In a piece on the TIME blog, Stephen Gandel comments on the New York Times article of 10 December, 2010 where credit card lender testing of sub-prime consumers was discussed. Mr. Gandel raises many good points about the quandary that banks find themselves in.
The issue of lending to strategic defaulters is both an analytic and an emotional one for the finance industry. Banks want to test if credit quality is changed for this segment, to see if they can both identify strategic defaulters, and then evaluate IF these consumers are good risk for credit cards or not. At this point, the banks are only TESTING the waters to see if this segment will repay. Few FICO clients have a decided upon approach to underwriting new accounts and managing the lifecycle of these consumers.
The emotional reaction to strategic default is noted in Mr. Gandel’s statement, and in conversations with banks. Even when banks want to test strategic default consumers, they don’t want to lend to households that have defaulted on loans with their bank.
There are two important points to be made with respect to lending to this segment, especially in contrast with recent problems this segment has demonstrated.
- First, lenders are only testing the waters and are still determining the policy. Those consumers that have chosen not to default are also being tested, where they may have impacted their credit history and score quality.
- Secondly, banks are approaching this segment differently. Banks are not proposing low interest charges and high credit limits, like the Alt-A mortgages that had low interest rates and high loan to value ratios 3 to 5 years ago.
If banks lend to these consumers with the same ‘generosity’ that occurred over the earlier part of this century, then the financial services sector will not recover, as Mr. Gandel stipulates. However, the level of this testing is so far significantly smaller in proportion to the experience of even the late 1990’s. Early indications are that regulators and banking policy oversight committees are prudently limiting each bank’s testing to very small segments of the addressable marketplace.