Equifax, Experian and TransUnion have implemented new policies that will improve the credit scores of an expected 20 million Americans. Are your analysts prepared? Have you reviewed your risk criteria recently to see how this might impact the credit quality of both new loans and the ongoing risk management of your loan portfolio?
Beginning this month, some credit scores could jump as high as 40 points, which may result in the reclassification of millions of consumers’ creditworthiness. For credit card issuers and other lenders, this is an important adjustment worth considering.
The policy change comes on the heels of a class-action lawsuit alleging the credit bureaus weren’t doing a great job ensuring that the damaging activity noted on credit reports actually belonged to the person whose score was dinged. It also claimed the process of requesting changes to these types of errors was too difficult for the average consumer.
To adjust for this, the bureaus will no longer add tax liens and civil debts to consumers’ reports if they do not have enough personal identifying information (PII) associated with the judgement. And many do not. In fact, it’s uncommon for tax liens or civil judgments to contain all the PII data points now required by the policy change. Any liens or debts that have already been noted on consumers’ credit reports will be removed if they do not have adequate PII. This will instantly improve the credit scores of an estimated five percent of Americans by anywhere from 10 to 20 points, and for some, 40 points or more.
While many consider this change to be positive for consumers, there may be a downside. If borrowers appear more creditworthy than their past behavior has shown them to be, they could be approved for dollar amounts or loan terms they are unable to handle. Their ability to repay may be somewhat disguised by a less-than-complete view of their credit histories, opening doors to new levels of credit that are actually inappropriate for their financial means.
Will lenders, then, make an adjustment to their underwriting criteria or raise rates to cover the possibility of increased risk? Will they be restricted from doing so by regulatory requirements? As the cost of funds increases along with rising interest rates, financial institutions may find themselves in need of new methods for evaluating creditworthiness.
Fortunately, the industry has begun to evolve its credit decision-making process, putting less emphasis on the FICO score. More lenders, optimizing their businesses for the big data revolution, are relying on predictive models to guide application approvals, set credit limits and determine the most lucrative pricing schedules for their loan portfolios. Those models pull hundreds of lines of data from just as many sources. Although FICO scores are an important piece of the data pie, they are far from the only factor analyzed by sophisticated predictive – and prescriptive – models. That said, many of these models will likely adjust as the impact of those 20 million “improved” scores comes online.
The other element working in most community banks’ favor is the type of borrower served by the majority of the nation’s local and regional financial institutions. Anyone with a score above 600, which accounts for most community bank borrowers, has a less than 2-percent chance of seeing their credit score rise.
How long it will take for the industry to feel the impact of the bureaus’ policy change is a bit unknown at this point. An additional element to the change is the commitment to re-verifying data on tax liens and civil debts every six months. Depending on how long it takes the bureaus to get really good at posting only those records in accordance with their new policies, we could see fluctuations in the scores of both new and existing borrowers for years to come.
Community bank executives and their credit managers, underwriters, compliance specialists and data analysts should keep an even closer eye on their lending portfolios in the coming months and adjust as necessary. While the changes are only expected to impact 20 million Americans, certain segments of the population are more likely to be impacted than others (specifically those with credit scores in the range of 351 to 500). If your bank serves these segments, you could see a notable change that requires decisive action with enough advanced planning to meet regulatory requirements.