Credit scoring with an eye to the future

Posted on Posted in Marketplace Lending, Research

Much has been written about the death of the FICO credit score.  See Wall Street Journal’s “Silicon Valley: We Don’t Trust FICO Scores” and American Banker’s “Will Fintechs Kill the FICO Score?” for recent (Summer 2016) articles.  The narrative invariably revolves around how the score is backward looking…considers limited individual past behavior…and can occasionally misfire and pronounce Ben Bernanke to be a bad credit risk.  And of course, mention is always made of the value of using additional data—what you studied…where you studied…what time you tweeted…what you posted…what others posted about you… See “Could Your Social Media Footprint Step On Your Credit History?” and from over three years ago (a long time in fintech), “Bad Credit? Start Tweeting”.

The FICO score is a bedrock of consumer finance– tried and tested.  It’s not perfect.  It can be enhanced.  And it could be forgiven for misappropriating Mark Twain and proclaiming “The reports of my death have been greatly exaggerated.”

WAIN Street’s Local Economic Vitality is a subnational ranking derived from macroeconomic factors such as labor market conditions, industrial production, sales, housing market conditions, and financial conditions.  It summarizes a borrower’s future economic prospects—a factor that influences consumer credit performance yet is not included in credit score construction.

Recent analysis by WAIN Street demonstrates how using Local Economic Vitality in conjunction with FICO improves predictive accuracy.

Difference in charge-off rates within credit score bands.
Difference in charge-off rates (basis points) within credit score bands. Each cell’s value is the equal weighted charge-off rate of loans in that segment less the credit score band’s equal weighted charge-off rate. Values less than zero mean the segment charge-off rate is less (better) than the credit score band’s charge-off rate.

Why does this work?  It works because as Yogi Berra said, “The future ain’t what it used to be”.  The analysis is available here:  Credit scoring with an eye to the future.