white paper Top US Bankcard Issuer Validates the Power of FICO 8 Score Key metrics exceed client expectations in originations testing March 2010»» Summary In recent validation testing, a top US bankcard issuer confirmed that the new FICO 8 Score and FICO 8 Bankcard Score provide significantly greater risk prediction over a previous FICO Score version. Based on a conservative estimate, FICO projected a financial benefit for the lender of $1.8 million to $5.5 million through conversion to the new scores. This paper details the validation and its findings, highlighting how both new FICO 8 Scores can help issuers boost profitability by reducing portfolio risk, mitigating losses, and identifying and capitalizing on new revenue opportunities. www.fico.com Make every decision count TM
»Introduction» One of the United States major bankcard issuers recently performed validation testing to compare the predictive power of the new FICO 8 and FICO 8 Bankcard Scores with the previous FICO Score version used by the lender. Specifically, the issuer sought to apply the new scores to originations decisions it had made using the previous FICO Score, and evaluate the respective score versions performance. The testing results, detailed below, confirm that both new FICO 8 Scores possess a superior capability in risk prediction. Equally important, the testing also underscores the timeliness of the new scores: Upgrades in the FICO 8 Score release are designed to keep pace with today s challenging lending environment and meet lenders and issuers increasingly difficult risk management requirements. Bankcard issuers, in particular, see a shrinking profitability target. The need for precision in making applicant and account management decisions in terms of a multitude of loss prevention and revenue generation decision areas has taken on an entirely new meaning. New validation by a major US Bankcard issuer shows an 8.9% lift in KS with FICO 8 Bankcard Score over the previous FICO Score version, resulting in a potential significant financial benefit of $1.8 million to $5.5 million, on 2 million new booked accounts. ------------------------------------------------------------------------------------------------------------ FICO 8 Score The newest and most predictive FICO Score The FICO 8 Score demonstrates a significant lift in predictability over prior score implementations for all industries. Now available at all three major national credit reporting agencies, FICO 8 Score offers the opportunity for better risk evaluation at a time when lenders need it most. The FICO 8 Bankcard Score is tuned to the bankcard industry and designed to give bankcard issuers greater predictive capabilities in origination and account management decisions. Consider that the bankcard industry is faced with unprecedented delinquencies, a still uncertain future economy, and the impacts and restrictions of the CARD Act of 2009. With this changing landscape, bankcard issuers face multiple challenges in identifying the most profitable new customer segments, and now require the best analytics and strategies for new customer acquisition. Just how much smaller has the window of opportunity become for bankcard profitability? In a recent study, FICO discovered that just 5% of an issuer s portfolio contributed 50% of its profits. No one can predict if this ratio will change, given new regulatory constraints on rate and fee changes. However, one thing is certain with more intense competition for good customers, card issuers are pressured more than ever before to find and keep highly profitable accounts. Using advanced analytics, such as the FICO 8 Score, will help lenders and issuers build their portfolios responsibly and create a profitable base of lowrisk customers with sustainable growth for the long term. Validation Highlights FICO 8 Scores Value in Bankcard Originations As further demonstrated in this recent validation, the FICO 8 Score and FICO 8 Bankcard Score significantly improve identification of those accounts most at risk, as well as those consumers representing lower risk. The new scores can be applied to making decisions on existing accounts, and on new applicants during originations. In its validation, the issuer in this study identified how the FICO 8 Score and the FICO 8 Bankcard Score could provide value for its origination decisions. Using the new scores, the issuer could increase profits by: Accepting More Applicants While Maintaining or Reducing Bad Rates: Many bankcard issuers are challenged to accept more good applicants while maintaining or reducing their current bad rate. The new scores can help issuers improve profitability with a low-risk and high-growth customer acquisition strategy. 2011 Fair Isaac Corporation. All rights reserved. page 2
