Not so long ago, having a competitive edge in the mortgage industry meant offering products to as many consumers as you could qualify; having bad credit was not necessarily a deal-breaker. Opportunities were plentiful, and lenders assumed it was safe to offer more ‘exotic’ products because there was plenty of business to cover any losses.
Of course, times have changed. The exotic products of yesterday are now on the extinction list. Opportunities are not as broad or plentiful as they once were, and in today's market, competitive edge comes from responding rapidly to limited windows of opportunity, or micro opportunities, and untapped markets, like the underbanked.
But how can you reap the rewards of micro opportunities and untapped markets without incurring unnecessary risk? Understanding the untapped customer base through the use of sophisticated analytics models and alternative data is the first step in decreasing business risk, yet this alone is not enough. To remain competitive, lenders need systems that are adaptive and can quickly reconfigure to address changes in the economy and evolving governmental regulations.
Traditional mainframe systems often cannot adapt quickly enough, preventing lenders from entering into emerging markets before they become saturated. When determining credit risk in a volatile market, the ability to respond quickly is critical. Thus, understanding the markets you are attempting to reach and having a flexible system that is capable of adapting rapidly to changes are key components of a comprehensive risk management strategy.
The tightening of market prospects, which shifts competitive focus to micro opportunities, is one of many consequences of the subprime collapse. However, this evolution need not signal a time of profit decline. Micro opportunities exist in many forms, each providing new revenue growth. The key to capitalizing on them is to know where to look and to act quickly, accordingly and safely.
Consider the potential withdrawal of a dynasty mortgage lender from a particular geographic region – a reasonable example, given that many national mortgage lenders are significantly reducing their mortgage and home equity activity within a particular area as a result of the crumbling economy. A regional opportunity would arise with this departure, allowing remaining institutions a small window to establish relationships with an abandoned customer base.
Indeed, numerous candidates with good credit quality would be caught in the crunch, with fewer lenders and fewer appealing offers available to them. Importantly, these customers would be more likely to pay a higher premium during this limited time in order to secure scarce loan options.
To take advantage of this opportunity, or any other, outbound telemarketing and other marketing strategies targeted toward people seeking mortgage and home equity products would need to be implemented quickly and intelligently. To do so, a company must possess not only an understanding of the market and the risk associated with that market, but also have the system flexibility to make rapid policy changes to secure the competitive edge. In today's world, if you are unable to respond to a change in the market within a month or two, you have missed the boat.
Risky business?
Because micro opportunities are limited in time and region, lenders need a system that is highly flexible, dynamic and powerful enough to filter those opportunities and take advantage of them before they are gone or another competitor has landed them. However, with such a short opportunity, it is also necessary to have a robust risk management strategy in place to avoid jumping into a new situation without a safety net.
The first component of a sound risk management strategy is to have more sophisticated models to analyze risk. Your model must adapt to each new market with a separate set of intelligence, processes and analytics capable of keeping up with each market and changes in consumer behavior.
In underserved markets, many "A" lenders have tried and failed, while those specializing in subprime have come out okay. Because people's information in underserved markets tends to change more frequently while they are establishing credit, there is a higher need to keep up with those changes and a different set of rules that need to be applied. Therefore, not only must risk analysis models include different types of data for each opportunity, but those models must also be implemented quickly and easily.
Another facet to understanding your markets is having all the information necessary to make sound decisions. Using alternative data in decisioning allows lenders to keep their core policy in place while offering more non-traditional loans.
It is important to remember that risky doesn't necessarily equal bad risk. In the midst of the subprime fallout and mortgage meltdown crisis, there is a misperception that subprime and the underbanked, or "thin-file" consumers, are one and the same. While subprime borrowers have negative credit histories, the underbanked simply do not have established credit.
Lenders who fail to establish methods for determining the creditworthiness of these consumers are missing opportunities. By using alternative data, lenders can have more complete data on a thin-file consumer and can make good decisions on otherwise risky loans. Financial institutions that establish solid policy and procedures and employ better data analysis and cross-sell techniques reap the rewards of successful lending through increased market share.
It is estimated that over 75 million Americans fall into the underserved consumer credit market. To succeed with providing credit and related financial services to this largely untapped population, you must be well-tuned to adjust to changing markets. Start by developing a model and philosophy that understands that many people who are considered to be high risk simply need an opportunity to build credit.
By offering products that allow customers to build a payment history and rewarding prompt payments with additional credit offers, you can add profitability to your business. By understanding the challenges your customers face, you can broaden the services offered and successfully tap a market largely underserved by traditional financial institutions.
Know when to fold up
Unfortunately, sophisticated risk analysis and insight into the customer base are not enough without the system flexibility to adapt quickly to market changes and government regulations. Inflexible systems not only prevent lenders from entering into new windows of opportunity quickly, but also impact their ability to get out early when the scenario becomes too risky. For example, lenders that were unable to enter into the subprime market early enough to make money when the loans were good were also unable to leave the market when these loans started to go bad.
System flexibility also allows you to address regulatory changes. In times of market volatility, the government sets regulations to help stabilize the market and ensure the problem does not happen again. For example, this year, all end users of credit information will be required to have policies in place to comply with "red flag" legislation that is part of the Fair and Accurate Transactions Act. A red flag is a pattern, practice or specific activity that indicates the possible existence of identity theft, and the legislation is designed to proactively stop fraud and identity theft by requiring credit issuers to pay closer attention to address discrepancies, changes of address and other potential risks.
To respond and adapt in turbulent times, mortgage bankers need to consider strategies for entering into new markets and making their systems more flexible. The good news is technology is available to quickly and easily customize the logic lenders employ to evaluate risk and adapt quickly to market changes.
Advances in decisioning and loan origination technology provide the capability for lenders to use alternative data sources to build as many layers as they want into their system to analyze risk. Access to both traditional and new data sources allows lenders to better evaluate risk, therefore minimizing its impact.
In many cases, lenders fail to adopt more flexible technology because the cost to "rip and replace" an existing system is often hard to justify, especially in a down market. For those institutions looking for a less severe solution, there are products available that upgrade components rather than the whole system. This modular approach provides a low-cost, and low-risk, alternative to an entire system overhaul and allows current operations to be maintained and enhanced. A modular approach to system upgrades also provides the ability to adapt to market changes in real time, a user-friendly environment that does not require programmers for system changes and a focus on business needs rather than technology.
In today's saturated mortgage market, macro opportunities are all but non-existent. Lenders must take advantage of micro opportunities before their competitors if they hope to succeed. Federal Housing Administration lending and underserved consumers also offer new opportunities to lenders.
However, all of these markets require greater system flexibility to ensure sound decisions are made. Powerful and flexible instant credit decisioning and loan origination solutions that allow you to adapt your business to the market without ripping and replacing your legacy systems are available. By integrating with your existing systems and bringing your lines of business closer together, a cost-effective solution is possible.
The capability to plug into the many different data sources you need – in real time – is essential. This ensures that you have complete data to understand your market segments in order to make sound lending decisions. Having this flexibility allows you to adapt to market changes, legislative policy changes, and implement more-sophisticated risk management procedures.
Micro opportunities often seem very risky on the surface, but by using additional tools to create a better risk profile and a safer, more flexible lending environment, lenders can effectively insulate themselves against these risks and can experience growth, regardless of market conditions.
Dennis Dixon is president of Zoot Enterprises, a Bozeman, Mont.-based provider of advanced instant credit decisioning and loan origination solutions. Dixon can be reached at ddixon@zootweb.com.
