Fewer people are involved in the loan origination and approval process today, thanks to efficiencies resulting from credit scoring. Over the past 10 years, many institutions began using an automated, score-only process to decide loan requests under $25,000. That number has been creeping higher as institutions gain confidence in the ability of credit scores to predict success in the loan portfolio.

How Scoring Evolved at Hibernia

Hibernia, a $22 billion institution operating in Louisiana and Texas, began using a judgmental scorecard by Fair Isaac to process small business loans in 1993. At the time Hibernia had 1,500 accounts in its $150 million small-business portfolio. Danny Hebert, senior vice president and manager of Hibernia's business banking center, said his institution was one of 17 banks that participated in the development of Fair Isaac's first pooled scorecard, which Hibernia began using in 1995.

In 1997, when it had 10,000 accounts in a $1 billion portfolio, the bank was using the scorecards to make small-business credit decisions on loans up to $50,000 without requiring financial statements.

In 2003, Hibernia introduced its own custom score. It currently has a $3 billion portfolio and 50,000 accounts.

Factors for Success

Hebert attributes Hibernia's successful credit-scoring program to these factors:

* Dedicated resources for scorecard management, including reporting and analytics on scorecard performance, especially overrides, and performance by score bands as well as scorecard modeling and validation.

* Vigilance in catching input errors and performing ongoing audits for that purpose.

* Clean data capture and coding.

* Understanding and buy-in of credit scoring by the sales force and central-lending units, especially management.

How Scoring Evolved at AmSouth

AmSouth Bank, a $50 billion regional bank in the Southeast, began credit scoring in 1995 with a FICO pooled card. Two years later it began using only credit scores to decide loans up to $35,000. When it introduced its custom scorecard last year, AmSouth increased its score-only threshold to $100,000 for certain product lines.

"Data verification and validation are a highly critical aspect of this process," said George F. Buchanan, senior vice president and business-banking senior credit officer, AmSouth Bank. "We have a dedicated resource team that analyzes the ongoing credit quality and the makeup of all the score components. Much of our data entry on loan applications is handled remotely, so we have a quality-control team that reviews the applications to ensure that all the data is entered correctly. This review is very important for validation. It is necessary to have good quality data on the front-end."

Hibernia was using a centralized system to input applications at the time of the audioconference, but Hebert said it would move to remote input of application data in the second quarter. "A lot of banks are now pushing this function out to the sales force, essentially eliminating data reentry," said Hebert. "At Hibernia we're now scoring all applications up to $250,000. In our small-business portfolio, loans under $250,000 represent approximately 80% of the loans."

Of the many efficiencies resulting from Hibernia's highly automated process, Hebert said the most important is that fewer people are involved in the origination and approval process for 80% of its loans.

The Decision Process

"Driving some of our efficiencies and success on the origination side is how we stratify our decision processes," Hebert explained. "We have several dedicated underwriting units based on the dollar size of the credits under consideration and the amount of due diligence required. We have one underwriting segment that is dedicated to credit decisions up to $50,000 based purely on scores. We use a second underwriting group that decisions credits from $50,000 to $250,000. That decision process involves a credit score and one year of financial statements and tax returns on borrowers and guarantors. It's still a very quick process, still very score dependent, but there are some overlays.

"For loan decisions over $250,000, we use more traditional underwriting techniques and have two underwriting groups. One group considers credits from $250,000 up to $500,000. For those, we use a very simple, almost checklist-type underwriting. From $500,000 on up to our limit of $5 million, we use a more traditional, but streamlined, analysis."

Buchanan said AmSouth has two groups in its underwriting center. "We have an objective underwriting team for the first tier, score-only / score-plus process. This group also handles some of our score-plus applications, looking at a few other elements in addition to the scores. Our subjective underwriting team is much more traditional. Like Hibernia, it has a graduated process for evaluation. For transactions between $100,000 and $250,000, it's very streamlined but escalates in complexity as the loan amount requested increases."

O'Connor noted that the loan sizes for which scores are used continue to creep up, resulting in cost efficiencies. "A number of institutions won't do the spreads trends or traditional analysis on low-scoring applications because they've found that if the request does not score above a certain level, even if it's a half-million-dollar credit, the deal will not pan out," he said.

Both Hebert and Buchanan said their institutions score every loan, even those over $1 million, because they hope the scores will provide historical data that they can use to compare loan performance against actual credit scores. "So we do score loans over $250,000. We just don't necessarily use the score for a decision," Hebert said.

Benefits of Credit Scoring

"As you analyze the portfolio, you can see that the scorecards absolutely work," said Hebert. "They rank-order risk, creating absolute hardcore facts that can't be denied. Over time, Hibernia has found that approved loans that did not meet our scorecard cutoffs performed two to three times worse than the loans above the cutoff. In addition, scorecards simplify and streamline the origination process by enabling branch managers and other platform personnel throughout our geographic region to facilitate more loan applications than were previously possible. It helps grow the balance sheet. There's no way Hibernia could have grown from 1,500 accounts in 1993 to 50,000 today without using scorecards."