Setting Initial Credit Limits: A critical decision for bankcard issuers is setting the initial credit limit as accounts are approved through the origination process. When a card issuer can more accurately assess the risk level of each applicant, it can more appropriately set initial credit limits. A more risky, but acceptable applicant may get a smaller initial credit limit, and a less risky customer may receive a higher initial credit limit. Setting Initial Interest Rate: Bankcard lenders assign initial interest rates based on different levels of risk. When risk prediction is increased, as the card issuer in this study found with the FICO 8 Scores, issuers are better able to assign the appropriate, most profitable interest rate for each new customer. Better Evaluation of Consumers New to Credit: Bankcard issuers have a particular challenge in originating cards for those new to credit. The features of the FICO 8 Score and the FICO 8 Bankcard Score are enhanced to work better with thin or young credit bureau files.»the» Validation Card Issuer s Data Validates Increased Power of FICO 8 Score and FICO 8 Bankcard Score In this recent validation, FICO examined the effectiveness of both the FICO 8 Score and the FICO 8 Bankcard Score to more effectively identify risk in the issuer s prime portfolio. The bankcard issuer, which had been applying the previous FICO Score model to its decisions, requested that FICO validate the predictive lift in the FICO 8 Score and the FICO 8 Bankcard Score versions over the prior FICO Score version. The FICO analysis for this validation provided three measures to the client: Trade-off Curve, Divergence and the Kolmogorov-Smirnov (KS) Statistic. TRADE-OFF CURVE ANALYSIS AND RESULTS 100% Model A CUMULATIVE % OF BADS Y% Z% Model B Random Line During the validation, the predictive strengths of the new and prior model versions were compared by plotting the percentage of accounts that went 90+ days past due or worse after scoring ( bads ), relative to the percentage of total accounts for that population segment. For the same population volume cutoff, the new scores identified more bads scoring lower and pushed below a given cutoff. These accounts, representing riskier customers, may not have received appropriate loss mitigation treatment with the previous FICO Score version. Likewise, better performing customers, or goods, would be pushed to higher scores above the cutoff and should have been eligible for growth and retention programs. 0% 0% X% 100% CUMULATIVE % OF TOTAL POPULATION The trade-off curves for both bad /total and bad / good revealed lift in predictive power of both new scores: the FICO 8 Score over the previous FICO Score version in use by the lender; and the FICO 8 Bankcard Score over the FICO 8 Score. The issuer validation was performed on a portion of its prime portfolio with a sample size of approximately 160,000 accounts, resulting in financial benefits for loss mitigation and missed revenue opportunity. 2011 Fair Isaac Corporation. All rights reserved. page 3
Loss Avoidance: The example below outlines the benefits the issuer could have realized on this portion of its prime portfolio had FICO 8 Score or FICO 8 Bankcard Score been in use during the examined period for loss avoidance on a trade-off curve. Assumptions for this example are as follows: The sample size of approximately 160,000 new booked accounts. Loss avoidance of $5,500 per account. Loss avoidance applies to only 50% of the new bads detected by FICO 8 Score as a conservative estimate, assuming additional analytics are also used in account evaluation. The loss avoidance projected to a portfolio of 2MM new booked accounts. Summary at 680 Score cutoff FICO 8 FICO 8 Bankcard Loss avoidance $5,500 per account 160K new booked accounts $132,000 $396,000 Loss avoidance $5,500 per account 2MM new booked accounts $1,650,000 $5,000,000 Missed Revenue Opportunity: The example below outlines the benefits the issuer could have realized had FICO 8 Score or FICO 8 Bankcard Score been in use during the examined period for missed revenue opportunity. Assumptions for this example are as follows: The sample size of approximately 160,000 new booked accounts. $350 missed revenue opportunity per account. Revenue improvement applies to only 50% of the new goods detected by FICO 8 Score as a conservative estimate, assuming additional analytics are also used in account evaluation. Missed revenue opportunity projected to a portfolio of 2MM new booked accounts. Summary at 680 Score cutoff FICO 8 FICO 8 Bankcard Revenue opportunity $350 per account 160K new booked accounts $12,600 $37,800 Revenue opportunity $350 per account 2MM new booked accounts $157,500 $472,500 2011 Fair Isaac Corporation. All rights reserved. page 4
Financial Impact: FICO 8 Score Implementation for Bankcard Originations Multiple Advantages to FICO 8 Bankcard Score Adoption: Loss Mitigation and New Revenue Opportunities In our example, we examined both the identification of additional bads below a cutoff score with FICO 8 Bankcard Score and the identification of additional profitable good customers above a cutoff score to whom you may promote and up-sell additional products. Assuming 2MM new booked accounts, the total estimated financial benefit for this top US Bankcard issuer for new booked accounts would be: $5,000,000 (loss mitigation) + $472,500 (missed revenue) = $5.5MM total financial benefit DIVERGENCE 100% How far apart? % OF POPULATION Bads How much overlap? Goods 0% Low High SCORE Divergence and KS Lift Analysis & Results The second measure used in the validation was divergence the summary measure of separation between distributions of two groups (e.g. good vs. bads ) by score range advantageously provides insight into the strength of a scoring model by measuring across the whole score distribution and showing the degree of separation of the two groups and the variance of the distribution. The divergence results for the client are an 18% lift in divergence for the FICO 8 Score over the previous FICO Score, and a 27% lift in divergence for the FICO 8 Bankcard Score over the previous FICO Score version. Divergence is a significant measure of how well the new FICO 8 scoring models perform in separating the goods from the bads, so it can make the best applicant and customer decisions with each model. 2011 Fair Isaac Corporation. All rights reserved. page 5
