits of desirable or undesirable trading partners b. The use of a scoring model creates consistency in the data gathering and decision making process for a credit grantor. Data also becomes available for reporting on portfolio characteristics. c. Although scoring provides the foundation for decision making, it does not have to limit the scope of data used for the decisioning process. Many Credit Professionals react to scoring as a threat fearing the art of credit granting will be lost d. When a standard such as a model is used, it is relatively easy to modify the model to either ease or restrict credit granting depending on the company s needs. e. For companies who are required to be SOX compliant, scoring provides a sound basis for consistent processes f. Use of a scoring model does not preclude the use of non-traditional factors such as Market Presence Index, Social Media Activities, Suites, liens, judgments, press releases, news articles etc. g. Alternatively, scoring models can create an undesirable dependency or a lack of judgment utilization h. Scoring can lead to irrational business decisions, particularly for larger dollar relationships. 4. CREDIT PROFESSIONAL CONSIDERATIONS a. Comparison of customers with similar traits b. Manage risk by segment or characteristics c. Adjust risk by adjusting model components d. Internal versus external data inputs. 5. DEPLOYMENT a. External scores and data b. Internal scores and data c. Combinations 5

6 6. LEGAL CONSIDERATIONS a. Anti-trust issues: Sherman Act, Robinson Patman Act b. Gathering information: Fair Credit Reporting Act and Privacy Laws c. Objective credit decisions: Equal Credit Opportunity Act d. Documenting the policy: E-Credit Laws e. Mitigating Credit risk through credit enhancements 6