'Emerging' Credit Scores May Leave Banks Behind

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By: Laurie Kulikowski
December 15, 2010

NEW YORK (TheStreet) -- A number of companies are contributing to the cause to get unbanked or underbanked consumers access to credit and may be outflanking traditional banks efforts expand their customer base.

Roughly 50 million consumers in the U.S. are so-called underbanked. The group includes immigrants and low-income individuals to teenagers and those who are just generally credit risks to more traditional banks and thrifts.

Banks are having a hard time serving the lower end customers, particularly as new consumer protection laws have banks scrambling to find future retail profits.

And while some banks are looking to attract these customers by offering prepaid debit cards, far more banks are looking upmarket for customers, effectively leaving the underbanked market in the dark. The demographic is finding it particularly troublesome to obtain a loan, since banks in general are unlikely to offer secured loans without collateral and unsecured loans (excluding credit cards) without at least seeing a credit score. A large portion of underbanked individuals do not have credit scores.

As a result, alternative financial services providers are seeing large demand from consumers. The potential for growth has spurred many firms from technology firms to risk analytics to microlenders to develop ways to cater to this growing population.

Arjan Schutte, senior advisor to the Center for Financial Services Innovation, an organization dedicated to providing access to financial services to the unbanked and underbanked communities describes companies like Atlanta-based L2C Inc. as "part of the plumbing that makes it possible to make more credit available to more people," he says.

Schutte is also managing partner to CFSI's investment arm, Core Innovation Capital, which invests money into companies focused on reducing inefficiencies in the underbanked market.

The group is looking to invest in infrastructure and internet companies that will help reduce what Schutte says is "inefficiencies" in the unbanked financial services market.

L2C specializes in assigning credit risk to consumers with so-called thin files -- those who have little or no credit history -- by using nontraditional data.
The company has been around for 10 years, and now serves credit card companies, banks, auto lenders, credit unions and unsecured lenders with data, its website says.

This past June, L2C teamed with TransUnion to offer its "Link2Credit Thin File Model" to help lenders expand their customer base into underserved markets.

L2C is just example of "organizations doing such neat things and so much more innovative in serving this customer than banks will ever be," he says.

And there are other companies looking to tap this potentially-rich consumer group by figuring out how to provide credit.

Experian (EXPN), the London-based risk analytics company that also provides credit scoring services, launched the Emerging Credit Score in 2008.

The emerging credit score helps identify and score consumers that have little to no credit reporting history, including thin-file populations, emerging consumers, and those who use alternative financial services, the company says. It combines traditional credit reporting agency data with alternative data sets to better reflect the financial behaviors that predict future credit activity.

More recently though, the company is set on adding more data to its traditional credit files.

Experian acquired RentBureau in June, which gave it access to millions of consumers with rental payment histories.

Unlike mortgages and other types of housing-backed loans, rental information is not on a traditional credit report. Beginning this week, Experian will be the first major credit bureau to incorporate rent data into its traditional credit score.

"Close to one-third [of consumers] rent, however those individuals do not get proper credit for those payments," says Brannan Johnston, Experian's vice president in managing director of Experian RentBureau. "We have great data on people that own their homes through their mortgage, however we've always missed renters. And for most renters, the No. 1 monthly expenditure is what they pay in rent."

Roughly 30% of those with rental credit history, do not have full credit files with Experian, Johnston says.

"That's really the core of the underbanked market," Johnston says. "Yet many of them do rent homes and responsibly pay their rent month after month."
For the Latino market specifically, Sears (SHLD) has partnered with Progreso Financiero.

The Silicon Valley-based Progreso Financiero or Progress Financial, is making loans in areas where unemployment is 20% and higher, however, "their losses are single digits and going down because they've really figured out how to really genuinely determine risk in this segment," Schutte says.

"That's in places like Sears, not Bank of America (BAC)," Schutte says.

Progreso Financiero's CEO James Gutierrez says part of the microlender's mission is to help consumers in this demographic build credit.

"When you don't' have a score it's like not having a face. You can never really move up and build assets and build wealth," Gutierrez says of the five-year-old firm that he also co-founded.

The firm doles out unsecured loans that are structured similar to the Federal Deposit Insurance Corp.'s Small Dollar Loan policy, a pilot program implemented by Chairwoman Sheila Bair last year.

Each loan has the same fixed terms - a maximum limit of $2500, a loan term between six to 18 months and a fixed APR of 36% (which includes origination fees).

While 36% is still abnormally high, relatively speaking, the interest rate is way lower than the 400%-plus payday loans that customers otherwise resort to, Gutierrez says.

"We're basically the best deal on the market," the Stanford and Yale alum says. "There is nothing else out there that helps build up credit score."

Progreso Financiero has a 50% approval rate for loan applications. And while Gutierrez declined to disclose the company's loss rates, he likened customers to having the equivalent of a 680 to 720 FICO-equivalent credit score, out of 800. The firm's repeat customer rate is roughly 75%, he says.

The secret, the chief executive says is the firm's "eHarmony-like" comprehensive questionnaire issued to potential customers. (The firm also purchases third-party data and alternative data for further credit risk assessment.)

"We've developed some of our own propriety [technology]. It's only after we made a lot of loans and also captured a lot of information that we can figure out, what is actually very predictive of determining, who is a good borrower and who is not a good borrower," Gutierrez says.
This week, Progreso Financiero will be making its 100,000th loan.

Progreso Financiero, which currently has 50 locations, primarily located in Latino-specific supermarkets in California and Texas, is ripe for growth and expansion opportunities in both geographic locations and product set, Gutierrez says.

Still it is not a depository institution, nor does it really have plans to become one. On the other hand, it wouldn't be surprising to see the company go public in the next few years.

"Our mission is not to stop at credit, but start at credit and move into other empowering products," he says. "This is not a transaction for us this is a relationship. We want to be a life partner when it comes to financial services."

-- Written by Laurie Kulikowski in New York.

To contact the writer of this article, click here: Laurie Kulikowski.

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