KOLMOGOROV-SMIRNOV (KS) STATISTIC CUMULATIVE % OF ACCOUNTS 100% Bads K-S Goods The third measure used in the validation was the Kolmogorov-Smirnov (KS) Statistic, which is a measure of the maximum difference between the cumulative percentage of two groups of accounts (e.g., goods and bads ) by score. The advantage of the KS is that it measures the point of maximum separation between cumulative distributions and is easy to visually interpret. The KS results for the client are an 8.4% lift in KS for the FICO 8 Score over the previous FICO Score, and an 8.9% lift in KS for the FICO 8 Bankcard Score over the FICO 8 Score. KS is a significant measure of how well the new FICO 8 scoring models perform in separating the goods from the bads versus the previous version of the score at a given score band. 0% Low High SCORE Score FICO 8 Score FICO 8 Bankcard Score % lift over previous FICO Score: divergence 18.1% 27.2% % lift over previous FICO Score: KS 8.4% 8.9% The table above outlines the percentage improvement of lift in Divergence and KS that could have occurred had FICO 8 Score or FICO 8 Bankcard Score been used throughout the issuer s prime card portfolio during the examined period.»» The New FICO 8 Score: Features and Benefits As demonstrated by these new validation results based on recent data, an upgrade to FICO 8 Score substantially assists issuers and lenders with critical business decisions and lending strategies. With an upgrade in predictability of up to 15% or more for certain key population segments, FICO 8 Score is a powerful tool for account acquisition and account management decisions. New features of the FICO 8 Score With the FICO 8 Score now available at all three major US credit bureaus, FICO remains at the forefront of delivering quality analytics in response to the market s need for better measurement of credit risk. Adoption of the FICO 8 Score is accelerating, and it is quickly becoming the standard for lenders and issuers focused on reducing risk. New features of the FICO 8 Score include: 2011 Fair Isaac Corporation. All rights reserved. page 6
Upgraded scorecard segmentation. Refined risk performance classifications. Mitigation of authorized user abuse with continued support of regulatory requirements. Minimized minor collection and public record infractions. Benefits across the customer lifecycle Using the FICO 8 Score gives you the potential to improve your risk management decisions across the credit lifecycle: Assign more targeted customer management actions. Refine risk-based pricing. Support regulatory requirements and government programs. Improve customer satisfaction. Better control loss reserves. Increase new account bookings at the same/better risk. Reduce delinquency and loss while booking the same volume. Streamlined Conversion To streamline lender conversion to the FICO 8 Score, the new model retains the same 300-850 scoring range, score reason codes, minimum scoring criteria and inquiry treatment as previous versions of the score. In addition, the FICO 8 Score helps lenders protect against authorized-user account piggybacking by incorporating new patent-pending technology that materially reduces the potential score impact associated with the abuse of authorized user accounts. By considering authorized user accounts in score calculations, the FICO 8 Score continues to support lenders abilities to comply with federal regulations. For more information on FICO 8 Scores, contact FICO at 800-777-2066 or cbhelpline@fico.com Global Standard for Measuring Risk Since its introduction 20 years ago, the FICO Score has become the global standard for measuring credit risk in the banking, mortgage, credit card, auto and retail industries. In its fifth generation, the FICO Score is called FICO 8. Today, FICO Scores are in use at more than 90 of the 100 largest US financial services institutions. To meet global demand, the FICO Scores are available to lenders in 20 countries on five continents. 2011 Fair Isaac Corporation. All rights reserved. page 7
about FICO FICO (NYSE:FICO) delivers superior predictive analytics solutions that drive smarter decisions. The company s groundbreaking use of mathematics to predict consumer behavior has transformed entire industries and revolutionized the way risk is managed and products are marketed. FICO s innovative solutions include the FICO Score the standard measure of consumer credit risk in the United States along with industry-leading solutions for managing credit accounts, identifying and minimizing the impact of fraud, and customizing consumer offers with pinpoint accuracy. Most of the world s top banks, as well as leading insurers, retailers, pharmaceutical companies and government agencies, rely on FICO solutions to accelerate growth, control risk, boost profits and meet regulatory and competitive demands. FICO also helps millions of individuals manage their personal credit health through www.myfico.com. Learn more at www.fico.com. FICO: Make every decision count. FICO, 300-850 and Make every decision count 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. 2010 2011 Fair Isaac Corporation. All rights reserved. 2647WP 04/11 PDF For more information US toll-free International email web +1 888 342 6336 +44 (0) 207 940 8718 info@fico.com www.fico.com