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New data insights can divine clues for how consumers will handle an economic downturn

By Joanne Gaskin

Credit scores have undergone a near constant evolution since being introduced decades ago. From more powerful algorithms built with machine learning techniques to the inclusion of new forms of alternative data, credit scoring has gotten increasingly better at its core function: assessing a consumer’s likelihood of repaying their debt obligations.

The ongoing importance of credit scores in mortgage lending and beyond stems from their ability to accurately assess consumer credit behavior across all economic conditions. Inherent in the nature of credit scores — like other algorithms that aggregate numerous data sources into a single metric — is that you can take multiple paths to the same result. For instance, two consumers can each have scores of 720, even if their underlying credit profiles show very different characteristics.

Rather than the traditional approach to tighten credit across the board, lenders can identify resilient consumers and keep responsible credit flowing.

For the scores themselves, which represent a consumer’s current credit risk by reflecting their past credit behavior, this is normal and expected. But the COVID-19 pandemic also has demonstrated the particular importance of understanding how a consumer is likely to respond during times of economic stress.
In other words, can you predict a future “what if?” risk that may or may not materialize? In fact, robust sources of data on consumer credit performance show that certain types of credit profiles with similar scores can be expected to show very different levels of resilience if an economic downturn occurs.
Today, new analytics tools are providing lenders and investors the ability to consider consumer resilience in residential mortgage origination by offering deeper insights and more precise risk assessments than ever before. One such metric is the FICO Resilience Index, a tool that complements the FICO Score (the industry-standard credit score) to assess how a consumer is likely to respond during a recession.
This can have a real-life impact on resilient consumers who seek credit during times of economic stress. Rather than the traditional approach to tighten credit across the board, lenders can identify resilient consumers and keep responsible credit flowing. This puts mortgage originators in a better position to withstand and respond more confidently to stormy economic weather, even when it strikes without warning.

Stark contrast

The potential of consumer resilience can help identify which potential borrowers are particularly likely to respond well to economic stress. Even among consumers with similar overall credit profiles, there can be vast differences in resilience that provide crucial insights. FICO research shows that within the same narrow score bands, the credit risk associated with the most resilient consumers may be unchanged during challenging economic times, while that of the least resilient clients can multiply by a factor of four or more.
The data underlying the FICO Resilience Index reflects real-world borrower performance during the Great Recession. FICO developers examined the comparative performance of similar consumers through two different phases of the economy — a “stressed” period from 2007 to 2009 and an “unstressed” period from 2013 to 2015. This research was able to isolate the credit factors that best predict resilience.
For instance, looking at two consumers with similar scores, the more resilient consumers tend to have fewer credit inquiries in the previous year, which demonstrates that they are not credit hungry or seeking to consolidate credit. They typically have lower total revolving balances, meaning they are not overextending their financial capacity. And they have more experience in dealing with credit, having lived through multiple economic cycles and learning to manage their finances through good times and bad.
Of course, these factors are all positive indicators for baseline scores, but the data shows that they are particularly predictive of resilience, even when directly comparing consumers with similar scores. During the “stressed” period that reflected the depths of the Great Recession, consumers with credit scores of about 650 who ranked highest on the resilience index actually had lower delinquency rates than those with scores in the 710 range that ranked lower for resilience.

Increased precision

By helping to account for borrower resilience during economically stressed times, these analytics have numerous uses for lenders and servicers across the mortgage credit lifecycle. At origination, they can be incorporated into strategies and cutoffs as a new decision key, complementing the standard use of credit scores. And rather than responding to periods of economic stress with broad-based credit cutoffs that can hurt consumers, foresights into borrower-level resilience equips lenders to keep credit flowing with greater confidence.
Because these tools are “always on,” resilience can be integrated into a lender’s existing credit processes regardless of the current economic conditions. By doing so before an economic storm hits, lenders can become better prepared to withstand and respond appropriately to early warning signs of financial stress. When a crisis arrives, resilience is a critical tool that enables lenders to respond with more precision to the challenge of exposure management.
Shifting to this approach could have hugely positive benefits for the mortgage industry. Using a random sample of 10 million credit records, FICO researchers explored how the industry might have responded to the Great Recession had the resilience index been available to inform risk-management strategies at the time. Using a hypothetical credit-score cutoff of 720 on the random sample carried an overall default rate of 4.2% or lower during the recessionary period.
If lenders had been able to incorporate consumer resilience, they could have originated 450,000 additional mortgages to consumers with scores between 640 and 720 — below the cutoff — while preserving equivalent or better odds of repayment throughout the recession. A decade later, lenders can act with much more precision to keep credit flowing to more consumers in good times and bad.

Uncertain future

The past two years have made one thing clear: It can be impossible to predict when an economic downturn will hit and how long its impact will resonate. As the economy continues to recover, the mortgage industry is turning its attention toward a more regular cycle ahead.
While recovery is on the horizon, the sunsetting of relief programs and continued macroeconomic uncertainty make gauging borrower resilience more important than ever for assessing credit risk. Mortgage lenders that incorporate resilience today will be the ones best positioned to cut through the fog and adapt to uncertainty tomorrow. Adding resilience-based analytics to a lender’s existing credit processes puts a company in a better position to withstand and respond more confidently to stormy economic conditions.
Critically, resilience offers essential predictive insights during all types of economic climates. In sunnier weather, lenders can monitor and build portfolio strength by considering consumer resilience in underwriting and account management. In stormy economic cycles, resilience (particularly through the ongoing use of index-based analytics) can allow lenders to keep credit flowing, limit their exposure to losses and avoid overly broad actions that can further hurt consumers during periods of economic stress.
Consumers and businesses across the U.S. have demonstrated remarkable resilience in the face of turmoil over the past two years. As everyone enters an equally uncertain future, the incorporation of new data-driven insights on consumer resilience will make loan portfolios stronger as well. ●


  • Joanne Gaskin

    Joanne Gaskin is the vice president of scores and analytics at FICO. She is responsible for the strategic direction of FICO’s scoring products and business partnerships serving the needs of the mortgage industry. Gaskin has more than 20 years of experience in banking and financial services. She led efforts to address some of the most important topics impacting the mortgage market today: regulatory compliance, credit-risk management, data security and eMortgages. She is a graduate of the Mortgage School of Banking, earning the accredited mortgage professional designation. 

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