1. 24 Non-Prime Times July/August 2016 nafassociation.com
Could a Potential Economic
Downturn Lead to Broader Use
of Alternative Data?
Alternative Data
O
rigination volumes in auto financ-
ing have been high and steadily
increasing in recent years. New
market entrants and more generous credit
terms have created an intensely competitive
environment.Nowwithconcernsofapoten-
tial economic downturn ahead, the smarter
andmoreexperiencedautofinancingsources
are building a stronger foundation for their
credit and loss management strategies.
One of the strategies often evaluated is
the incorporation of alternative data in deci-
sioning processes. The topic lands on most
industry conference agendas, including the
recent National Auto Finance Association
(NAF) event in Plano. While there are many
risk management and financial incentives
encouragingfinancialserviceproviderstoana-
lyze alternative data, a number of obstacles
should be considered before a provider can
determine if alternative data adds value and
more importantly, where to source it.
Over the next several issues of Non-Prime
Times, we’ll explore the obstacles to using
alternativedatainriskand/orportfolio man-
agement. Let’s start with one of the most
common obstacles.
“I am not sure how to effectively test
and evaluate alternative data.”
Foryears,autofinancingsourceshaveused
traditional credit reporting data and scores.
Over the years, financial service providers
began implementing custom scoring with
traditionalbureauscoresusedasonecompo-
nent of the model. The scores also serve as a
benchmarkingtoolforportfoliocomparisons
for investors. These methods are tried-and-
true underwriting disciplines they built their
businesses on.
Today,however,thesemethodsarecoming
into question as not being robust and com-
prehensive enough to include all potential
consumers looking to buy and finance new
and used vehicles. Talk of alternative data (not
to be confused with alternative lending or
marketplace lending) or non-traditional data
canbeheardallaround,butmostnon-prime
auto financing sources struggle to accurately
assess the sheer amount of data available to
them. By looking at the businesses currently
enjoying the benefits of alternative data, we
can learn how they generated a credible cost-
benefit analysis.
The key to a successful analysis involves
starting with a proper input file, creating a
comprehensive data set and streamlining the
list of potential alternative data providers to
a manageable group.
Key components for the input file
Financial service providers are wise to
create a single file for evaluating multiple
data sources. By utilizing one file, providers
cansetastandardperformancedefinitionfor
measuring the impact of alternative data. In
addition,astandardfileremovestheimpactof
seasonality and the confusion created by dif-
ferences in performance across multiple files.
A well-constructed data file should include
the following:
• Relevant sample size – More is better with
agenerousrepresentationofapplicationsthat
are funded or approved but not funded, as
well as those that are denied. By including
all types of application outcomes, financial
serviceprovidersarebetterabletodefinitively
measure the impact a data source offers.
• Performance indicators – Financial ser-
vice providers who provide granular detail
on performance of funded loans are better
positioned to understand how ancillary data
mayhavechangedtheirdecision.Inaddition,
aserviceproviderprovidingthestatusofloans
maybeabletobetteranticipatefuturetrends.
A comprehensive data set
To best realize the value of any potential
data provider, it’s best to provide as much
dataaspossibleintheinbounddataset.Asan
example,consumerstabilitydata,information
aroundaconsumer’saddress,phonenumber,
e-mail address and the frequency of change
within those fields, is highly predictive. If a
financial service provider captures applicable
data on a consumer, it should be included
in the file.
Clear data test goals and objectives
When testing alternative data, it is incum-
bent on financial service providers to have
the endgame in mind. Service providers are
generally seeking to qualify more consum-
ers, eliminate risk, improve acceptance, or
risk adjust pricing. The better both parties
(the financing source and the data provider)
understand the task at hand, the more likely
the objective will be met.
Forexample,inarecentdatastudy,acredit
card provider who sought to increase accep-
tance by utilizing third-party data to qualify
marginal consumers found that consumer
presence in the vendor’s database resulted
in a 58 percent increase in default. While
that number was eye opening, it wasn’t the
objective – and the financial service provider
never acted on it.
Measurements
Companies that have successfully imple-
mentedstrategiesutilizingalterativedatahave
firstcalculatedtheimpactontheirriskopera-
tions via several measurements.
Hit rate – Number of applicants who
would have been present in the alternative
data file at the time of application.
In a recent conversation with a CRO of a
non-primeautofinancialserviceprovider,we
were given the standard measure applied for
presence of data sources, “Unless one in five
of my consumers has a hit, I cannot seriously
consideraddingthecostofprogrammingand
integrating.”
Scott Brackin

2. nafassociation.com July/August 2016 Non-Prime Times 25
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Alternative Data
If the data source has an adequate cover-
age then the requirement shifts to the utility
of the data.
Disparity – Measure of how much lift is
provided.
Even in the instance of high hit rate alter-
native data sources, often including public
recordtypeservices,disparityisn’tguaranteed.
If a data source has near universal presence
but offers minimal separation, there is only
increased cost to implement and access the
data service.
One non-prime auto financial service
provider shared the results of a data test she
conductedwhere consumers matchedbythe
third-party service defaulted 300 percent
more frequently than the general popula-
tion. As earth shattering as that sounds, the
alternative data only showed up in 2 percent
of inquiries.
Impact – Measure of how implementing
the data effects the entire operation.
Whiletheprocesssoundssimple,oftenthe
results are not clear.
A financial service provider recently con-
ductingadatastudyonbankbehaviorfound
that while there was a relevant hit rate and
the disparity of performance was profound,
the ability to realize the potential savings was
mitigated by the cost.
Implementation strategy – The practical
application of data.
Recently, an installment financial service
providersharedthattheresultsshowntohim
by a data vendor were “too good to be true.”
When asked to clarify, he shared, “we were
shown a huge savings potential but my CFO
can’t see how we realize that if at the expense
of so much loan volume.”The challenge for
executives is that while they realize there is
data available from sources outside the tradi-
tional CRAs, they often are unable to create
a live environment where the existing model
worksinconcertwithadditionaldatasources.
Auto financing sources that successfully
negotiate the implementation process do so
by evaluating how they can identify upside
opportunities, as well as, obvious declines
within the framework of their existing
operation. For example, a non-prime auto
finance company reduced its instance of first
payment default by 50 percent in the ini-
tial six months, but later realized additional
value by utilizing positive trades as a means
to separate consumers with equal traditional
credit scores.
For the remainder of this series of articles,
we will look into other common objections
to the use of alternative data including legal
and regulatory obstacles, the inability or lack
of desire to report data, as well as technology
and resource challenges.
We will also share past experiences of auto
financingsourcestoprovidesomeinsightand
success stories that will help readers figure
outtheeasiestwaytodetermineifalternative
data has a role in their business and to what
degree. Stay tuned…
Scott Brackin is vice president, Auto Finance,
for FactorTrust. Scott has more than 20 years of
experienceintheconsumercreditindustry.Heis
currentlyfocusedonprovidinginnovativeinfor-
mation solutions to automotive finance service
providerstodrivegrowthwhilemanagingrisks.