By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She is currently writing a book about textile artisans.
The Wall Street Journal ran a story this morning about a problem confronting banks: the COVID-19 pandemic has made it difficult to decide who remains credit-worthy and who not,.‘Flying Blind Into a Credit Storm’: Widespread Deferrals Mean Banks Can’t Tell Who’s Creditworthy
As regular readers know, banks have been profligate in awarding credit before any of us had even heard of COVID-19. But in this game of credit musical chairs, the music has stopped, and an unknown number of chairs have beeen yanked away. The models banks used to allocate credit when the game began can no longer predict who will find a seat. (I leave aside the broader question of whether they ever could do so accurately.)
Over to the WSJ:
Banks have pulled back sharply on lending to U.S. consumers during the coronavirus crisis. One reason: They can’t tell who is creditworthy anymore.
Millions of Americans are out of work and behind on their debts. But, in many cases, the missed payments aren’t reflected in their credit scores, nor are they uniformly recorded on borrowers’ credit reports.
The confusion stems from a provision in the government’s coronavirus stimulus package. The law says lenders that allow borrowers to defer their debt payments can’t report these payments as late to credit-reporting companies. From March 1 through the end of May, Americans deferred debt payments on more than 100 million accounts, according to credit-reporting firm TransUnion, TRU +0.96% a sign of widespread financial distress.
The credit blind spot has further clouded the outlook for lenders. For years, strong consumer spending and borrowing helped propel them to record profits. Now the economy is in shambles, and they are trying to figure out what is going to happen to all of the debt Americans racked up in better times
I know, I know: Cry me a river. The banking industry usually enjoys close control over our Congresscritters. Seems, however, that the COVID-19 pandemic blindsided it – as it has the rest of us.
The real problem here is that banks no longer really know their customers, but have seemingly placed over-reliance on a magical number – or more accurately, algorithm, which calculates one’s credit score.
What’s a banker to do?
Alas, you can be sure thie industry’s solution to the dearth of information isn’t one that will assist most of its customers in these trying times. Per the Journal;
Lenders that are having a tough time spotting risky loan applicants are approving fewer borrowers for credit cards, auto loans and other consumer debt. They are also hunting for new data sets that could indicate who is in financial trouble and how much they need to set aside to cover soured loans. The Federal Reserve last week said the biggest U.S. banks could be saddled with as much as $700 billion in loan losses in a prolonged downturn.
“Without accurate information, their only option is to pull back on credit,” said Michael Abbott, head of banking for North America at consulting firm Accenture PLC. “Banks don’t know who is going to pay and who isn’t. It’s like flying blind into a credit storm.”
Banks started tightening their underwriting standards in March, when the first wave of coronavirus layoffs began.
By early April, 33% of banks that responded to the Federal Reserve’s senior loan officer survey said they had increased their minimum credit-score requirements for credit cards over the previous three months, up from 14% in January. Bank respondents tightened lending standards for all consumer-loan categories tracked by the survey.
Loan originations have fallen, a result both of the tightening and a decline in consumer demand. An estimated 79,000 personal loans were extended in the week ended May 10, compared with 226,000 in the week ended March 22, according to Equifax Inc.EFX -0.24% Auto loan and lease originations fell to 266,000 from 390,000 during the same period. General-purpose credit-card originations totaled 483,000, down from 856,000. In 2019, weekly card originations rarely fell below 1.2 million.
What will be the consequence for the bottom lines of banks? It’s well above my paygrade to analyze the problem, but I can speculate that the answer won’t please borrowers. Only now are banks addressing the latent flaws in their models. accoring to the WSJ:
“Banks are looking very carefully at their underwriting models to see if they need to be adjusted to factor in latent risk,” said Rob Strand, senior economist at the American Bankers Association.
And, just in case you weren’t already completely paranoid about how your smartphone is used by banks to hoover up seemingly innocent data, the Journal mentions:
Lenders are looking for data that will help them figure out which applicants are a safe bet and who’s likely to run into financial trouble.
They are also considering using unemployment data—such as cellphone records that show unemployment office visits and benefit-deposit data—that could help them figure out how to account for future loan losses, according to people familiar with the lenders’ discussions. Some banks are reviewing cash flow in deposit accounts to get a better idea of the risk lurking in their loan books, the people said.
Credit-reporting companies have been in discussions with lenders about additional data sets that could help identify hidden risks. The conversations also involve how to pinpoint applicants who fall short of lenders’ credit-score cutoffs but are likely to pay back their loans.
Fair Isaac Corp., FICO -2.44% the creator of the widely used FICO credit scores, is rolling out an index that will appear next to loan applicants’ scores and inform lenders how likely the applicant is to withstand financial difficulties during the downturn.
“It gives [lenders] that extra filter of how a person is going to handle an economic downturn,” said FICO Chief Executive Will Lansing. “The increase in approvals will be more than the increase in rejections.”
Do you believe that? If you do, there’s a bridge I’d like to sell you that’s located mere miles away from my Brooklyn home.