Nurturing Near-prime Customers to Evolve into Prime Ones

Aug 15, 2017

Retail establishments routinely fight to win over the best customers. Those with expendable funds and/or a willingness to use credit to buy products from them. While its challenging, those that build the right customer experience have found loyalty in a very price conscious market. Companies like Amazon, Overstock.com, Target, and even Best Buy now have found unique ways to set themselves apart and create loyalty.

Similarly, financial institutions looking to grow loan volume often focus their marketing on their prime customers. When that reservoir of prime borrowers is tapped out, banks can either invest in wooing new prime customers away from the competition, or begin tapping their pool of near-prime customers.

However, the Great Recession reminded financial institutions of the perils involved in subprime lending. The industry largely backed away from subprime mortgages, only to begin funding more subprime loans in other categories. Many financial institutions have increased subprime lending in areas such as auto and personal loans; American Banker cites a Wall Street Journal report that in 2014, nearly 40 percent of all auto loans, credit cards and personal loans went to subprime consumers. Knowing they’re walking a riskier path, many financial institutions are anticipating a corresponding rise in loan losses, and have increased their reserves in preparation for a glut of defaults.

What if, instead of merely accepting that a near-prime customer is a riskier and less profitable borrower, financial institutions focused on helping those not-quite-perfect customers “grow up” to become prime ones? Success could increase loan originations and reduce defaults in the short term, and create more engaged, profitable, and enduring customers in the long term.

Understanding subprime and near-prime terminology

Another side effect of the Great Recession is the widespread antipathy toward marrying the term “subprime” with anything lending related. Consumers and financial institutions alike share the sentiment. Industry watchers like the Wall Street Journal have pointed to that trend as the motivation for the rise of the term “near-prime,” implying it’s just the politically correct substitute du jour for the less appealing “subprime.”

However, we would argue the difference between subprime and near-prime customers goes beyond terminology.

The difference between customers who are prime and those long-considered subprime is significant and easy to define. The best customers are those with healthy account balances, spotless payment histories and muscular credit scores of 700 or higher. Subprime are those with credit scores below 600, poor payment histories, little or no bank account balance or history, and/or severe blots on their financial histories, such as a previous loan default.

In between those two extremes are the near-prime customers, the folks with credit scores that are credible but not great, who have one or two late payments in their histories, whose bank account balances consistently stay low or dip below minimum balance limits, and who don’t spend as much as their prime peers. Many of these people are actively trying to improve their financial standing, and would benefit from some help and guidance from a trusted source of financial information — such as their banks.

Nurturing the near-prime

Your financial institution likely already serves many near-prime customers. You have a readily available source of high-potential customers, you just need to help nurture them into becoming prime. What can banks and credit unions do to encourage the spending and savings habits that will allow near-prime customers to evolve into prime ones?

  • Education — Providing near-prime customers with relevant, useful education is as simple as enhancing informational content on your financial institution’s website. While you’re communicating with customers about product offerings, include educational information that’s related to the product but not necessarily promotional.
  • Loyalty rewards — Multiple studies, including the 2016 North America Consumer Digital Banking Survey from Accenture, have shown customers who feel engaged with a loyalty program spend more with the brand. Yet often, the behaviors or spend levels required to earn rewards fall outside the regular behaviors of near-prime customers. Evaluate your loyalty program to see if you can reasonably tweak thresholds to put rewards in range for more near-prime customers. Programs like the one offered by our Deluxe Rewards solution can bring rewards to these previously unrewarded sectors to help them stay loyal and invested in improving their habits.
  • Tailored product offerings — Some banks around the world are encouraging savings habits by offering products designed to reward savings. For example, in Australia, ANZ offers an account that pays additional interest if account-holders deposit at least $10 a month and make no withdrawals in a month. Consumers love low interest rates when they’re borrowing money, but low interest earnings on savings accounts can make them less inclined to put money away. Giving them the chance to earn more for saving more could inspire greater savings, and build the financial foundation they need to be able to one day afford products more profitable to the financial institution, such as a mortgage.
  • Digital tools — Many of your near-prime customers are older millennials who are approaching a more financially mature phase of life. Their affinity for all things digital is well-documented. By ensuring your millennial near-prime customers can easily interact with your financial institution through their favorite digital channels, like a robust mobile app, you can encourage greater engagement. After all, deposit institutions that introduce remote capture for checking and savings deposits regularly see an uptick in consumer deposits immediately following the launch.
  • Address fees — No consumer loves bank fees, but research tells us that near-prime millennials find fees particularly odious. Of course, fee income is an important revenue stream for financial institutions, so you’ll never want to eliminate fees. However, look at how fees are apportioned across your products. Are they disproportionately onerous for deposit accounts? Is your fee structure clearly communicated to customers? Do your near-prime customers have a clear understanding of when certain fees will apply to them, and what they need to do in order to avoid incurring fees?

Of course, it’s just good business for banks to prepare for the worst and increase their reserves, especially if they’re heavily leveraged in the new subprime lending arena. However, while you’re planning for the worst, it could also pay to take steps to grow the next crop of the best, most profitable prime customers — and ensure your financial institution will have earned their loyalty in the years when they were stuck in near-prime limbo.

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