Despite the potential benefits of alternative data, privacy concerns linger about how the data is collected and shared with lenders. Earlier this year, the Consumer Financial Protection Bureau (CFPB) announced that it is looking into privacy and security concerns surrounding the growing acceptance of alternative data and sought public comment on both issues.
The CFPB’s main concerns center around two issues. First, the bureau wants to ensure that data collection agencies are transparent about the sources they use for data collection and the manner in which they disseminate alternative data to lenders. By verifying how alternative data is collected, the bureau hopes to gain insight into whether the utilization of alternative data disadvantages any specific groups. Second, the bureau is looking into how easily consumers can correct false, incomplete, or biased information that is reported about them. This second concern speaks to a broader policy goal of the CFPB: to promote fairness in lending.
Many auto lenders are already savvy to the opportunities presented by alternative data usage. In a 2015 TransUnion survey conducted by Versta Research entitled The State of Alternative Data, it was estimated that 53% of auto lenders were using alternative data. In 2016, TransUnion estimated that 85% to 90% of auto lenders were implementing some form of alternative data in their creditworthiness evaluations. TransUnion’s CreditVision Link service aims to reach full industry utilization of alternative data and to improve the data quality of those already including alternative data sources. CreditVision Link is the only scoring service in the market that combines traditional data with alternative data and reports risk in a single score. TransUnion’s target customers are lenders across various industries, including auto lenders. Sierra Auto Finance, one of the auto lenders employing CreditVision Link, claims in TransUnion’s marketing materials that its “current custom application score is significantly more predictive than [its] previous custom score application” as a result of CreditVision Link.
In a 2016 case study conducted by TransUnion, three top 10 auto lenders increased their portfolio size by up to 25% by supplementing traditional credit data with alternative data. One of the companies surveyed, Sierra Auto Finance, noted that most consumers have used alternative credit products such as cell phone and utility services, magazine subscriptions, or payday loans but that those transactions are not reflected in traditional credit reports historically utilized by the auto lender to make determinations related to the creditworthiness of applicants. By incorporating alternative data, the surveyed auto lenders noted that they were able to increase their return on investment without increased risk exposure.
Another relatively new player in this space is Equifax. The consumer reporting agency partnered with LexisNexis in 2016 to provide PowerView Score which uses some alternative data and it has been directly marketed towards auto lenders. PowerView Score has a score that is a simple, three-digit number claiming it can help reduce manual reviews by auto loan officers. This potential increase efficiency allows lenders to reduce approval times for borrowers and increase employee productivity.
The demand for an increased supply of auto-backed securities also contributes to the need for auto lenders to use alternative data. Similar to mortgage-backed securities, auto-backed securities are made up of a pool of auto loans that are bundled together allowing investors to buy a piece of the bundle and hope to mitigate the risk of a single borrower’s default. Investment in auto-backed securities has been increasing rapidly since 2010. In 2009, $2.5 billion worth of new auto-backed securities were sold. In 2016, sales from groups including Santander Consumer USA Holdings, Skopos Financial and others spiked to $26 billion.
One Car manufacturer, Fiat Chrysler Automobiles NV, forged a partnership with Spain’s Banco Santander SA to provide auto-backed securities directly to the financial markets. Delinquencies of the underlying auto loans in auto-backed securities reached 4.7% last year, the highest since 2010 when 5.4% were delinquent, according to Wells Fargo. Alternative data has the potential to make these investments safer by giving investors a better idea of the quality of the underlying assets in their investments.
Wall Street’s insatiable appetite for high-yield investments will likely continue to fuel an increased demand for auto-backed securities. This will fuel the auto lenders into having more markets demanding their products, thus requiring such lenders to loosen standards of their borrowers. Alternative data may provide these lenders with a way to evaluate the borrowers in a manner which will help prevent likely defaulting borrowers from being approved while still meeting the demand for auto-backed securities. The cycle is not without risk, but can be made safer with more information on the characteristics of those approved for auto loans.
The Path Ahead
Clearly, there is a going to be a demand to open up the auto lending market to more borrowers, which demand is fueled by the consumers, auto-backed securities and other investors and the lenders themselves. Thus, the future of alternative data is promising in the auto lending industry. If auto lenders embrace alternative data to capitalize on the vast amounts of data available on individual consumers, this market will open up allowing for tremendous expansion in the auto lending market.
Debbie Hoffman is a managing member of Symmetry Blockchain Advisors where she works with clients through her expertise in law, finance, blockchain, cryptocurrency, and technology innovation.