ALTERNATIVE DATA TRENDS GIVE INTELLIGENCE TO LENDERS FEBRUARY 2016 The Alternative Credit Bureau
National experts agree that a full 20 percent of U.S. households or nearly 50 million consumers -- are underbanked, meaning that they had a bank account but also used alternative financial services (AFS) outside of the banking system 1. The financial crisis of 2008 and the emergence of Gen Y has created a massive generation of digital consumers that have higher debt, lower incomes, less trust of traditional financial institutions and a view of banking that differs greatly from their predecessors. These consumers are looking for banking products that provide value, convenience and functionality that can, at times, be offered by non-traditional providers. Historically, when analyzing borrowers, lenders have taken a myopic, mainstream approach, relying on the traditional Big Three credit reporting agencies. This results in shallow strategies that ignore the underbanked, leaving a big gap in the information lenders can use to make smart decisions. The growth of the underbanked market presents alternative lenders with many opportunities. However, those opportunities can only be realized when we truly understand this population. Once we know more concretely who the underbanked population is age, habits, etc. the industry has an incredible opportunity to develop innovative products fitting their specific needs. WHO ARE THE UNDERBANKED? Lenders are continually faced with the challenge of how to efficiently manage risk while lending to the underbanked, but knowledge is power. The FDIC loosely defines them as those who have used alternative financial services (AFS) in the past 12 months. As a group, they are consumers with a checking and/or savings account at a bank or credit union but with less than average use/access to other basic banking products such as credit cards, loans and other traditional services. 2 But we can do better than that, using data to better know the underbanked. Understanding them as individuals and in a variety of sub-groups gives you a level of intelligence the industry hasn t had before. And intelligence means smarter business. ALTERNATIVE DATA IS THE MOST EFFECTIVE WAY OF DETERMINING HOW CREDITWORTHY AN UNDERBANKED CONSUMER CAN BE We can take a closer look at this audience by executing a deep analysis of alternative data. Alternative data is a loosely used term that includes both financial data collected from non-traditional lenders, and non-financial payment data, such as public records. Alternative data is the most effective way of determining how creditworthy an underbanked consumer can be, and is also an absolute must to determine ability to repay. From demographics to loan behavior data, alternative credit bureaus, like FactorTrust, provide lenders with a more holistic view of underbanked consumers, consumers that the big three often miss. While it might be more difficult to locate, it proves to be extremely predictive of future borrowing behavior. The most recent FactorTrust Underbanked Index, released in 2015, shows insight into significant shifts in income, employment and default rate trends over a three-year period within this specific group of consumers. The Index, which provides a range of data points including demographic, loan behavior, seasonal effects and others, helps shed light on underbanked consumers and highlights national data and trends based on expert analysis from FactorTrust s database of tens of millions of records. 1 https://www.fdic.gov/householdsurvey/ 2 http://thefinancialbrand.com/41258/underbanked-potential-research-2014/ ALTERNATIVE DATA TRENDS GIVE INTELLIGENCE TO LENDERS 2
PART ONE: STANDOUT TRENDS Some key insights from the most recent Underbanked Index, which tracked data from mid-2012 through of 2015, include: Income: Showing a growing diversity in the borrower pool, the average monthly income of loan applicants has trended upward over the three-year period. The average monthly income falls between $2,778 and $3,099. The uptick largely happened the latter half of 2014 with a rise beginning in 2014 and steadily increasing to the $3,099 high in 2015. The rest of 2015 saw a small and undramatic fall. Average Monthly Income $3,200 $3,100 $3,000 $2,900 $2,800 $2,700 $2,600 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 2012 2013 2014 2015 Avg Monthly Income Unemployment Rate Unemployment Rate sourced from Economic Research Division, Federal Reserve Bank of St. Louis ALTERNATIVE DATA TRENDS GIVE INTELLIGENCE TO LENDERS 3
Number of Accounts: Despite drastic economic changes in the broader market, the underbanked do not fluctuate in their banking relationships, keeping accounts to a minimum. The average number of bank accounts among the underbanked have remained fairly steady over a three-year period. In 2012, the average amount was 2.39 bank accounts, with 2.21 in 2015. Average Number of Bank Accounts Per Borrower 3 2.5 2 1.5 1 0.5 0 2012 2013 2014 2015 ALTERNATIVE DATA TRENDS GIVE INTELLIGENCE TO LENDERS 4
