When it comes to helping auto financing sources improve profitability in the new year, one crucial element is alternative credit data. Several years ago, this type of data was still in its infancy. But in 2017, we saw alternative credit data begin to turn the corner. Now we are seeing many lending institutions beyond traditional finance companies not only considering its impact, but fully embracing alternative data. Use cases have shown that alternative credit data has helped with loss mitigation and pricing, as well as expanding the consumer universe for financial service providers. While it wasn’t long ago that alternative credit data was considered an emerging concept, it is now becoming increasingly more mainstream.
In 2017 we also saw ongoing declining originations among auto finance companies. This decline began in the third quarter of 2016. As a result, lenders are pulling back in the sub-prime market, with a corresponding reduction in the lending community on prime, near prime and sub-prime originations.
Reduction leads to gaps, new players revealed
With a reduction in originations, a gap is exposed. This gap presents itself as an opportunity as we move into the new year. Some prime plus and super prime lenders are investigating opportunities within the near prime consumer market. With the reduction of lenders in the near prime and sub-prime markets, newcomers now have the ability to price appropriately, while buffering some risk exposure.
Near prime sweet spot
As lenders are finding out, near prime can be a true sweet spot if they can make a more informed credit decision, offer competitive pricing, and remain efficient with their servicing strategies. Also, near prime often includes used vehicles which are of interest to dealers because of high inventory levels. In addition, with the change of strategy to exit sub-prime lending by major full-spectrum lenders (those who lend to all consumer categories), opportunities have been created for others to gain new market share.
This new lending opportunity can be a welcome offset to some of the potential unfavorable trends anticipated for 2018, including increasing interest rates and slowing vehicle sales. Although, higher interest rates can mean financing sources are able to charge more and, if done right, generate more revenue. In fact, the auto industry reached new heights in terms of total balances ($1.17T) and total number of borrowers (83M) in 2017 (Q3).
Credit unions looking to buy deeper too
Many credit unions are looking into the near-prime segment, as well. They are evaluating and validating the same opportunities that other lenders are considering. The underwriting process can be different for them because they spend more time getting to know their members, and in turn, these consumers become more familiar with the credit union. Credit unions also tend to have a large interest in the refinance market. Consumers in this market are becoming increasingly savvy and taking advantage of competitive credit opportunities. One example: a consumer buys a car from the dealer, then goes to a credit union shortly thereafter to get a better, lower rate. Meanwhile, the consumer has benefitted from receiving a higher trade-in amount on the front end and a lower rate on the back end.
Many of these lenders in the past would not have been as aggressive to enter the market were it not for alternative credit data. With alternative credit data, they now have the ability to underwrite consumers at almost all credit levels, or close to it. By having more information than they’ve had in the past, they are better equipped to find these opportunities and to price more appropriately. Alternative credit data is typically defined as unique tradeline, employment, banking, or contact data reported by alternative lenders that generally have not reported this data to traditional credit bureaus in the past.
Specialty finance companies that get funding from secondary markets were among the first to embrace alternative credit data. Most of these companies have also primarily focused on near prime and sub-prime segments. Now we are seeing other traditional companies, such as banks and captives, considering alternative credit data. It is in the next state of adoption. One example is the recent announcement by a top captive auto finance company to look beyond traditional credit scores to boost sales – including specifically looking at alternative credit data and applicants with limited credit histories to help accomplish this goal. The two-year pilot will research what alternative credit data attributes work best to most effectively set pricing and evaluate risk appropriately.
The changing market conditions have impacted these lenders and will likely motivate other lenders to be more effective and efficient with their underwriting and pricing strategies and to embrace new technologies. With sub-prime and full-spectrum lenders, their first objective is to understand the complete financial view of a consumer’s obligations, past performance and current stability. Alternative credit data can help with this key objective and provide a more full credit picture of consumers, allowing lenders to identify pockets of profitable consumers across all credit tiers—especially in sub-prime markets. As a result, lenders have opportunities to serve more consumers looking to build better lives.
Brian Landau is the SVP and auto business leader, TransUnion. Landau joined TransUnion in 2014. He is responsible for executing TransUnion’s growth strategy for auto and providing thought leadership to the market. Landau has more than 15 years of experience in general management and management consulting, working for and serving many of the largest financial institutions in North America.
Randy Bobb is the vice president, Sales, Auto Finance with FactorTrust |TransUnion. Bobb has more than 20 years of experience with information services, software, analytics and consulting. He is responsible for leading the auto finance sales team at FactorTrust around risk management solutions for underwriting, account management, servicing, and marketing for large auto finance companies, captives, banks, credit unions and buy-here, pay-here companies. Connect with him at email@example.com.