In a statement to the House Budget Committee, Fed Chairman Ben Bernanke observed that banks were continuing to be very conservative in their lending, and that more policies such as "Second Look Programs," in which lenders take a look at a broader set of borrower information in order to justify the loan, should be developed. This makes good financial sense for both the borrower and the bank.
It's no mystery, of course, why bankers severely curtailed lending. As banks looked for ways to stabilize themselves, the clearest and most immediate way to staunch the hemorrhaging was to shut down the lending spigots to the subprime segment.
The result: many card issuers and other lenders drastically cut back on their marketing and issuing.
Some banks have even been considering getting out of the credit card business altogether. But while not lending money, or only lending to those with sterling credit scores, may protect a lender from loss, it certainly won't help business grow.
Top-line growth is necessary for long-term survival. Some of that can come through increasing business from the existing portfolio. And we strongly believe that's an important part of any bank's strategy. But even that has its limits. Real growth means getting more customers. That's true even when the pool of prime borrowers is limited.
Of course, issuers know that it's not enough to gain just any new customers — they want good, profitable customers, people who sustainably use their product, again and again and again. But where can you find someone like that without slashing your own margins to the bone between low pricing and high premiums?
In fact, there is a whole population of people who are dying to use your card on a regular basis, for the simple reason that they can't get a card anywhere else. That is, the subprime segment.
But aren't the subprime, well, sub-prime?
Yes. And, more important, no. This is where there are several shades of gray, and this is where we go back to the problem of oversimplified explanations of the financial crisis.
Because while subprime has come to mean bad for most bankers, what it really means is "below a certain level on a rating scale." And credit score in isolation ignores a more common-sense question: does this prospect have the sustainable capacity to repay the loan?
Meanwhile, the tools that could determine capacity have atrophied in the last decade and a half. It used to be that an issuer would look at a range of information in evaluating a prospect's creditworthiness: income, assets, credit history, etc.
That took effort and time, and during the go-go days of the end of the millennium it was pretty much abandoned for just the credit score alone.
And while these days bankers understand the need for due diligence in issuing credit, they're still not prepared to completely go back to the time-intensive ways of old. As a result, they've come to rely almost exclusively on one simple score, sub-620 FICO, to define subprime and have been drastically pulling back from that market.
The shift is clear: At the end of the fourth quarter of 2008, 39.9% of booked accounts fell into this segment. A year later that figure had been cut in half. And while there has been an increase as of this year's first quarter to 27.2%, this is still far below previous levels.
But we've found that score taken in isolation is actually a poor predictor of a consumer's ability to handle credit and his or her future capacity.
For one thing, it looks at only a small piece of an individual's financial picture, and some of what gets overlooked is becoming increasingly important in the current environment. For example, more people these days are making at least part of their income from freelance work, but that won't be reflected in a standard financial snapshot.
Moreover, even the piece of the picture that the score does reflect may be several months out of date. The upshot is that many people who are defined by the score as subprime are in fact very creditworthy. These may, for example, be customers who were historically "prime" but due to an event caused by sudden (and temporary) capacity challenge were reclassified downward. And, because they are being thought of as subprime, they are not being targeted for credit cards. Not yet, anyway.
Recently a number of third-party vendors have started to offer some new forms of real-time data. When analyzed well, this information can identify those people who are being ignored by most issuers but who represent strong potential profit when offered the right line at the right price.
Bankers who are able to take advantage of this information will be primed for growth, even while their colleagues are talking about retrenching.
This methodology is now being used by a few pioneering issuers with great success.
Such new data sources and early results point to a clear conclusion: with the right credit risk management tools in place, banks can, and should, be looking at and once again lending to nonprime borrowers, as long as they are in the segment of borrowers most likely to be able to handle the debt responsibly, pay back the money, and remain profitable customers for the lender.
