Finding A Better Credit Fix For Near-Prime Customers
Fair Square Financial entered the financial services world a few years ago with two observations about why the world needed another non-bank lender. The first being that the ways credit is underwritten could use a good deal more specificity.
The second — according to CEO of Fair Square Rob Habgood in a conversation shortly after closing their latest $100 million funding round — is that the market was incredibly stratified in a strange way: Due to the peculiar particulars of the Card Act, combined with the damage done by the Great Recession (and not quite so great recovery that followed), a segment of consumers was devoid of credit options.
Prime customers and super-prime customers were in good shape of lenders vying for their business and loyalty. Subprime customers — and the higher interest rates associated with underwriting their unsecured debt — were also served with a variety of products in the market. But, Habgood noted, when it came to those in between — the 600-700 FICO score crowd — the market got notably thinner and products less well-designed to meet card holder needs. And this, , isn’t a niche class of borrowers, of whom anyone would call underbanked. They are just vastly underserved.
The Middle-class Gap
These are the 50 million consumers who fit the very definition of middle class — they make north of $60,000 but less than $100,000 a year. They have a family, two cars in their garage, hold less debt than the average consumer, and have 2.5 credit cards in their wallet. Habgood said that, as the credit markets are currently designed, these consumers must often choose between two imperfect options.
Subprime cards are easily secured by this class of borrower, but those cards come with high APRs, thin rewards (if any) and low credit limits. They are designed, Habgood noted, for a class of riskier borrowers and offer these near-prime consumers little more than the ability to be charged like their credit is a good deal worse than it is in reality.
On the other side of the spectrum, he said, there are the prime cards with much lower rates, richer rewards programs and robust spending limits, all meant to entice the card holder to push as much spend through the card as possible. Near-prime customers get offers for these cards all the time, but do they actually sit down to apply?
“What we see is four times out of five they are rejected for that offer, because they don’t meet enough of the issuers standards,” Habgood said.
Cutting the middle class out of the credit markets, or offering products that are out of line with their actual needs, seemed a missed opportunity to the team at Fair Square — and hole they were eager to fill. That brought Habgood and his team to the second observation: Once a better product was available in the market, there needed to be a better way to onboard eligible consumers.
A Better Option
On the better card front, according to Habgood, the effort there is creating what consumers have said they want —a product they can be fairly certain they will qualify for, with a “non-gimmicky” rewards program, a transparent fee structure and a product that “grows” in relationship to how customers use the card.
“I mean if you think about even applying for a card,” Habgood said, “customers don’t want to apply, get rejected and, in the process of getting rejected, bring down the credit score some more.”
That’s a friction point that is fairly easy to remove, he noted, by making sure denials aren’t an option.
“We send all our offers out pre-approved,” he added. “If we are offering a customer a product, then we have done that work upfront.”
The rewards program is also designed to be straightforward — card holders get 2 percent cash back on grocery, gas and pharmacy purchases. And, other than interest charges associated with the card for those who carry a balance, there aren’t other fees built into the card. The customer just pays their bill.
Ollo, the credit card company marketed by Fair Square, works hard to start customers with “actually useful credit lines” that grow up with the customers, with a reviewed balance increase after five months and continual monitoring from then on so customers can have credit lines “appropriate to their actual spending needs.”
A New Approach
The secret to making a better than average offering for the near-prime customer is data and the machine learning that Fair Square turns loose on it. Habgood says that’s because, like many innovators in the non-bank lending system, the standard methods for evaluating customers — as exemplified by FICO — is just not a sufficient tool in an era when smart AI can help firms do much better by their customers. It’s not that they look at fundamentally different criteria than FICO does, but that Fair Square is dedicated to looking a bit deeper.
Habgood said, “If the standard-risk algorithm is looking at 30 or so data points on a consumer, we are looking at something more like 120.”
He also noted they are looking at them in a different context. The FICO model is basically static — a list of everything that has happened in a consumer’s credit life over a decade or so — and is not sensitive to what Habgood called the “direction of the story.”
For Fair Square, it doesn’t just matter what is in a customer’s past, but the order in which those events happened. If the consumer is making more money over time, extinguishing more debt and showing greater levels of responsibility, the right thing — and smart business move — is to reward that customer with more access to credit. Consumers, particularly middle-class consumers, are vulnerable to financial shifts and runs of bad luck. According to Fair Square, the model it has tried to build differentiates between consumers whose credit bumps and bruises signify pervasive risk and those who suffered a temporary setback in life that they are working through.
A Bright Future
So far, Habgood noted, they are satisfied, and even a bit surprised by the results. Customer recruitment is higher than they thought it would be and delinquency rates are lower. The challenge now, he said, is the pursuit of scale.
“Starting from scratch,” he said, “we are obviously at a big-scale disadvantage.”
“This investment validates our business strategy and management team, and recognizes the remarkable progress we have made since we launched the business,” said Habgood.