Payroll Frequency: Knowing payroll frequency can be important knowledge for lenders when approving loans. How often one gets paid by the boss varies, depending largely on the industry, but the most common frequency for payroll among 25 different business segments (including government, healthcare, business services, insurance, automotive and transportation) is bi-weekly. In the most common employee segments, dining and retail, employees are paid bi-weekly 82.9% and 80.7% of the time, respectively. But not every industry can count on a check every 14 days. The FactorTrust Underbanked Index showed that over the past three years 92% of agriculture employees, 74.6% of utility workers, 99.4% of childcare workers and 100% of personal care workers are paid only monthly. Payroll Frequency by Employer Segment 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Real Estate Medical Healthcare Insurance Entertainment Community Services Hospitality Communications Security Services Telecommunication Dining Manufacturing Retail Shipping & Delivery Automotive Services Banking /Finance Education Transportation Business Services Government Self-Employed Utilities Agriculture Childcare Personal Care Bi-Weekly Monthly Semi-Monthly Weekly ALTERNATIVE DATA TRENDS GIVE INTELLIGENCE TO LENDERS 5
Average Age: 2012-2015 data showed a seasonal trend: the average age of all underbanked loan applicants spikes in each year (to over 40 years old), sees an overall decline the remainder of the year and spikes again in the following year. Potential reasons include the holiday lull, tax season and auto borrowing behavior. However, the age range of the underbanked applying to alternative loans is fairly narrow throughout a 12-month period (average of 39 to 41.7 years). Applicants Average Age by Month 42.0 41.5 41.0 40.5 40.0 39.5 39.0 38.5 38.0 37.5 2012 2013 2014 2015 ALTERNATIVE DATA TRENDS GIVE INTELLIGENCE TO LENDERS 6
Busiest Months: Since the regulatory change in 2013, overall inquiries have trended up with a high last, suggesting a possible holiday need for cash and a subsequent drop in due to the holiday lull and tax refund season. We saw a big increase in 2014 due to growth of installment lending base and FactorTrust s expansion into new markets. Short term loan applications were the largest segment in the application mix in 2015 (46% of all inquiries) followed by installment loans at 30%. Virtual Rent to Own companies have recently started using alternative data loans to assess risk and were 4% of inquiries in 2015. (more information can be found below) Applicants Monthly Share of Inquiries over Three Year Period 4.5% 4.0% 3.5% 3.0% 2.5% Average 2.0% 1.5% 1.0% 0.5% 0.0% 2012 2013 2014 2015 The Takeaway The need for loans by underbanked consumers is growing. As more consumers apply for more loans, the data reveals needed information which allows lenders to more accurately assess risk. That data includes address, banking, employment and income that can provide insight into a borrower s stability. Stability directly corresponds to credit risk and enables lenders to provide stable underbanked consumers with better offers, giving them the credit that they deserve. ALTERNATIVE DATA TRENDS GIVE INTELLIGENCE TO LENDERS 7
PART TWO: NON-PRIME LOAN TRENDS The analysis of the Underbanked Index three-year data certainly shows that the market is ripe for non-prime lenders. The number of applicants interested in securing these loans (including rent-to-own, auto, line-of-credit, installment and shortterm loans) from non-traditional lenders steadily increased over the past three years. In the past year alone, data shows these inquiries have increased by 50%. Inquiries by month by Industry Monthly Share of Inquiries over Three Year Period 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 2012 2013 2014 2015 Auto Loan Installment Virtual Rent to Own Short Term Loan Let s take a look at some specific non-prime loan categories: Auto Loans: Steadily increasing since early 2014. Represents 21% of the mix of 2015 applications. Installment Loans: After remaining steady representing under one percent of all loan requests for over two years in the database, installment loans saw a jump in in 2015 to nearly 30% of the applications. Virtual Rent to Own: This category had a few lenders in late 2013 show interest in using alternative data to assess risk. Interest has increased recently. While it only represents 4% of the applications in 2015 we anticipate ongoing increased interest in this category. Short-term Loans: Interestingly, the mix of applicants seeking to secure short-term loans is declining, suggesting an improvement in the economy or borrowers moving to other products. The Takeaway Not only is there an increase in activity by these borrowers, but alternative data is being used to help underbanked borrowers secure more, new types of loans, such as cars and items that require personal financing that have better, longer terms. ALTERNATIVE DATA TRENDS GIVE INTELLIGENCE TO LENDERS 8
