The housing crisis and the financial downturn that followed, without question, have profoundly altered the consumer lending landscape.
According to data from the financial advisory and research firm Deloitte, one change that may be underappreciated is the rapid emergence of an important customer segment that could have powerful implications for lenders Ã¢â‚¬" the first-time defaulter.
A survey conducted by the firm's Center for Financial Services found that 11 percent of banking customers have experienced a negative credit event for the first time in their lives within the last two years.
Deloitte says traditional approaches to consumer lending may lead lenders to believe that first-time defaulters represent unacceptably high long-term risks and may tend to be unprofitable customers in the future.
However, the company's analysts argue had it not been for the economic recession, many of these first-time defaulters would have remained in good credit standing, and some have the potential, indeed the propensity, to resume good financial behavior.
Targeting this segment of first-time defaulters could become a unique revenue opportunity for financial institutions, Deloitte says.
The firm explained in its report and survey analysis, that historically, customers who did not fulfill their credit obligations have been treated separately and differently, subject to higher fees and rates to offset the credit risks associated with them.
However, Deloitte points out that many banks are now shutting their subprime lending units, indicating that they will be increasingly relying on prime customers to generate growth. As a result, the firm says competition for prime customersÃ¢â‚¬â„¢ business is likely to be fierce and margins may be compressed further Ã¢â‚¬" but some prime customers themselves have become casualties of the financial crisis.
A study by Deutsche Bank in early 2010 found that the number of subprime customers in the United States increased from 15 percent pre-crisis to 25 percent by April 2010 as borrowersÃ¢â‚¬â„¢ credit records garnered blemishes.
In addition, Deloitte notes that prime customers have been struggling with their mortgage payments: foreclosures on prime fixed-rate loans drove most of the increase in the rate of newly initiated foreclosures from 1.11 percent in the second quarter of 2010 to 1.34 percent in the third quarter of 2010, based on information from the Mortgage Bankers Association. Deloitte explained that this is the highest level of foreclosures for prime fixed-rate loans since the initial tracking of the data in 1998.
By focusing solely on those who have never defaulted, the firm warns that financial institutions may be overlooking the growth opportunity associated with the first-time defaulter segment.
Based on the results of the Deloitte Center for Financial Services survey, the profile of a first-time defaulter is:
* Majority female (57% polled were female vs. 43% male)
* Half earned $50,000 or more in 2009
* 25% have completed college
* 36% live in the South
* 14% are unemployed (though still looking for jobs)
Deloitte says a first-time defaulterÃ¢â‚¬â„¢s experience during the default process is likely to influence their expectations of and decisions to engage with future lenders. The firm found that when slipping into delinquency or outright default, first-time defaulters witnessed a significant and negative change in their interactions with lenders.
When asked more specifically about their experience during the default process, Deloitte says first-time defaulters, rated interactions with their lender as Ã¢â‚¬Å“poorÃ¢â‚¬Â on several dimensions of customer service, including promptness, willingness to listen to their concerns, and offering constructive solutions.
Given these reported findings, the firm found many first-time defaulters became disinclined to borrow in the future from the same lender, and some even partially blamed their lender for allowing them to overextend their credit.
Ã¢â‚¬Å“It may be the case that some financial institutions deliberately use the default process as a way to encourage apparently undesirable customers to defect,Ã¢â‚¬Â Deloitte said in its report. Ã¢â‚¬Å“However, a deeper understanding of the default base suggests that these institutions may also be driving away potentially valuable first-time defaulters.Ã¢â‚¬Â