Underwriting is the foundational process for lenders. It determines whether to extend credit at all, how long the credit should be extended, and under what terms and pricing. Yet it’s not pervasive in all areas where credit is extended, as this graphic highlights:
In both situations, the customer has use of credit, and has to make payments to which they’ve committed. Should everyone be granted credit and then prove they can make payments? No. The underwriting process protects the lender, and the consumer as well.
Let’s unmask the two situations referenced above:
Before a new account is opened, the application gets the full underwriting treatment: income and employment data, FICO score, credit report, risk model. The lender is determining the risk of repayment. And depending on the underwriting, the lender can vary elements like maturity and APR.
On the other hand, the 1-30 DPD delinquent customer is less likely to get the “underwriting treatment”. If you were to step back a moment, how would you distinguish the two situations? If you were to abstract out the two situations, both are cases where the customer is being extended time to repay their obligations.
Still sounds weird to “underwrite collections”, no? Here are three reasons why it makes sense to underwrite delinquent customers:
- Haven’t they already shown they’re bad payers?
- Those credit reports cost me money
- OK, so I know the customer’s risk. What now?
Let’s explore these further.
Reason #1: Haven’t they already shown they’re bad payers?
In evaluating an applicant for a new credit account (credit card, personal loan, purchase financing, etc.), the lender makes an assessment of the risk of repayment in the weeks and months that follow. Lenders know there will be some delinquencies and charge-offs in newly opened accounts. They decide whether to approve based on probabilities of a customer becoming delinquent in the future.
Given that the customer has already proven they’re a repayment risk, why underwrite anymore? You’ve got your answer, right? Well, no.
Not all delinquencies are created equal. Here’s a sample of what I mean. These are the 7-month distributions of three outcomes for credit card customers in the first bucket of delinquency (1-30 DPD):
| 1-30 DPD, outcome seven mo later | Percent to total |
| Current | 59% |
| Delinquent | 22% |
| Charged-off | 19% |
It’s clear that some customers will be fine in the months that follow. But a significant number of customers will end up late again, or worse as charge-offs. This is the same dynamic lenders face on credit applications!
That alone argues for underwriting delinquent customers.
Reason #2: Those credit report pulls cost me money
When evaluating a new customer, the cost of a credit report is an acceptable cost of doing business. Assume a credit report costs anywhere from $2 to $3 per applicant. The upside is obvious: interest and fee revenue generated by the new account. The credit report costs are incredibly valuable and an economic bargain.
When it comes to collections, what are the economics of running a report? With 59% of customers returning to current status seven months later, why pay that much?
The answer: you don’t need to. It turns out you can learn much about a delinquent customer’s repayment risk with a few key questions. At Scorenomics, our BackOnTrack® platform allows you to triage delinquent customers, using these questions to make a statistically rigorous prediction. The Triage Risk Ratings table below is for BackOnTrack completers only, whom we stipulate exhibit better payment characteristics than the delinquent population at large:
| Triage risk rating | BackOnTrack completers’ delinquency rate | Index | Applied to overall 1-30 DPD population |
| 1 | 14.4% | 0.46 | 18.9% |
| 2 | 22.3% | 0.71 | 29.3% |
| 3 | 32.1% | 1.03 | 42.2% |
| 4 | 38.2% | 1.23 | 50.3% |
| 5 | 45.1% | 1.45 | 59.3% |
| overall | 31.2% | 1.00 | 41.0% |
For a fraction of the cost of a typical credit report, collections groups gain highly valuable insight into the repayment risk of their early delinquency customers.
Reason #3: OK, so I know the customer’s risk. What now?
Consider the current primary activity of collections groups to early stage delinquencies: repeat messaging (email, calls, texts, letters, app notifications) to the customer that their payment is past due.
Marketing wants to deliver products that help the consumer satisfy their own jobs-to-be-done. It’s a story of satisfaction and relationship building. The use of risk is in the service of that mission.
Collections has a different mandate than does marketing. Many times, collections is encountering customers experiencing distress. This is not satisfying some new product need. It’s securing payment while helping a customer through a rough patch.
In a previous post about empathy in collections, I used this absurd example to make a point about differentiated treatments for customers in collections:
- Context: Customer has been busy and forgot their payment. Action: The bank offers to convert their delinquent credit card balance into an installment loan and then close out their account.
- Context: Customer has lost job due to major medical issue, suffering long term cash issues. Action: The bank offers a $25 credit to enroll in autopay.
Here’s the key for collections. Given an understanding of a customer’s (i) specific situation; and (ii) risk of future repayment, what would you do differently early on? In a previous post about next best actions for collections, I listed some different treatments a collections group would have to decide on for a given situation:
How would you know which one to offer? Underwriting! Understand your customer, understand how to help them and your institution.
Underwriting powers the processes of financial institutions. It’s time to bring it more fully into collections.
Click here to find out how Scorenomics BackOnTrack® analytics can help you learn underwrite your early stage delinquent customers, and apply the appropriate response.
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