April 12, 2012
Lenders Again Dealing Credit to Risky Clients
Annette Alejandro just emerged from bankruptcy protection and doesn't have a job, and her car was repossessed last year. Still, after spending her days job hunting, she returns to her apartment in Brooklyn where, in disbelief, she sorts through the piles of credit card and auto loan offers that have come in the mail.
In the depths of the financial crisis, borrowers with tarnished credit like Ms. Alejandro were almost entirely shut out by traditional lenders. It was hard enough for people with stellar credit to get loans.
But as financial institutions recover from the losses on loans made to troubled borrowers, some of the largest lenders to the less than creditworthy, including Capital One and GM Financial, are trying to woo them back, while HSBC and JPMorgan Chase [JPM 44.01 1.05 (+2.44%) ] are among those tiptoeing again into subprime lending.
Credit card lenders gave out 1.1 million new cards to borrowers with damaged credit in December, up 12.3 percent from the same month a year earlier, according to Equifax's credit trends report released in March. These borrowers accounted for 23 percent of new auto loans in the fourth quarter of 2011, up from 17 percent in the same period of 2009, Experian, a credit scoring firm, said.
Consumer advocates and lawyers worry that the financial institutions are again preying on the most vulnerable and least financially sophisticated borrowers, who are often willing to take out credit at any cost.
"These people are addicted to credit, and banks are pushing it," said Charles Juntikka, a bankruptcy lawyer in Manhattan.
The banks, for their part, are looking to make up the billions in fee income wiped out by regulations enacted after the financial crisis by focusing on two parts of their business — the high and the low ends — industry consultants say. Subprime borrowers typically pay high interest rates, up to 29 percent, and often rack up fees for late payments.
Some former banking regulators said they worried that this kind of lending, even in its early stages, signaled a potentially dangerous return to the same risky lending that helped fuel the credit crisis.
"It's clear that we are returning to business as usual," said Mark T. Williams, a former Federal Reserve [cnbc explains] bank examiner.
The lenders argue that they have learned their lesson and are distinguishing between chronic deadbeats and what some in the industry call "fallen angels," those who had good payment histories before falling behind as the economy foundered.
A spokesman for Chase, Steve O'Halloran, said the bank "seeks to be a careful, responsible lender," adding that it "is constantly evaluating the risks and costs of funding loans."
Regulators with the Office of the Comptroller of the Currency, which oversees the nation's largest banks, said that as long as lenders adhered to strict underwriting standards and monitored risk, there was nothing inherently dangerous about extending credit to a wider swath of people.
In fact, an increase in lending is a sign that the economy is improving, economists say. While unemployment [cnbc explains] remains high, consumers have been reducing their debts. Delinquencies on credit card accounts and auto loans are down sharply from their heights in the crisis. "This is a natural loosening of credit standards because the banks feel they can expand again," said Michael Binz, a managing director at Standard & Poor's.
And lenders miss many potential customers if they focus just on people with perfect credit.
"You can't simply ignore this segment anymore," said Deron Weston, a principal in Deloitte's banking practice.
The definition of subprime borrowers varies, but is generally considered those with credit scores of 660 and below.
The push for subprime borrowers has not extended to the mortgage market, which remains closed to all but the most creditworthy.
Capital One Financial [COF 53.73 1.04 (+1.97%) ] is one lender that has been courting borrowers with damaged credit, even those who have just emerged from bankruptcy, with pitches like, "We want to win you back as a customer."
Pam Girardo, a spokeswoman for Capital One, said, "Our strategy is to provide reasonable access to credit with appropriate guardrails in place to ensure consumers stay on track as they rebuild their credit."
Ms. Alejandro, 46, was one of the borrowers fresh out of bankruptcy courted by Capital One. So far, she has turned it down.
David W. Nelms, chief executive of Discover Financial Services, the sixth-largest credit card lender in the United States, told investors this month that the company planned to extend credit to a broader group of borrowers. But, he added, Discover [DFS 32.68 0.50 (+1.55%) ] is not "suddenly going to go into the subprime business."
Credit card lenders extended $12.5 billion in loans to subprime borrowers last year, up 54.7 percent from 2010, according to Equifax [EFX 43.45 0.95 (+2.24%) ] and Moody's, but still below the $41.6 billion in 2007.
Lenders are ramping up their advertising, according to Synovate, a market research firm. Others are developing credit cards specifically aimed at borrowers with damaged credit. Capital One, for instance, introduced a credit card last year that allows these borrowers to lower their interest rate after making timely payments for a year.
Auto loans are particularly attractive for lenders since they were largely untouched by many of the new regulations. The new Consumer Financial Protection Bureau said it had not yet decided whether it would oversee the largest nonbank auto lenders.
At the same time, the market for securities made up of bundles of auto loans is heating up. Last year, investors scooped up $11.7 billion in auto loan securities, up from $2.17 billion in 2008. The pace of securitization in credit cards is slower, with lenders selling roughly 30 percent of their card portfolios to investors, down from 60 percent before the financial crisis, according to S&P.
Steve Bowman, the chief credit and risk officer for GM Financial, an auto lender, said he expected subprime auto loans to continue to grow. Unlike mortgage lenders, Mr. Bowman argued, auto lenders understand how to manage risk while still making loans to borrowers with poor credit.
But Moody's [MCO 41.85 1.08 (+2.65%) ] was already sounding the alarm last year that some very risky borrowers were getting auto loans. The market, Moody's wrote in a report in March 2011, could be growing "too much too fast."
Ms. Alejandro is not the only borrower with bad credit to question why anyone would offer a loan. The offer, of course, does not necessarily translate into the issuing of a card.
Shauna Ames, 41, an office manager from St. Paul, said she got a credit card offer from Capital One even though the company had won a lawsuit against her for $5,485 in overdue credit card debt last September. Ms. Ames, who had filed for bankruptcy, said she was surprised at the offer. "I still can't believe it," she said.
Ms. Girardo, the Capital One spokeswoman, said the bank doesn't solicit customers that it has previously sued. "We believe we can establish long-term relationships with products that are predicated on consumer success," she said.
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