bad credit company

AT A GLANCE Lending to people with poor credit histories is big business in the UK. However, the sub-prime market, as it’s called in the US, has come increasingly to the attention of the mainstream lenders. In 2003, HSBC bought the US financial services provider Household International, the largest global player specializing in sub-prime lending. The industry has been bedevilled by a poor image, especially in relation to home credit collection on poor council estates. The rise of US-style credit unions in the UK is also being supported by the high-street banks, for example Barclays. SUB-PRIME I t is almost impossible not to have noticed the increase in advertising of products relating to mortgages, remortgages, car loans and debt consolidation – especially to people who have a poor credit record or who are finding their existing debt difficult to manage. In the US, such lending is known as “sub-prime”. In the UK, the term is less well-known, but the concept is the same with products being marketed at those who have been refused credit elsewhere or who have county court judgments (CCJs) against them, for example. Following the recession of the 1990s, many people had experienced some kind of episode that had harmed their credit rating – whether it be a house repossession, falling into arrears with housing or utility payments, or being made bankrupt. Many mainstream lenders, who themselves suffered during the 1990s housing-market recession, reacted by exercising extreme discretion in their lending criteria, particularly through the use of mechanized and centralized credit-scoring systems to select only low-risk borrowers. Many people continue to lose out through this selection process, cuts FINANCIAL WORLD September 2005 41 Lenders catering for people with poor credit ratings have had a good run of it since the recession of the 1990s – despite the poor press. But with the mainstream banks moving onto their patch, Kris Sangani asks, what now for the sub-prime industry? albeit for different reasons. More people have contract or flexible terms of employment, and income that is variable or hard to verify. The consequence of this is that a gap has opened up where borrowers – keen to become homeowners and with the willingness and ability to repay a mortgage – find they are excluded from mainstream, highstreet lenders’ criteria. The mainstream lenders get interested Research company Datamonitor estimates that, in 2004, 9.1 million people in the UK were systematically refused credit by mainstream lenders as they fell into the non-standard bracket. Subsequently, these people are turning to sub-prime lenders for borrowing. The UK subprime sector took root in the mid-1990s with the entry of niche lenders that identified a need to build on a more individualized approach to underwriting and pricing the risks involved in lending to sub-prime borrowers. It is now a major business. As a result, the growth of the sector is attracting the attention of mainstream lenders, says Oksana Selezneva, analyst at research firm Datamonitor and co-author of a report into the UK sub-prime lending market, Overview of the UK non-standard and sub-prime lending, 2005. “The mainstream lenders are finding that their profit margins are being squeezed and this explains their interest in developing products suitable for the sub-prime lending market,” she says. However, Selezneva also points out that mainstream players face significant obstacles to entry into this market: “The sub-prime lending market is very much segmented and few of the key players operate in more than a handful of them. There are no companies who are dominant across the spectrum.” Although mainstream lenders have, in some circumstances, developed their own sub-prime products, they have also moved into the sub-prime market in other ways. In 2003, for example, HSBC bought US financial services company Household International – the largest The sub-prime market and its products Unsecured lending An unsecured personal loan is one of the most common types of lending. Typically, the interest would be several points higher as the customer may have defaulted on loans in the past or may have difficulty in proving their income. A common type of personal loan is motor vehicle financing. It used to be the case that customers would choose a car first and then think of the financing. Yes Car Credit Finance changed all that and has performed particularly well in this sector in the past few years. It not only offers financing but also has a nationwide network of used car showrooms, which it packages with its financing. This has spurned a relatively new business model for providing car finance. However, it is likely to face increased competition as it is joined by a number of other players, such as Approved Car Finance and Welcome Car Finance. patterns, this is becoming increasingly common. There are also subprime mortgage products available to consumers who may want to buy a council house or who may have a poor credit history. Doorstep credit collections This is the most controversial area of sub-prime lending. Typically, lenders would collect on a weekly basis the amount owed on a debt on the doorstep. In November 2003, the National Consumer Council announced that it was launching an investigation, citing the perceived uncompetiveness of the market and the vulnerability of providers’ traditional customer bases as the main reasons for its decision. The findings were published last summer and resulted in the matter being referred by the Office of Fair Trading to the Competition Commission as a “super complaint”. Secured lending Many firms offer secured loans as a second charge on properties. However, being a second charge, the lender would be second in the queue to primary lenders in case of default and, therefore, many will only lend if there is equity available in the property. Because of the increase in house prices, this is not a problem for most homeowners. In fact, many will still lend if there is no equity on the basis that house prices may rise and they will still be able to recoup their finances. Because of the perceived risk, the interest rate is typically lower than for unsecured loans. Non-standard credit cards The main credit card lenders are constantly