How the Leeds Building Society (now part of HBOS plc) used Data Mining
“Leeds Permanent is generally regarded as an organization that is strong on controls and management of the business… to the benefit of the members. Emphasis is on strong and prudential management.” That is how John Miller, Executive Director at “the Leeds” sums up the Society’s approach to business in the current market. It is a market that has been forced to reconsider its approach to the management of arrears and repossessions in the face of recessionary pressures and mounting bad debt.
The Leeds, established in 1848 and merged with the Southdown Building Society in 1992, and became Britain’s fifth biggest building society. Against a net profit of UK£186 million announced for the financial year ending in September 1993, the Society has had to accept a charge of over £131 million to cover bad debt and irrecoverable interest. Although John Miller points out that this scale of provision is typical of building societies throughout the country, the figures appear in sharp relief against the figures for previous years: £105 million in 1992, £44 million in 1991, £20 million in 1990 and just over £2 million the year before that.
The situation in the 1970’s and 1980’s, where a house was an appreciating asset and could cover an outstanding mortgage, has been replaced by declining (or, at best, static) prices, and much-publicised “negative equity”. The Leeds is acutely aware that effective management of the problem is in the long-term interests of all parties.
The Society has introduced a “Customer First” strategy to help ensure that all products, business processes and staff attitudes are geared towards customer needs and responsibilities. It is a principle that is reflected in a comment by Leeds Permanents Finance Director, Roger Boyes: “Our philosophy is to be as helpful as possible when people get into difficulties. If we can stay with them and bring them out on the other side, we have created a trust.”
From all points of view, anticipating arrears difficulties is preferable to waiting until the problem occurs. Credit scorecard techniques were introduced by the Leeds during the early 1990’s in an attempt to identify lending risk from the outset.
Although weightings have been adjusted regularly and scoring methods have become increasingly sophisticated, it is an approach that cannot take account of changing circumstances, such as employment and marital status: “Credit scoring simply provides a gating criteria,” says John Miller. “We have an existing portfolio of mature and seasoning loans and we need to know how much of a problem there is yet to come through. Given the scale of current provisions, there is a potential risk if arrears are not better understood and managed, and thereby enhance our prudential control.”
This “data mining” challenge – forecasting arrears problems amongst the Society’s 500,000 mortgage accounts – is partly being addressed by the Leeds with the help of expert systems and rule induction technology. The Society has used a system from XpertRule Software (a Manchester company working in partnership with Price Waterhouse on this project) to profile the characteristics of accounts; assessing the risk of other customers encountering problems. The approach, as Managing Director Akeel Al-Attar explains, recognises the current interest in Business Process Re-Engineering and organizations” increasing accumulation of data: “Rule Induction differs fundamentally from Neural Networks and related technologies. Analysis of the data can help organizations to unearth understandable patterns.”
A variety of data profiling has been carried out by the Leeds: Healthy accounts versus accounts in arrears; moderate arrears versus accounts ending in severe arrears; regional variations in arrears and arrears according to other definable characteristics. The method of analysis identifies a combination of key characteristics which may lead to accounts with varying levels of risk of being in arrears – potentially leading to repossession. Not surprisingly, the results reflect classical risk factors, such as high loan/property value ratios. However, at the Leeds, there have been some surprises: one of the scenarios included business that had been “introduced” to the Society by a third party – a factor that would typically have been viewed as reassuring.
In a different exercise, Phil Bourne from Price Waterhouse observes that “high-income earners” was a characteristic of one high risk group: “The software from XpertRule has no prejudiced opinions,” he says. “There are no preconceived ideas to influence the correlations that are made. The key to profiling is that no one attribute is taken in isolation. A single low-risk factor can be over-written by other factors. Accepted thinking needs to be stood on its head.”
John Miller agrees that one of the benefits of the system from XpertRule Software is that is goes back to first principles: “It is coming at the problem from a different way – not requiring the input of knowledge. It is radical and exhaustive.”.
XpertRule Software and Price Waterhouse have an agreement to work together on Building Society projects. Phil Bourne comments on the consulting firm’s decision to use XpertRule’s profiling software as the basis of a number of proposals to the Building Society market over the past four years: “We were impressed initially by the work they had done for another society. In line with our procedures on new software products, their software was sent to the Price Waterhouse World Firm Technology Centre at Menlo Park in California. We need to know that software products exist, to know that they are robust and to test the structure and consistency of the software. XpertRule’s software was approved without reservation.”
John Miller believes that the assessment of risk factors will allow the Leeds to help customers and to manage potential debt more effectively: “Almost inevitably, we will incur a major loss on the sale of a house – typically £18-20,000 if we allow an arrears situation to regress into a repossession. Apart from the capital costs and possible reduced value of the property, there will be an accumulation of legal costs and interest. Profiling techniques can help us to recognise the circumstances and stop the process early in the pipeline. By getting close to them, we can find ways of keeping our customers in their home and of helping them to cope with repayments.”
Although reduced interest rates are likely to limit the impact of arrears on Building Societies, Phil Bourne believes that it will remain a problem for the next five or six years. However, he sees account profiling having longer-term benefits for building societies – in particular in the targeting of marketing activities: “Credit scoring techniques have helped societies gather a lot more information about customers – information that would not have been available five years ago. This information can provide the raw material for profiling. And knowledge about customers presents an opportunity to cross-sell other financial products that match characteristics of specific profiles.”
John Miller also recognises the long-term potential of customer profiling – particularly given the popularity of fixed term mortgages: “In the past, customers were left on the mortgage book after they had been taken on board. Now, we actively review accounts. Many customers start with a fixed interest mortgage that is later converted to a variable rate. However, if we are to offer the right proposition at the end of the fixed term, we need to understand the customer and the profile that he fits.” He adds; “We have good customers and we want to keep them.”
Phil Bourne believes that reduced interest rates and competition will force building societies to review cost structures: “A squeeze on margins will encourage societies to focus the activities of their arrears management departments – concentrating their efforts on those accounts that stand the best chance of being recovered.”
A strategic philosophy adopted by the Leeds in the late 1980’s includes three essential elements: Customer First, Cost Effectiveness and Financial Strength. The organization’s new corporate headquarters near the Leeds city centre is a reflection of the Society’s confidence in the future and intention to further develop cost-effective resources. However, if Phil Bourne’s assessment is correct, then cost-effective business management will become increasingly relevant to the success of every building society – assuring a healthy future for customer profiling technologies such as those offered by XpertRule Software.