During the six days our family was without power after Hurricane (or is it Superstorm?) Sandy swept through New Jersey, my wife worked very hard to keep our kids happy and busy. Before the storm hit, she went out and bought some new board games for us to play, in case we were without power for an extended period. One of the games she bought was Mouse Trap. The game involves building a Rube Goldberg trap to catch game pieces shaped like mice. My wife spent 20 or 30 minutes building the mouse trap before declaring we were ready to start playing. I pulled out the instructions to figure out how the game was played, and then realized that the mouse trap is built as the game is played, not before. So after laughing for a few minutes, we took the game apart and started over again. (For those of you keeping score at home, I won.)
Building a better mouse trap without using or understanding all the information that is made available can be very difficult. The same is true in loan underwriting. Data is important, but so is context. A former chief information officer at Google is trying to incorporate machine learning and predictive modeling into a loan underwriting model to better assess a consumer’s credit risk.
The new company is called ZestFinance, and the underwriting program called Hilbert (named after statistician David Hilbert). The company is currently working in the payday lending industry, but it’s easy to see that the model could be applied to any consumer (and even commercial, perhaps) lending sector, including auto finance.
The credit bureaus have been so reluctant to share information about their formulas and models that it’s difficult to compare them to what ZestFinance says it is doing. What ZestFinance says is that its model is giving more loans to more people while improving default rates. As proof of concept, the company has raised nearly $73 million in funding to date.
There’s always been a contextual component to subprime lending. One banker once described subprime lending as “story loans,” because every subprime borrower had a story behind why his or her credit scores were low. Medical problems, family problems — there was usually a reason. Assessing the human component of credit risk has always been the hardest part to loan underwriting. ZestFinance claims it can do that. Whether true or not, it could signal a new evolution in consumer lending. One in which everyone may need a new set of instructions.
I hope the new mouse trap works. If it is to apply to payday lending, to what end is the product being developed? Just another payday loan designed to keep poor folks poor? Or is their a desire to help those elements of our society break the debt trap and reenter society as financially responsible?
The Fed just released a report in October that shows that payday lending has no financial value to the borrowers. Nor does it help them ever increase their credit scores whether that payday loan was reported to the credit bureau or not.
Four bad banks have engaged in a controlled form of payday lending by limiting it to loans against established direct deposits only for their customers. Their main argument is that it is “cheaper” than the traditional payday lenders; or, their customers will just go somewhere else and pay the higher rates. While this may be true, it is of enormous profitability for those four banks. I have provided product profitability estimates to some of those four bad boy banks and none have been able to refute my numbers. The ROE is over 1000% after all losses, income taxes, cost of funds, operating costs. Remember that banks with their taxpayer insured franchise can leverage their capital ( I only used 9:1). A payday lender might get 3 or 4:1 from their creditors. So those four bad boys (Wells Fargo, US Bank, Regions, and Fifth-Third) are not in this business as a community service! It is pure greed! They are using PERVERSE ADVANTAGE of their state usury law exemption to abuse their minority and poor customers. Anyone at those four banks care to prove otherwise? I have issued this challenge for months on this site and other comment banking websites and no one at those banks will take me on.
Perhaps Zest Finance will show us that payday lending can be done at interest rates below 36%. Otherwise, they are only a new form of ripoff artist joining others. Another reason for the CFPB to provide “PROTECTION”. As for banks, how can the banking industry ask for Dodd-Frank relief when they have these four rascals around?