The limitations of the current credit risk modeling approach – the FICO score – are manifold, but nowhere are they more glaring than the complete inability of FICO to evaluate young people. A system based entirely on prior payment history discriminates against youth who are just entering the financial world. For students seeking to continue their education, and needing loans to get there, the consequences are severe – automatically labeling as a credit risk may shut them out of the private loan market and prevent them from attaining higher degrees, regardless of their potential.
Around this striking weakness of the current education finance market is where People Capital, a p2p student loan platform, is seeking to innovate. I wrote about them nearly a year ago when they secured a major funding round and became further intrigued with their recent announcement of the beta launch of their platform. This past week I had the opportunity to speak with Alan Samuels, their Chief Product Officer, about the company and its fresh approach to credit risk modeling.
Our discussions focused on the Human Capital Score (HCS) – a methodology developed by the People Capital team in conjunction with leading labor economists and academics that provides an alternate measure of credit risk. Alan explained the need for this alternative, saying “there is a world of different between an 18 year old with a poor credit score and a 30 year old with a poor credit score.” HCS seeks to value ability to pay rather than propensity to pay and calculates future income potential based upon a variety of variables including GPA, standardized test scores, college and major. Alan explained that “there is a body of knowledge around early achievement” and the data sets of the above variables – representing hundreds of thousands of individuals tracked through their college experience and after graduation – were pulled into their model. With this theoretical and data-driven underpinning, student borrowers can enter in the necessary attributes into People Capital’s model to receive their HCS, which is used in conjunction with, or in place of, FICO on the site to help lenders evaluate credit risk.
I asked Alan why he thought lenders would participate in the platform, whether the main selling point was social (helping students achieve their goals) or financial (accessing a strong asset class). His quick response was that there is a clear “socially responsible element” that is helping them gain traction with community development organizations and credit unions. He also emphasized the “double bottom line” that can be achieved via the platform for mission-driven organizations that are also looking for a return. Finally, from a purely financial perspective, “student loans typically have a lower default rate and we provide an additional mechanism to improve that” and their construct offers “a slightly different asset class than on Lending Club or Prosper in that the loans are tax-efficient for borrowers (because they can be deducted from taxes) and good for lenders (because they cannot be discharged in bankruptcy).”
People Capital is currently focused on the undergraduate experience, but I asked, given the potential of disruption offered by their innovative risk approach, about their plans for the future and whether they could see themselves transforming the way young people interact with the financial system. Alan responded that the HCS really focuses on future potential and sees possible applications in a variety of spheres, including the recruiting industry to rank the potential of individuals, financial services to serve as a platform for youth, and major purchases such as when young people buy their first house or their first car. I would add that the HCS approach holds promise as a robust way to evaluate individuals who are entering the emerging market of selling equity in themselves.
Something Alan said during our conversation has really stuck with me: “It is shocking that given how expensive college is, people don’t have a more rigorous way to evaluate whether they are going through a good decision process.” Answering my question from a previous post on investing in people, Alan has the data to show that, “the Yale English graduate may be more interesting to talk with at a cocktail party, but the score shows that you have a much more solid income stream from the person who chooses to study engineering at a third tier school.”
The HCS innovation shows potential to greatly improve the current approach to education financing in two major ways: 1) More fairly and accurately evaluating the risk of young people seeking loans for educational purposes; and 2) More robustly challenging future students to think critically about what the education they seek will realistically help them achieve post-graduation before making such an investment in time and debt.