Usually I spend my time talking, writing and teaching about sales related issues. Typically they center around topics such as motivation, sales techniques, goal setting, etc. Very often though, when I get to the question and answer part of my presentations, I am asked questions about credit. This is a topic that is near and dear to every sales person but because it is usually out of his or her control, it is not discussed as a part of most sales training courses. Even when it is, the training usually consists of selling the decline while trying to get the next deal from the vendor or broker. Because understanding credit issues is essential to success in this business I decided to do some research and write an article about an area of credit that is used frequently, especially in small ticket leasing, but is often misunderstood – the principal’s personal credit bureau and associated scores reading fluency strategies.
Why is the principal’s personal credit report so widely used in our business? Actually there are many reasons. They are inexpensive, usually two to four dollars per report depending on your volume. The information is rich – many consumer credit issuers report their results to the credit bureaus. They are available to any credit issuers, so a new company can have access to the same information as established lessors. The primary reason, though, is that they are predictive. For a variety of reasons the consumer credit report of the owner/partners/officer(s) of a business is one of the most reliable sources used to determine the likelihood that the lessor will have a positive experience with the lessee.
As I prepared for this article, one fact became clear to me – much of the information reviewed on the consumer credit bureau as well as the associated scores is commonly misunderstood and used incorrectly. Not only can this cause your company to decline an acceptable credit or approve someone with a high probability of defaulting but it can cause you to lose a vendor who gets his deals approved elsewhere or sever a relationship with a vendor who has too many defaults. I have found that some information that is commonly relied on is often incorrect. The scores are often misinterpreted or relied on too heavily. People also often override scores with information that is not only factored into the score but the people who developed the scores found that particular information not to be very predictive of the likely results. As the person responsible for the relationship, it is your job to make sure you know when to challenge the unwarranted decline and when to move onto the next deal when this one stinks.
What Do These Scores Mean?
There are three main consumer credit bureaus; Experian, Trans Union and Equifax. Each of those has many scores associated with them used for a wide variety of products. The two that are most commonly used in our business are the Fair Isaac (FICO) score and the bankruptcy score, with the FICO score the more prevalent of the two. For purposes of this article I will focus on the FICO score as that is more widely used and, consequently, more often misunderstood. The FICO score has different names for each bureau. For Experian it is called the Experian/Fair Isaac risk model (these people are known for their math, not their creativity), for Trans Union it is the Empirica, for Equifax the Beacon. Even though they are different models built for different bureaus they are designed so that the scores predict the same results. In other words, if the same issuers, etc. report to the same bureaus, a 660 Empirica score should predict the same result as a 660 Beacon score.
The FICO score predicts the probability that that consumer will have accounts that are 91 days delinquent or worse (including chargeoff or bankruptcy) within the next 24 months given the information reported on his or her credit report at that time. That fact is important to understand. It does not take into account the fact that the company just lost their best customer who accounted for 80% of the company’s revenues or that their biggest competitor down the street just got indicted for price fixing. It doesn’t take into account anything about the business. Not how long they have been in business, how high their sales are or even if all of their customers are suing them. It is conceivable (and not that improbable) that a company can be in bankruptcy and the principal can have a perfectly acceptable FICO score. It turns out, though, that because the information on the bureaus is extensive and the scores are very reliable for their designated purpose that they also happen to do a very good job of indicating the likelihood of poor payment performance of small ticket lessees. Translated – the owner of a business who has a score indicating a higher probability that he will pay his personal bills late also has a higher probability of defaulting on his company’s obligations. They will not have the same probability though. It’s just that someone with a low score has a higher probability of default than someone with a higher score.
The people at Fair Isaac use many factors obtained from the credit bureaus in determining their scores. For the Empirica model, for example, there are 30 active factors available for the model to use. When you obtain a score from one of the credit bureaus you should see the four factors that, for that person, had the most negative influence on the score. Even people with good scores will have a list of the most negative factors. They will be in order starting with the most negative. This is important to know. Next time you look at a score and you ask yourself: How did that guy score so low? Just look at the factors and you will have your reason. You may not always agree with it but you will have your explanation. Often you will see two different bureaus for the same individual and they will have large differences in their score. First, use the factors displayed to determine why the gap in scores. Then use the score of the bureau that had more relevant information. For example, if the lower score had as its first factor listed Serious delinquency and the higher one didn’t, see if the serious delinquency was only reported on the one bureau. If that is the case and the other information seems similar, use the lower score in your decision making process.
As I mentioned above, the credit bureau scores will not tell you the probability that your lessee will default on their lease. They do tend to rank order small ticket leasing customers in terms of probability of default if other factors are equal. That means that if other factors are similar, a customer who scores a 620 should have a higher probability of default than someone who scores a 630. It does not mean that someone starting up a restaurant and has a bureau score of 660 has a lower probability of default than a doctor who has owned a medical practice for 15 years and has a bureau score of 650.
Once you accept the fact that the scores do a good job of rank ordering your customers (you should verify this independently) you can take advantage of the value of the scores. If the scores work and you use them properly you should be able to increase your approval rates, lower your loss rates or a combination of both. Other benefits of relying on scores are as follows: More objective decision making, faster decisions, measuring application quality from your sources, forecasting loss rates and risk adjusted pricing.