PART THREE: DELINQUENCY RATE TRENDS On average, delinquency rates decreased in 2014 versus 2013, demonstrating a better consumer credit quality and a growing sophistication of lenders underwriting processes. While the delinquency rate for 2015 saw a recent uptick, defaults are still below 2012 rates by more than 20%. Delinquency Rates September November January March May July September November January March May July September November January March May July 2012 2013 2014 2015 Average loan amounts have remained fairly constant from 2012 to September 2015. The year 2013 saw a rise and decline in average delinquent balances, and these have remained largely flat since mid-2014. Average Loan Amount and Delinquency Balances $600 $500 $400 $300 $200 $100 $0 2012 2013 2014 2015 Avg Loan Amt Avg Delinquent Bal ALTERNATIVE DATA TRENDS GIVE INTELLIGENCE TO LENDERS 9
Average number of trades per consumer per quarter for short term loans start out each year at a low point then continue to climb over the next few quarters. Installment loans see a similar trend, but not nearly as dramatic of a climb. In any quarter, the average number of short term trades per consumer exceeded the average number of installment loans per consumer. 2.5 2.0 1.5 1.0 0.5 0.0 2012 2013 2014 2015 2012 2013 2014 2015 Short Term Loan Installment Q1 Q2 Q3 Q4 The Takeaway Lenders are safely lending more loans to underbanked consumers using alternative credit data. It could also be that consumers that take out multiple short-term loans can find the credit they seek in fewer installment loans. PART FOUR: WHAT S NEXT? With upcoming regulations and an election in the next 12 months, the available credit information on underbanked consumers will get deeper, richer and more accessible. The CFPB s proposed rule for the short-term, small-dollar credit market is expected to be issued in the first quarter of 2016. It is expected that lenders will be required to implement the rule during 2017. Some feel the rule is an effort to kill the industry, while others are saying this will only strengthen innovation and the use of technology to advance consumers access to credit. We believe the latter, and here s why: The need for short-term loans will continue to grow as the underbanked population increases. To comply with the proposed rules for underwriting and ability to repay, all lenders will be expected to report to a bureau, which will increase the amount of contributed data made available to lenders. As a result, lenders will gain access to better, deeper credit profiles on underbanked consumers. ALTERNATIVE DATA TRENDS GIVE INTELLIGENCE TO LENDERS 10
Lenders will need more automated solutions for further data verification and validation, thereby increasing the quantity and the quality of the alternative data that is reported. In addition, new and enhanced processes will supplement lenders capabilities to more cost-effectively assess credit risk and a consumer s ability to repay, allowing lenders to evaluate more borrowers than ever before. Increased regulations will also encourage partnerships that drive new insights. We anticipate that we ll see the melding of non-traditional data sources with traditional data sources (such as the Big Three ) to provide more comprehensive service offerings. For example, alternative credit reporting agencies, such as FactorTrust, will work with traditional sources to develop more robust solutions to help determine an underbanked borrower s residual income which is a key component in assessing one s ability to repay. As a result, there will be totally new data attributes available for analysis and research to understand underbanked consumers ability to repay. Finally, the 2016 election cycle will impact the financial services in general. History suggests that if the Democrats win the open races, they will continue to push regulators to penalize financial service companies that, in their mind, are treating consumers unfairly. As a result, lenders will tend to continue to be cautious and enhance processes that could be seen as cutting edge. If Republicans prevail, the regulators will remain, but we can expect to see an increase in budgetary oversight over current practices and anticipate the aggressiveness of the regulators would be curtailed. FACTORTRUST: A PARTNER LIGHTING THE PATH TO OPPORTUNITY FactorTrust ensures success by providing the only alternative consumer reporting agency (CRA) with a scoring model built exclusively on proprietary data and a team of in-house predictive analytics experts and statisticians with extensive experience in consumer credit. With the ability to analyze more than 800 existing and derived patented data attributes, scoring is accurate and dependable. Companies such as FactorTrust have built a business around collecting quality data from a variety of less traditional sources. We have gathered additional intelligence by accessing public and private records, sanctions and identity-related information. Information from these sources not only augments our proprietary data, but also allows us to score anyone, especially the underbanked. ALTERNATIVE DATA TRENDS GIVE INTELLIGENCE TO LENDERS 11