The debt ceiling debacle in Washington, D.C. two weeks ago should have reminded us all that so much of a country’s economic health is driven by spending and that spending, whether a country’s or an individual’s, is so often fueled by credit.

What is credit?

Credit is debt for which the lender trusts the borrower to repay at some future time. Payback terms usually include the rate of interest, the total that can be accessed, the amount and timing of the payback, whether by installments or otherwise as well as the consequences of default. The period of the loan or credit can be short-term, long-term or it can be revolving, as in the case of credit cards or overdraft arrangements, for example.

Who defaults?

Typically, defaulters are borrowers who have been overextended financially. People who study customer behaviour analytics in the U.S. have identified two growing segments among those who default on loans arising from the global financial crisis, using 2008 as a base year: First-time defaulters and strategic defaulters.

A first-time defaulter is defined as a borrower, who prior to the base year, had a completely unblemished credit payback history. Then, negative things started happening. First, it was probably unemployment or under-employment that led to a reduction in income. Then came the inability to pay bills when they fell due. There would probably have been three or more 30 days’ late payments on rent or mortgage; three or more 30 days’ late payments of credit cards and three or more 30 days’ late payments of other loans. Classified as, “temporarily credit impaired,” about 11 percent of U.S. retail banking customers were on the books in this category in 2010.

Researchers who interviewed a representative sample of these first-time defaulters identified other negative events preceding the default such as: Inability to pay medical bills; delinquency in taxes; and at least one contact by a collections agency.

A September 2010 Deloitte study containing most of these findings, also provided a quick profile on the first-time defaulter: 57 percent female, 43 percent male; median income USD 50,000.00 annually; 25 percent have completed university; and 14 percent were unemployed and still looking for work.

Strategic defaulters started showing up on lenders’ records about the mid-third quarter, 2009. In September, 2010, 35 percent of mortgage defaulters (600,000 persons) were strategic defaulters. These are mortgage holders whose property values had fallen 75 percent or more below the amount owed on their mortgage. While they could afford to continue paying their mortgage, they decided to walk away from it. Strategic defaulters are otherwise persons of good credit standing. About half have high FICO credit scores (660 and above) and all show credit utilization of 30 percent or below. This means that in all their credit arrangements, excluding mortgage, they utilize less than 30 percent of the total amount allowed.

Banks and other lending institutions are now actively researching and developing new products suitable for first-time and strategic defaulters, who, otherwise, are . a highly desirable market.

Business & Individual Credit Rating Systems

Two systems are currently in use worldwide: The Dun & Bradstreet (D&B) for businesses and the FICO score for individuals. The basis for the D&B ratings goes back to 1841, though Dun & Bradstreet was not formed, itself, until 1933. The FICO, which is an acronym for the company, Fair Isaac Corporation (established in 1956) developed, owns and introduced FICO in the early 1980s. Their credit score, which ranges from 300 – 900, with 650 being the beginning of a good score, is used by lenders to determine a borrower’s qualification for a loan, the interest rate and the size of the loan.

Dun & Bradstreet develops and provides business information reports that are used primarily for making credit decisions about companies. D&B maintains a data base of more than 190 million companies worldwide.

Jamaica

While there are those who argue that credit is the culprit, I do not support that view. Three should be nothing evil or prejudicial about a credit arrangement that transparency and regulation would not expunge. I believe that credit usually goes bad in the hands of the borrower and this, too, is of great interest to us on the lending side.

A Credit Reporting Bill that would create the legal framework for the establishment of a credit rating bureau in Jamaica was tabled in Parliament more than a year ago. In addition to licensing a credit rating bureau, the bill would also authorize the sharing of information on individual credit histories among selected organizations. .

Gary Peart is the CEOof Mayberry Investments Limited. You can email him at gary.peart@mayberryinv.com.