It's critical to continually monitor the performance of scorecards and the origination quality. "You have to keep on top of that origination information, and understand how you might need to tweak it if you see things going sideways," said Buchanan.

Portfolio Management at AmSouth

Portfolio management activities are critical both to maintain credit standards and to maintain books of business without the expense of a fairly high aggregation factor from customers at smaller dollar amounts. AmSouth has found that its renewal and review process and its behavioral scores have created efficiencies, opportunity, and growth.

Renewal and review processing. Roughly a third of AmSouth's monthly loan center volume is renewal transactions. The bank reasoned that there must be a better way to handle those accounts than handling them as it would a new account, particularly in light of the renewals' approval rates.

"We found that anywhere from 80% to 90% of those loans were going through a normal process and ultimately getting renewed," said Buchanan. "So we developed a process that allows us to triage those credits, based on dollar size, behavioral scores, and our collateral mix. We then became able to approve about 85% of them in an automated, low-touch fashion.

"This process allows the sales force to focus on generating new business, and it creates efficiencies in our loan center. We have a standalone unit that manages the renewals and review process for most loans and lines up to $250,000. We sometimes process higher loans that way based on certain products and collateral types."

The behavioral score. The behavioral score is designed to assess the overall risk volatility and to predict the performance of existing accounts in the total portfolio. AmSouth reviews monthly the internal performance as well as its external data on every account. "This process allows us to prioritize our renewal work queues," said Buchanan, "and it provides cross-sell opportunities as well as allowing us to focus on certain customer segments through the process.

"Internally, we look for payment performance, collateral, product type, and deposit information. We also bring in external data on those customers, such as external delinquencies, external charge-offs, and updated bureau information. A variety of sources can provide that data, including the credit bureau agencies, business data repositories, public record information, and government and Internet sites.

"Next, we integrate that process into our collections and workout area. And again, behavioral scores allow us to queue collection calls through our collections area and system so that they're not calling customers that ultimately are going to self-cure. Behavioral scores can predict losses, and by analyzing those scores you can impact many processes, including policies for charge-offs and nonaccrual recognition. Ultimately, we may be able to use behavioral scores in working with third-party agencies on either collection or workout on those accounts that are outsourced."

Portfolio Management at Hibernia

Hibernia's risk management functions are similar to those of AmSouth. It uses a custom behavior score; it scores its portfolio monthly using external credit bureau data and other external data, as well as internal information on deposit accounts and line of credit utilization.

"From a portfolio management perspective, scorecard management has really taken off over the last few years, and we're continuing to tweak our process to make it better," said Hebert. "Behavior scorecards are much more powerful than origination scorecards because they use real-life data. Scored loans are already on the books, so you have the benefit of using information that is specific to the bank and specific to the loan.

"Hibernia uses scorecards in various ways, depending on the dollar amounts. We have line-of-credit blocking strategies that are a function of our behavior score, and we use early workout strategies to correct small problems before they become big problems."

Most institutions renew more than 90% of deals in their traditional middle-market book of business, said O'Connor. Many of them use early warning systems to manage exposures $1.5 million and under. "They're not touching those credits unless they see issues from this electronic evaluation," he said, noting that some institutions have started to segment their existing portfolio in deciles. In the lowest three deciles, management discusses whether it should exit those customers before a credit impairment occurs, while it tries to generate revenue by up-selling and cross-selling its highest-scoring customers.

Hebert and Buchanan agreed that potential to generate revenue is one of the big advantages of portfolio management. "There's no better way to get management to agree to more resources for portfolio management than when you make them realize it contributes to revenue generation," said Hebert.

Developing Early-Warning Systems

There is no stand-alone product that an institution can purchase for portfolio management, although many vendors help institutions develop behavioral scorecards. Hibernia and AmSouth both developed an internal data warehouse, and they work with their IT groups to introduce external and internal variables on a monthly basis.

For the process to work, senior management must be willing to invest in staff to perform the analytics, and they must discourage excessive overrides from the field. "We have seen organizations that have had 20%, 30%, 40% overrides, and while everyone feels good about those for the first eight to 12 to 14 months, the overrides come home to roost in 20 to 30 months," said O'Connor. "Some organizations debate the value of the scorecard. They think it doesn't work because they have high charge-offs and past dues when the truth is that the scorecard never got a chance to work because everyone was overriding it."

The panelists agreed that institutions will always want to do some overrides, and both institutions try to maintain an override rate of about 5%. Putting the authority for overrides in the hands of very few management-level staff helps limit the number of override requests. "As soon as requests for overrides need to be bumped up a few levels, it's surprising how many times they don't get done," said Hebert.

Contact Kathleen M. Beans by e-mail at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it

Kathleen Beans is manager of communications at The Risk Management Association and a frequent contributor to The RMA Journal.

COPYRIGHT 2005 The Risk Management Association
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