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.
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.
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?
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.