By John J. Coffey, C.P.A. and Gene Palm, www.profitres.com, originally published January 2003, ABA Bank Marketing

·          What are credit scores?

·          Uses of credit score data

It should come as no surprise that bankers and their customers think very differently about the same things!  For instance, a loan is a liability for the customer – but it’s an asset for the bank.  However, the customer’s loan could become a liability for the bank if the customer fails to pay the loan back.  In light of this, a loan officer will review the “credit score” of the customer to determine their credit worthiness before they make a loan to them.

What Are Credit Scores?

The most common credit score used today is the FICO^® score (an acronym for Fair Isaac Credit Organization) named after “Fair, Isaac”, the company that developed the scoring routine.  The top three major credit reporting agencies, Equifax, Experian and TransUnion all use FICO^® scores; however each has their own brand name for these scores.  For instance, Equifax calls their FICO^® scores “BEACON^®” scores.

The FICO^® score is a mathematical formula that takes into consideration the customer’s payment history, amounts owed, length of credit history, new credit and types of credit.  The score ranges from a low of 300 to a high of 850.  A customer with a low score poses a high credit risk and will be charged a higher interest rate for a loan, while a customer with a high score is a lower credit risk and will be charged a lower interest rate for the same loan.  For instance, a customer with a FICO^® score of 500 could be charged 2.91% more interest for a 30-year fixed mortgage than a customer with a FICO^® score of 720 or better.

Uses of Credit Score Data

In order to use FICO^® scores within your Marketing Database, you will need to ship an extract of your data to a credit agency.  After they score your data you will need to append it back into your Marketing Database.

Because a FICO^® score is a numerical value, it is ideal for use within your Marketing Database as a segmentation tool.  Statistically, customers can be segmented into one of five groups based on their FICO^® score:

Below 620:  20%

620-690:  20%

690-745:  20%

745-780:  20%

Above 780: 20%

As a bank marketer, it’s important to know that traditional direct mail strategies have been targeted to customers with FICO^® scores between 680 and 780.  If a customer has a score below 680, they are a potential high credit risk and if their score is above 780 their response rate is low.  Either extreme lowers your marketing campaign’s profit margin.

The bottom line is that you will be able to develop very focused direct marketing research by using FICO^® scores.  For instance, if you want to sell a home equity line of credit to your customers, you could develop the following query using demographic and FICO^® score data elements:

Home Ownership = Yes  AND

Length of Residence >=3 Years  AND

Home Value >= $100,000  AND

Income >= $50,000  AND

Age >= 45  AND

Presence of Children = Yes  AND

Married = Yes AND

FICO^® >=680 AND FICO^® <=780

It’s important to note that if you decide to use FICO^® scores for direct marketing purposes, you will need to contact your Compliance Officer to make sure you are using them correctly.

FICO^® scores can also be used to enhance the profitability algorithm of your Marketing Database.  Your Marketing Database utilizes profitability assumptions for net interest income, non-interest income, non-interest expense and provision for loan losses in order to calculate profitability at the account level.

The provision for loan losses (the cost for bad loans) is calculated as a percentage of the loan balance.  Each loan portfolio has a different provision for loan losses value based on the risk of the loans.  For instance, an unsecured (risky) loan may have a high provision for loan losses value of 1.78% while a secured (and less risky) home equity line of credit loan may have a low value of only 0.14%.

What’s exciting is that the customer’s FICO^® score can be used to weight the provision for loan losses for each of their loan accounts!  For example, a customer with a low FICO^® score can be given a higher proportion of the provision for loan losses cost while a customer with a high FICO^® score can be given a lower proportion of this cost.

Once this account-level customization has been completed, you will then be able to use a Distribution Report to segment the profitability of your customers and products based on FICO^® scores.  This will help you perform more accurate pro forma analyses as you design your direct marketing campaigns!

Sources:

www.investorwords.com

www.myfico.com

www.fairisaac.com

John J. Coffey, C.P.A. and Gene Palm are the principals of Profit Resources, a consulting company that specializes in MCIF technologies.  © Profit Resources, Inc. 2006