PM Perspective: Credit Scoring Millennials Beyond FICO
With millennials claiming to fear credit card debt more than death, John Kerschner, Head of U.S. Securitized Products, shares how one company learned new ways to lend.
My team just got back from Las Vegas at the SFIG 2018 Conference – that stands for Structured Finance Industry Group. It is a conference of over 7,000 people of all things structured. Me and my team do somewhere between 75 and 100 meetings over three days, and it always gives us a few new ideas to come back to Denver.
One of the most important and interesting meetings that we had while we were there was with a company called Upstart.
They are based in Palo Alto, started by a bunch of ex-Google employees. The problem they are trying to solve is how do you lend to millennials? Now a lot of people don’t know this, but millennials don’t really like credit card debt. The baby boomers, over 70% of them have credit cards. My generation, Gen X, over 50% do, and millennials, less than a third of them have credit card debt. In fact, there was a study that recently came out that said that millennials are more scared of credit card debt than they are of dying. So traditionally, what banks and other traditional credit card lenders would do is use something called FICO-based lending. Most people know what a FICO score is, and it is based on the fact that people, when they come out, they’ll usually get a credit card, they will get an auto loan, eventually a mortgage loan and over time they will build up a credit history. Obviously, if you have a young millennial, she just graduated from college, lives in an urban area, doesn’t have a home, probably doesn’t need a car, so uses Lyft and Uber, and doesn’t like credit card debt, she has what is called a very thin credit file. Not a lot of data there to really score her in order, if she wants to borrow.
So Upstart is a firm that wants to give unsecured loans to, they target millennials. So they target this group of people that doesn’t have very thick credit files. And they do this by looking at things that are very correlated with payment behavior, principally coming from education. So they look at the education and also they ask, when they do the application for the millennials, they constantly are asking them questions that they think will be correlated with good payment behavior. Now a lot of these things are things you would think about that are just good for human nature, things like being able to delay gratification, being able to be goal-oriented, being able to avoid distractions. So those things are very correlated with doing well in school, but also with paying your debts on time.
One very interesting thing about the algorithm they have developed, is they are non-linear and they constantly improve over time. Now it is early days yet, their firm is relatively new, but so far the data has shown that their algorithm that they have developed is doing a better job than the FICO-based lending that we have seen from a lot of companies in the past.
Upstart has already come to our market, the structured finance market, for a deal, where they are taking the loans that they are making to the millennials and then they securitize those loans into securities.
So as investors, you have to constantly look at these new ideas and new ways of lending to people. And we really think this is the future of lending, taking something that historically wasn’t used, but you need to develop these new models for millennials, because they don’t borrow the same way their parents did.