Why non-prime lending offers unmatched opportunities for growth
Tuesday June 18, 2019
The non-prime market is growing at a strong and steady rate. Banks and non-prime lenders in today’s current financial market are increasingly taking up the opportunity to offer appealing credit to consumers and create new revenue. For many consumers, the answer to the need for fast cash has been payday lenders (PDLs), while eCommerce has opened up options powered by Fintech. As balances grow and delinquencies fall due to an increasing use of big data in underwriting, lenders are starting to take notice of the non-prime lending market.
The market for unsecured finance
Many consumers are virtually ignored by banks and conventional lenders. They might have no savings or a poor credit record, earn a non-traditional or volatile source of income or have an insufficient or poor credit history. They could also (temporarily) be going through hard times, but remain likely to repay their debt.
These consumers are ones that traditional credit underwriting doesn’t take into account: the single mom who has recently gone through a divorce and been taking out payday loans to get by; the over-extended and stressed debtors who need temporary finance; the consumer who has recently experienced a financial setback but has no access to credit. This creates a market for short-term finance, one that has been met with payday lending. In Canada alone, 60% of payday loan (PDL) customers do not have access to a credit card, 90% thought PDL was the fastest and most convenient option and most PDL customers (45%) used PDLs for unexpected necessary expenses, and (41%) for expected necessary expenses (Financial Consumer Agency of Canada (FCAC)) Yet payday lenders charge high interest rates, creating more debt. This leaves a market gap, one non-prime, non-payday loan companies can leverage to break the loan payday cycle and serve the needs of low-income customers at a rate of interest that isn’t prohibitive.
The non-prime unsecured lending market is still in its infancy. Many companies are providing unsecured lending direct to consumer with varying degrees of success through an online process, or through retail as their prime origination channel, with limited automation or a robust POS technology solution. Others offer installment options or partner up to provide joint solutions to the unbanked. What all these companies have in common is that they’re attempting to find their niche while at differing points on the Fintech adoption curve. Data, technology and analytics are allowing improved assessment and re-pricing of risk, creating more opportunities for non-prime lenders and leveling the playing field.
What does this mean for non-prime lending?
While the market for unsecured credit remains relatively untapped, there’s several ways in which to assure growth when offering non-prime finance:
1. Look at how efficiencies can be improved
Many businesses in the non-prime space still manually run many of their processes, from adjudication and review to fraud mitigation. In most cases, they don’t have the products, analytics or instant decisioning required for nonprime customers. Indeed, many finance companies don’t even have their billing set up to match the pay date of the consumer. Increased automation across the application lifecycle is required to reduce fiction in the underwriting process, allowing increased scalability and growth. This is where SCORE comes in. We advise clients on how they can improve their processes and make operations seamless through automation. By analyzing processes and systems, SCORE can recommend software and a centralized system that avoids duplication, errors and inefficiencies.
2. Use segmentation effectively
The key to success in the financial services market lies in improving performance by identifying risk or improving productivity through improved allocations. The non-prime space focuses on a higher customer risk segment with relatively less credit history and lower than average industry charge-off rates, but a potentially higher rate of growth. While most lenders think that non-prime customers are bad borrowers, credit scores offer a lagging indicator of risk. Effective segmentation through automation, scalability and accelerated decisioning in an increasingly competitive environment is required – while the efficacy of underwriting processes on booked customers in terms of rank ordering risk must be measured.
This allows financial companies to identify profitable accounts and improve approval rates. Customers too can benefit from reduced rates and fees, with APR rates that can be customized according to identified segments such as individuals new to credit. SCORE provides models that combine alternative data with data from credit bureaus to differentiate risk within typically "unscorable” or "unbanked” segments of consumers, enabling responsible credit decisions.
3. Assess risk
Traditionally, lenders have relied on credit scores as the last word on a borrower’s likelihood of repaying a loan. More recently, some lenders have begun utilizing alternative data sources in an attempt to better predict risk when making the decision about whether to extend credit to a customer.
This could be monitoring bank accounts or financial behaviour after a customer has taken out a loan; assessing current finances and wealth (assets, net worth, taxes paid); cash flow; non-credit financial bills (such as rental and utility payments); relevant degree or occupation; and even life stage (empty nester, growing family etc.), among others.
Where a typical credit bureau score may be low, a collection score can provide a different dimension to risk assessment for existing customers in the alternative lending space, both from an underwriting of a new loan perspective (pay day lending has a short amortization window, which aligns with the shorter performance window in collections scoring with SCORE), or for cross selling, upselling or enabling credit limit adjustments.
Many non-prime lenders can then offer variable rate pricing / interest rates based on risk, using such alternative data for underwriting. SCORE reviews existing credit policies, procedures and opportunities for streamlining and improving underwriting practices with the view of optimizing the overall decision matrix to increase applicant flow and approval rates, increase booked rates and decisioning turnaround and to decrease costs per funded application with a view to increase market share and profits.
If you’d like to find out more about our capabilities in the non-prime space, contact us today on 647.309.1803 to get the conversation started. SCORE helps non-prime lenders to predict which accounts are most likely to collect through advanced segmentation and improved underwriting practices, offers consulting and diagnostic services to improve adjudication, streamline processes, ensure faster decisioning turnaround and decrease costs. Financial Consumer Agency of Canada (FCAC)