stealing each other’s customers with ever more attractive profit-eating deals. This has led to a high degree of customer churn. Therefore lenders are looking at new pastures and a number of mainstream credit card providers have moved into the non-standard credit card market, such as Barclaycard and Capital One. However, in order to serve the non-standard market, operators must adopt a more bespoke approach to credit scoring, claims Datamonitor’s Oksana Selezneva. “Traditional credit scoring techniques are not sophisticated enough to consider the circumstances of those with particular needs,” she says. Mortgages The most common type of sub-prime mortgage product is the selfcertified mortgage for customers who, for whatever reason, cannot prove their current and future income. Because of flexible working 42 September 2005 FINANCIAL WORLD global player specializing in sub-prime lending. In addition to its prominence in the US, the company also operates in the UK under the HFC Bank and Beneficial Bank brands. “We provide a number of ‘near-prime’ products and we have specialist credit rating skills, which our parent company finds valuable”, says Patrick Long, a spokesman for HFC Bank. Despite such moves, existing players, such as London Scottish Bank, which has been around for more than a century, appear not too worried by the entry of mainstream players. London Scottish Bank provides sub-prime products in a number of lending sectors, such as mortgages, unsecured personal loans and doorstep-credit lending. The bank has developed specialist credit scoring skills that are not automated and which, it claims, enable it to offer loans to those who have adverse credit histories, such as CCJs and defaults, at competitive rates. However, the industry is constantly battling to rectify its poor image. Many claim that companies who operate in the sub-prime market are taking advantage of vulnerable communities. This criticism has been most marked in relation to home credit collection. The firms that operate in this market usually target council estates and neighbourhoods where income levels are significantly lower than the rest of society. Bad press of such lenders has filtered down into the more reputable sub-prime lenders and has even resulted in a “super complaint” into doorstep lending raised by the National Consumer Council and investigated by the Office of Fair Trading. Roy Reece, chief executive of London Scottish, is particularly critical of that investigation. “Clearly, consumers must be protected by regulation or legislation as appropriate, but we are firmly of the view that the industry is competitive,” claimed Reece in a report to investors. “If our members don’t make lending facilities available to these communities then they are likely to fall prey to unlicensed credit lenders and loan sharks”, says a spokesperson for the Finance Industry Standards Association, a compliance body representing a number of sub-prime lending companies. The rise of the credit unions In addition to sub-prime lenders, there is a further set of organizations that have been providing lending facilities to poorer communities for over a century. These are the credit unions, which are growing fast and becoming more professional. In the US, credit unions are professional organizations offering a range of financial products, such as insurance and checking (current) accounts. It’s a growth that their UK counterparts would like to emulate. “We see credit unions as providing an important public service in poorer communities, therefore we want to grow the movement and develop a robust business model” Members of a UK credit union have to have a common bond, for example, by living in the same community or working in the same profession. The rationale is that members are therefore less likely to fall into arrears. However, growth in this market has traditionally been hampered because members are required Peter Kelly, head of financial inclusion, Barclays to save with the union for a fixed period, usually three months, before they can take out a loan. But with the assistance of Barclays, the Association of British Credit Unions (ABCUL) is helping credit unions update their IT structures with the introduction of the Pearls system – a financial monitoring and business planning system developed by the World Council of Credit Unions (WOCCU) in the early 1990s – to enable them to assess the creditworthiness of new applicants efficiently, securely and immediately, removing the need to build up a credit history through saving. “We see credit unions as providing an important public service in poorer communities, therefore we want to grow the movement and develop a robust business model,” says Peter Kelly, head of financial inclusion at Barclays. “The best way to do this is to break the link between savings and loans.” In fact, Abbie Shelton, a spokeswoman from ABCUL, claims that the credit unions are already threatening the doorstep credit market. “The movement is growing and where there is a strong union the doorstep credit lenders cannot get a toehold,” she says. However, the industry is dependent on a steady flow of customers with tarnished credit histories. A number of mainstream banks in recent months have announced increased provisions for bad debt in their annual accounts and a rising non-standard population is good news for the sub-prime sector. This is why fewer credit-impaired individuals in the UK are being denied credit by the major players. Many are now willing to offer their services to customers with minor debts. Their entry into this specialized market is continuing to help it gain momentum and earn a more respectable reputation. It is now difficult to distinguish between products offered by non-standard and mainstream lenders, and there is greater acceptance of credit repair, which has been accompanied by less negative press coverage of the industry. The sub-prime lending market in the UK, on the back of continued growth and success, is now a much more professional and established business. However, its attempts to expand further – and beyond the UK market – are being hampered by the traditional financial players moving onto its turf. FW Kris Sangani is a financial services and technology writer. FINANCIAL WORLD September 2005 43