Push for New Consumer Credit Data Hits Snags
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Raj Date, the former deputy director of the Consumer Financial Protection Bureau, plans to work with banks to create cheaper short-term loans for cash-strapped customers, despite mounting regulatory scrutiny of the products.June 7
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Before the credit bubble burst, data providers were bombarding lenders with sales pitches for a wide range of new products to assess the likelihood that a consumer would repay.
Their message went something like this: a traditional credit report can only tell you so much about a person, especially someone who doesn't have access to mainstream credit. Landlords, cable TV operators, utility companies and court records can fill in the missing details.
Then the financial crisis hit, and consumer lenders worried far more about potential losses on loans they'd already made than they did about finding creative ways to make new ones.
But today, with consumer credit experiencing a revival, the alternative data industry is back.
Companies such as Experian, Equifax and LexisNexis, and many smaller competitors, are aggressively pitching their services especially to subprime lenders, many of whose customers don't have traditional credit reports. The data providers are promising more loan approvals and lower loss rates.
"Alternative data could have generated $1.7 billion for credit card issuers and $1.9 billion for auto lenders in 2012 alone," a recent press release about a study by LexisNexis gushed.
But many of the same hurdles that slowed the market's development last decade are still present today. The barriers include regulatory requirements and operational impediments, and their persistence suggests that the day when lenders will have a full picture of every consumer's financial history is still a long way off.
"It will require major partnerships between multiple industry and likely government actors" for the use of alternative data to achieve scale, emails Rob Levy, director of research at the Center for Financial Services Innovation, a group that supports the use of alternative data as a way to expand access to consumer credit.
Although the alternative data market remains young, there is already a staggering range of consumer data available for lenders to purchase, beyond the traditional information on loan repayments that is contained in credit reports.
Companies are selling information on individuals' criminal records, their bankruptcies, professional licenses, economic trajectories, the frequency with which they move, their payday loan history, rent payments, cable TV bills, cell phone payments and on and on.
Industry representatives point out that subprime borrowers have long been asked to provide this kind of information on their loan applications, but such self-reporting is inefficient and prone to error.
The size of the alternative data market today is unknown, but supporters argue that its potential scope is huge. Seventy million Americans have either a thin credit file or no credit file at all, according to a report last year from the Center for Financial Services Innovation.
This group includes young adults and recent immigrants many of whom belong to the nation's fast-growing Latino population and others who have not used traditional consumer loans.
"Sometimes this population is referred to as 'The Unscoreables.' Sometimes they're called the underbanked," says Ankush Tewari, a director of strategy and market planning at LexisNexis.
Alternative data providers are trying to convince lenders that they can properly evaluate consumers who don't have credit scores, and that those borrowers can add to the lender's bottom line. Much of the marketing is geared toward the booming subprime auto loan market, though there are also pitches to credit card issuers and to banks that are looking to add consumer checking accounts.
A recent marketing report from Equifax was titled "Credit Scores Don't Tell the Entire Story for Auto Buyers." It touted one of the company's products as a way to "further mine subprime risk bands" without sacrificing credit quality.
Some lenders appear to be using alternative data to price risk as they move further down the credit spectrum.
In a recent study commissioned by LexisNexis, one anonymous credit card issuer said that it is using alternative data to select the better loan candidates out of a pool of risky borrowers. "Now we're able to identify a subpopulation for whom the chargeoff rate is within acceptable range," the credit card issuer was quoted as saying.
So far most of the concerns from skeptics of alternative data have involved issues of fairness to the consumer.
The industry's backers argue that missed rent checks and other negative payment data are already showing up in consumers' credit files, because they get reported by collections agencies, but consumers don't get credit for their positive payment history.
The vast majority of Americans are paying their bills on time, notes Sarah Chenven, director of programs and strategic initiatives at the Credit Builders Alliance, which works to help low-income people build their credit. "So it seems unfair for them also not to benefit from that," she adds.
Still, there is no question that some consumers will be more likely to be turned down for a loan because of the use of alternative data. Late payments that go to collections don't show up on a credit report for months, whereas alternative data reporting has more immediate consequences.
Some consumer advocates are raising particular concerns about the reporting of utility payment information.
"In the cold-weather months, those bills go sky high," Chi Chi Wu, a staff attorney at the National Consumer Law Center, said in congressional testimony last fall. "People have trouble paying that for a few months, but then they catch up. And we're concerned that those spikes of late payments are what's going to hurt low-income consumers if we have regular monthly utility reporting."
Others are concerned about the sale of alternative credit data outside of the lending sphere. Prospective employers are another market for the data.
"Employers using credit reports almost overwhelmingly use them as a negative factor to disqualify a candidate for a job," Mary Spector, a law professor at Southern Methodist University, testified last year on Capitol Hill.
Compliance with regulations has emerged as a key factor in the alternative data marketplace. Certain providers are touting themselves as compliant with the Fair Credit Reporting Act, a federal law that contains a range of consumer protections, implicitly suggesting that some of their competitors are not.
In addition to that law, data providers must contend with a patchwork of state laws and concerns about potential fair-lending liability. The latter worry is that using alternative data to make a credit decision will have a disparate impact on minority borrowers, subjecting the lender to the risk of a lawsuit.
But probably the bigger impediment to widespread adoption of alternative data involves operational challenges. One persistent problem is that many of the potential suppliers of alternative data, particularly in the rental housing market, are mom-and-pop businesses.
In 2010 Experian purchased RentBureau, a credit reporting agency focused on collecting payment information from landlords. Currently the system has information on 10 million renters, mostly provided by larger property management companies, but still lacks data on the other 90 million or so Americans who rent.
"It's a very difficult business," acknowledges Brannan Johnston, vice president and managing director of Experian RentBureau.
Given the problems associated with signing up landlords, Experian has begun allowing renters to sign up on their own to report their payment history.
Another barrier to the alternative data market's growth is its fragmentation. There are roughly 400 credit reporting agencies in the United States, according to the Consumer Financial Protection Bureau.
With all of the disparate data sources, lenders face a technological challenge in integrating the data into their loan origination platforms, says Daniel Parry, an executive vice president at the subprime auto lender Exeter Finance.
Exeter uses a variety of alternative data sources in its loan underwriting process. "Some of them are very good things like felonies, convictions [and] other types of liens that are highly indicative of default," Parry says.
But Parry does not expect the alternative data industry to take off until significant consolidation occurs, and lenders are able to get everything they need from a few major companies.
"I think the industry has to evolve, where the data can be delivered efficiently," he says.