With Consumers So Dramatically Changed, So Must Underwriting Transform
Consider this fact. In November 2007, the average American saved 1.9% of his after-tax income, according to the Bureau of Economic Analysis. Guess what that rate was as of last June? Try 6.4%.
This statistic alone should give you pause, and should spur a profound reassessment of underwriting guidelines and principles. Today’s American is different than he was in 2007, and lenders’ underwriting guidelines should reflect that.
Earlier this week, an American Express-commissioned report outlined changes in the way Americans shop. The report, which is excellent, is actually more than just about shopping, even though it is titled “The New Era of Pause and Purchase” — it outlines the way Americans have altered their attitudes about life and the future. These are not just I-like-bell-bottoms-this-spring changes in attitude. The economic crisis has spurred a profound realignment of consumer sentiments, according to the report. And my reaction was: underwriting guidelines need to change.
Let me explain. Most lenders have tightened their underwriting since 2007. This was based on two principles: a) miscalculated risk exposure; and b) limitations on capital. Capital is anything but limited today. The waterfall of deposits (see above statistic) has banks awash in capital. Ideally, this would lead to more lending, but that Reason A still lingers. Or does it?
Some statistics:
- 58% of Americans say they are more cautious now as a consumer;
- More than half (52%) of American consumers plan to save or invest money over the next six months (Harris Interactive); and
- Two-thirds of respondents expect to spend less on eating out (66%) and entertainment (62%) (Harris Interactive).
These are not just happenstance changes. This is the majority of Americans who are spending less and being far more conscientious about their money. In the words of the Amex report:
Americans are feeling cautious and understandably more hesitant to spend. They have been wounded by the recession, and currently face historically high unemployment, a fragile economy and long and costly wars. …
US consumers are shaken, and are therefore more careful, considered and focused on getting the best value and quality in their purchases.
Obviously, the above statistics refer to “expectations” of spending, and it is certainly possible that expectations will deviate from reality. But I think there is something truly different about the US consumer today. It’s the high unemployment rate for such a long duration of time. Couple that with the under-employment rate in America, and you have a profound financial scar seared into the US consumer’s psyche.
This change should be reflected in underwriting. I would expect that 2010 vintage credits will perform noticeably better than loans in previous years with similar economic conditions. And I think collection rates will improve, too. The report asked, “How would you describe yourself as a consumer?” Here are the responses:
- Cost conscious – 75%
- Quality-driven – 62%
- Traditional – 35%
- Basic – 34%
- Prudent – 32%
“Cost-conscious” people do not let their credit scores get out of whack. “Traditional,” “basic” and “prudent” people do not let their debt-to-income rations get out of whack. Smart lenders will recognize this, and take advantage of the change in sentiments. This can’t be done by tweaking the automated underwriting guidelines. This needs to be a profound exercise in credit risk analytics. I know, it’s not easy, but the rewards could be anything but “traditional.”
View the American Express report here.
