Victims of Circumstance

Over the years, we’ve watched the manual underwriting process evolve into an automated one, with loan decisions generated in split seconds. The current market turmoil might upend that methodology, though, as artificially low credit scores keep potential car buyers out of the market.

In a nutshell, here’s the premise: Increasingly, there are consumers who used to be model borrowers, repaying their loans on time, month after month. They lose their jobs — and their ability to make those monthly payments. They either miss a few payments until they get back on their feet, or have their vehicles repossessed. A few months later, they secure new jobs, potentially at lower pay grades. But when they go to apply for vehicle loans, their credit scores are hammered. What may have been close to 800 credit scores are now 580s or 600s.

Multiply that situation by the number of newly unemployed in the U.S. (524,000 in December alone, and 2.6 million for all of 2008), and we could be in for an even longer slowdown in the auto finance sector.

The way I see it, lenders need to delve deeper into the details to determine the root of lower credit scores. Are they largely one-time occurrences that walloped consumers’ credit? I’m not suggesting that we revert back to manual underwriting processes, but we should certainly leverage the tremendous technology available to better identify these victims of circumstance.

If not, lenders will pass up some great borrowers who simply hit on hard times. And borrowers will have to wait longer to secure credit, which will significantly slow the industry’s rebound.

Tags: credit, credit-score, underwriting

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Comment by pradike on January 14, 2009 at 12:17pm: Relaxing standards would only magnify the negative results...so I'd have to disagree.

Comment by Dusty Crone on January 14, 2009 at 12:28pm: Fundamentally I agree. The problem now is the lack of confidence in those same individuals that they will have the new job a year from now. These are not willingness issues, but ability issues. I do think that logic is solid in a strong economy, but not in one where unemployment is still going up. In fact, there are subprime companies that have that exact underwriting strategy (prior to last year) - talk to the applicant, determine if it was a one-time problem, and give a second chance, assuming the problem was far enough behind them. In that scenario, you can have a book of 450 beacons that perform well - I've seen it!

Comment by Jonathon Levin on January 14, 2009 at 12:30pm: A credit score should be used as a benchmark but not necessarily the answer to how credit worthy the customer is. To help address the lower credit scores, manual decision making will enable one to dig deep into the credit with taylored customer interviews to learn what the root causes were that harmed the credit. I call this Story Telling financing; there is a story behind the scarred credit. The story may allow for better terms on a credit score that may not look so good on paper. Take the time to get to know the applicant and avoid passing up on good deals that may not look so good.

Comment by Michael Smitka on January 14, 2009 at 12:40pm: Are there still the personal ties between the dealership F&I person and the local lending officer who could (manually) override a low score? One of the downsides of the greater "marketization" of such transactions is that human ties are weakened or disappear -- and the sort of information that would make or break a deal is not likely to be well conveyed by a credit report and standard fill-in-the-blank loan application. What is the new job, how stable, lower income but what of other expenses, etc? Note this logic / insight lay behind the work on monetary policy transmission that helped bring Bernanke to note among his economist peers: bank failures disrupt these sorts of informal networks, and hence mean potential credit transactions don't occur. It's easy to come up with analogous situations in the manufacturing end of the auto industry, there are things you can do between (parts) suppliers and assemblers when the engineers and buyers/sales people know one another that won't be attempted when it's a set of new faces.

Comment by Herb WIlliams on January 14, 2009 at 12:48pm: I think we are moving in the right direction. Today It is not just Credit Scores for the Bureaus that are a factor. Today we are moving to Red Flag Reports that will stop alot of the Fraud that we see in financing.

We are also seeing alot of backend systems that check more than Credit Scores in the underwriting process. The Biggest problem is 60 percent of the data coming to the underwriters is wrong and has to be corrected in the contracting process. It's the old problem garbage in and garbage out.

Comment by Michael Smitka on January 14, 2009 at 12:57pm: GIGO - familiar. What are the people links to make the corrections? Who does it where, using what tools? Note I've not worked in this end of finance to know such details, maybe everyone else does so don't bother teaching me if it's common knowledge.

Comment by John Paulsen on January 14, 2009 at 1:25pm: It's unclear to me how a manual decision would help solved your premise. Underwriters don't have access to most of the factors that would allow them to judge the potential for unemployment.

A better solution would be an affordable unemployment insurance product. A proper developed product. Most of the product development for a product like this has been on the consumer side. A collection side product could help increase profit and help collectors with customer service. The product I have in my head would be purchased by the bank on certain loan tiers. I brochure could be sent out to customers explaining how they are "already signed up" for this product. "Welcome Callers" could also ask other tiered customers if they would like to add the product to their loan.

This concept would still help keep underwriting cost down and add after the loan revenue to the contract holder.

Comment by Steve Rabago on January 14, 2009 at 2:00pm: Or dealers can carry their own paper until it's adequately seasoned for resale. They can make a local call based on their own underwriting standards. ZimpleMoney provides the low cost loan administration tools for dealers to manage their own portfolio. This methodology nets the dealer a sale, increased cash flow, and smaller discounts when they sell the portfolio. Sounds like a win-win to me!

Comment by Herb WIlliams on January 14, 2009 at 5:58pm: I also feel that the manual decision is not fixing the problem by having a solution that can validate data as it comes into the system this insures the data is correct.

A Red flag report validates 26 areas of appliction, there are many other tools that can insure the data is correct and not garbage. There are alot of solution that will support these tools but we as a group are not supporting them because it does not sell cars.

Comment by Steve Cortes on January 14, 2009 at 6:10pm: Although this appears to be a great opportunity I do see aproblem. The major players have had the automated process for so long that there are fewer underwriters that have the experience and knowledge to make a manual decision. For years we have seen many of the indirect lenders price and decision deals based on Beacon Score and not the true customer picture. Too many of today's underwriters are trained to decision based on what the system is recommending and do not have the expertise to even read a credit report.