Feelings of uncertainty are emotions credit risk professionals know all too well after battling several months of COVID lockdowns, business closures, supply chain issues, and now geopolitical unrest added to the mix. Creativity and vigilance are now new norms for credit risk portfolio managers. Today’s business environment requires refreshed perspectives on how to identify and monitor avoidable risks and to reduce the impact of the unavoidable.
Understanding the foundations of Credit Portfolio Management
Credit Portfolio Management is the practice of managing and monitoring all aspects of your company’s credit portfolio. You can then proactively measure, track, and act on emerging risks impacting your organization’s profitability. This includes understanding and measuring the impact on KPIs such as Days of Sales Outstanding (DSO), bad debt, disputes, and collections.
The power of Credit Portfolio Management lies in understanding your internal customer data to develop strong portfolio segmentation and treatment strategies. In your initial inventory of portfolio data, you may find your portfolios reside in different systems leading to information inconsistency. Alternatively, you may find information gaps in data leaving room for improvement.
Those findings are common obstacles in establishing a portfolio baseline and are part of the initial evaluation step. […] Portfolio Management practices often use analytics through the use of predictive credit risk and fraud scores which help spot future risks before it’s too late.
The first step to effective Portfolio Management is taking an inventory of your portfolio and establishing a performance baseline. Your institution may have one or many portfolios based on how your organization structures its lines of business and products, and baseline performance may vary across these products.
Having a solid understanding of your customer data and what information is available to you helps determine what type of insights you can derive before you go outside looking for external data sources to use to standardize or augment your own internal data.
In your evaluation of portfolios, you may find data residing in various systems. Many companies already using an ERP (enterprise resource planning) system find it optimal to keep their Portfolio Management processes embedded in their current system. Then augment any data gaps with external data to increase the effectiveness of their programs. However, any changes or additions of outside data will likely require your technical team’s involvement when you’re working within your internal systems.
[…] As you advance your techniques, you can begin increasing the sophistication of your portfolio management practices by introducing Portfolio Scoring, a process defined as appending credit scores and other credit risk data to all the accounts in your portfolio. Implementing ongoing Portfolio Scoring helps drive further automation into your Portfolio management program and can be used to benchmark your portfolio’s performance over time.
Hitting it out of the park with credit scores
One of the simplest ways to introduce risk automation to your portfolio management process is by adopting a credit scoring strategy. Scores are statistical models intended to predict a specific credit event (e.g., delinquency, bankruptcy, default) by evaluating numerous data attributes simultaneously.
The result is usually a statistical value that can instantly measure and assess risk. Depending upon the type of score utilized, credit managers can use scores to benchmark against the general business population’s performance, a specific industry, or even a creditor’s very own portfolio.
Credit scores can be used both for new customer acquisitions and portfolio management. However, when using scores to evaluate risk on existing customers, you can combine them with your own internal aging and payment data to provide a complete 360 degree look into your portfolio performance. By appending risk scores in bulk to an entire portfolio of customers over time, clients can quickly identify analytical trends and apply score-based segmentation strategies to manage risk more effectively at both an account and portfolio level.
Types of Scores
“Generic Scores” or “All-Industry Scores” are traditionally found on credit reports, and batch Portfolio Scoring data appends will calculate their value based on a sample of companies from the general business population across all industries.
A generic score will continually benchmark the likelihood of payment risk, such as delinquency, default, and bankruptcy against the general business population.
These scoring models provide an affordable, off-the-shelf solution to quickly and easily assess credit risk (click here to see the different models).
Custom scores, or scores built based upon your own portfolio data, can also be built by engaging analytical and modeling experts to help increase predictiveness. This process includes an in-depth evaluation of your portfolio’s performance over several time periods to create a customized risk score based on your portfolio’s performance and your unique “bad” definition. Custom models require more upfront investment and an implementation runway but can provide a high return on investment.
Reports to Help You Decide – Comprehensive vs. Summarized
Between your quarterly Portfolio Scoring efforts, you may need to review a customer on a one-off basis. When making credit decisions about customers, you sometimes need only a summary of pertinent risk data. Other times, you need more detailed information to support your analysis.
