TransUnion Uncovers Unique Dynamic Connecting Payments for Subprime Vehicle Financing and Credit Cards
By Nick Zulovich, Editor
July 31, 2013
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CHICAGO — A new TransUnion study reinforced an intuitive belief risk management departments at vehicle finance companies might already have had: Consumers with the ability to pay larger amounts than the minimum payment due on their credit cards had significantly lower delinquency rates on not only their credit cards, but also their auto loans and mortgages.
While TransUnion indicated consumers who made the minimum payment, or close to it, generally had higher delinquency rates, one of the study authors spotted a unique situation when it came to individuals who had a vehicle contract in the subprime financing space.
"When we looked at auto portfolios and looked specifically at subprime, we tend to see a reversal of that trend," Antoni Guitart, director of research and consulting at TransUnion, told SubPrime Auto Finance News this morning after the credit agency released study results.
"We think there is kind of intuitive explanation," Guitart continued. "When we see consumers make very high payments on their credit card relative to their minimum and these same consumers have an auto loan, we believe there is a strong indication that these consumers have a made a choice in terms of which credit products and obligations they're going to pay that month.
"They're making payments on their credit cards 20 or 30 times above the minimum, most likely they have chosen that they're going to keep current on their credit cards and have access to that cash flow and liquidity," he went on to say. "That's why we see higher delinquency and default rates among those consumers for subprime auto than for consumers who just make the minimum payment.
"We believe it's related to the consumer payment hierarchy and a dynamic that's probably useful and important to understand if you're a lender in the subprime space," Guitart added.
Explanation of Study
The TransUnion study found that, of the consumers who make payments on their credit cards, each month about four in 10 will pay off their entire credit card balance. Six in 10 of those making payments on their credit cards will only pay part of their remaining balance, and of those six consumers two will pay off only the minimum owed.
"TransUnion's study has confirmed the conventional wisdom that transactors - those consumers who pay off their entire balance each month - are better risks than revolvers, i.e. consumers who only pay a portion of their balance, and moreover has quantified just how big an increase in risk revolvers represent," said Ezra Becker, co-author of the study and vice president of research and consulting in TransUnion's financial services business unit. "Just as importantly, the study revealed that not all revolvers are equal: those who pay more than the minimum on their credit cards, even if they don't pay off the full balance, present less risk across product types.
"Our findings are good news for consumers, particularly those who only pay off portions of their credit cards each month," Becker continued. "Even if they can't pay the full balance, they may now find that lenders view them in a more positive light depending on the amount they do pay."
Among the metrics developed by TransUnion as part of this study was the Total Payment Ratio (TPR), which was calculated by dividing a consumer's total monthly credit card payments by the total minimum due on all of that consumer's credit cards.
For instance, a person making $1,200 in payments on three credit cards when the aggregate minimum due on those cards was $600 would have a TPR of 2.0. A person making $1,200 in payments with an aggregate minimum due of $200 would have a TPR of 6.0. TransUnion used this metric to analyze how credit users performed on various loan types.
"Our study clearly demonstrated that as the TPR increased, delinquency levels decreased on credit cards, auto loans and mortgages," Becker said. "In some cases, individuals with lower credit scores but higher TPR levels outperformed those with higher credit scores but lower TPR levels."
"The only anomaly we found was that higher TPR levels actually resulted in higher auto and mortgage delinquencies for subprime and near-prime mortgage borrowers, but we attribute this performance to the mortgage crisis and its impact on the payment hierarchy - many consumers facing foreclosure placed a higher emphasis on paying off their credit cards," Becker went on to say.
TransUnion also developed a metric called the Aggregate Excess Payment (AEP) to better gauge how many dollars in excess of the minimum payment were made. This variable was calculated by subtracting the total minimum due from the total payments made across all of a consumer's credit cards.
Two consumers with a TPR of 2.0 could have much different AEP profiles. For instance, a consumer making $2,000 in payments with a total minimum due of $1,000 would have a TPR of 2.0 and an AEP of $1,000. A consumer making $200 in payments when the total minimum due was $100 also would have a TPR of 2.0, but their AEP would only be $100.
"The AEP variable also performed quite well as a risk splitter across credit products, even when controlling for traditional credit score," Becker said. "Having more than one metric to understand payment behavior provides flexibility to lenders in managing their risks and engaging their customers and prospects. At a time where understanding ‘ability to pay' is so important, we find that these insights can be hugely worthwhile for lenders."
Potential Uses for Vehicle Finance Companies
Guitart explained that TransUnion rolled out this study since risk managers are often looking for tools to gain a better understanding of consumers that might be high risk or low risk. The tool also can have significant implications in terms of how finance companies price their credit products and the provisioning of reserves
"Generally a lender, at least in our experience, is going to be fairly agnostic in terms of prescriptive uses of new data elements. They will want to test them in their portfolio. They will want to test them in their strategies. That's really the way to go about it," Guitart said.
"The way we envision this working and the way we've seen it work in our internal data here is these types of new measurements that we have, which again had not been available in the past, should be complements to the current strategies the lender has," he continued.
"We believe there is not going to be a complete overhaul of the strategy systems that lenders are using, rather there's going to be an enhancement," Guitart went on to say. "That enhancement is going to be provided by this new view of the data that will allow them to differentiate beyond what the credit score can do, showing who are the higher-risk consumers and who are the lower risk consumers."
Continued Examination of Credit-Card Payment Behavior
Guitart indicated the study has been "a long investment and a long project." But TransUnion already is planning to watch these metrics going forward.
"I think it's going to be important over time to monitor these results to understand if there are any shifts in the dynamics that we see or simply to validate the initial findings are consistent with what we see over time," he said.
"What's going to be more important, especially for individual lenders, is for them to start implementing some of these new concepts and drivers of risk and to test them in their own strategies because that's where they can really understand in what areas of their portfolio this might be most useful and at which point in their credit cycle it might be most useful," Guitart went on to say. "We think this has applications for prospecting, underwriting, portfolio management and provision as well as in the back end even for collections."
Nick Zulovich can be reached at email@example.com. Continue the conversation with SubPrime Auto Finance News on LinkedIn and Twitter.
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