If you rely on a report that contains too much information, you waste time searching for what you need. You also spend money on data you don’t need and won’t use, hurting your bottom line. Experian makes it possible for you to select reports in a variety of formats, as well as access key data sets based on the specific information you need. […]
Establishing a Sound Credit Policy for Portfolio Management
Now that you understand the basics of data, scores, and other tools at your disposal, you can start increasing the automation of your Portfolio Management practice.
[…] The first step for automation is creating rules or developing a weighted scoring approach from your written credit policy to identify risks in the portfolio while maintaining compliance with your organization’s current policies. Credit scores are used for automating new account reviews, and provide an easy-to-understand risk level.
In many automated policies, other risk attributes are used to help segment and establish the appropriate credit limits and terms. Internal aging data can be used to automate the account review process while integrating a balance of credit scores and other risk variables to speed up the account review process.
[…] Automation of your credit policy for new account onboarding and existing customer account reviews can help credit managers gain significant time savings to deploy resources to more critical and strategic tasks.
Staying on Top of Things with Alerts
In addition to ongoing portfolio account reviews, credit managers are turning to proactive alerts to ensure you’ll never be caught off guard by a change in your customer’s payment behavior. These alerts can help you know about critical issues before it’s too late, giving risk levels time to adjust accordingly and keep your company safe from financial loss.
To create an alert, you set up a trigger, a specific event with parameters. Be discerning, though; it’s easy to get trigger happy and set up too many alerts, this can cause analysis paralysis, and significant events get lost in all the noise.
Some typical alerts implemented in Portfolio Management programs include:
Tracking credit score decreases
Monitoring for new Bankruptcy filings
Obtaining Late Payment alerts when your customers pay other vendors slow
New Collection account placements when creditors send your customer to 3rd party collections.
Collecting Outstanding Debt with Collections Prioritization
If all prior efforts to manage and mitigate customer delinquencies have proven to be unsuccessful, using an accurate and intelligent collection model can significantly increase your ability to collect outstanding debt and improve the cash flow of your business.
Many customers will pay their debts in response to simple collection methods, such as calls, emails, and letters. However, your business has limited time and resources on hand. Suppose you spend significant time working with a customer who will not repay a debt regardless of the offers or efforts. In that case, you lose out on revenue from customers who very likely will pay with simple outreach.
Also, many customers will pay their debts given time, regardless of the collection method employed. By identifying which customers will self-cure, you can focus on the customers who need active prompting to pay their debts.
To help with this challenge, Experian developed a Commercial Recovery Score (CRS) that can predict the likelihood of recovering on a commercial debt over the next six months.
[…] One other thing to consider is that late payments can be due to a simple error, such as a lost bill or the customer forgetting to change their address when moving. Experian also helps with these challenges by providing alternate contact information (addresses, phone numbers, contact names), which helps collect the bill without paying expensive fees to a 3rd party collections agency or legal entity.
Is it Fraud or Bad Debt?
When you see late payments, do you see a delinquent customer, or do you see Fraud? Non-payment is the first signal of potential Fraud, especially on a new account. When fraudulent accounts are opened to never repay, this is referred to as first-party Fraud.
Fraud impacts your DSO; therefore, quickly determining which delinquent accounts are likely Fraud can reduce your risk and your DSO. Introducing scores, such as Experian’s First Party Fraud score at the time of account origination, helps protect you from opening new fraudulent accounts, reducing risk, costs, and improving the customer experience by differentiating fraud types to apply the right type friction.
For ongoing Portfolio Management, leveraging this score over time via Portfolio Scoring can help you ensure less of your delinquencies are coming from bad actors.
Moving forward with Credit Portfolio Management
Organizations that implement successful Portfolio management practices see significant results – increased portfolio efficiencies, higher profit margins, lower write-offs, and reduced frauds. Changing your existing portfolio management practice does not have to be an overnight transition.
By combining minor, incremental improvements with the correct data, processes, and technology, you’ll begin paving a path to modernizing your realistic and sustainable portfolio.
Take the next step
Reach out to Experian to strengthen your Portfolio Management practices today.