Addressing Bad Credit on the Job Interview

It is no secret, finding a job in this economy has been challenging enough.  Now many employers are adding another hurdle to landing a job. Credit checks are increasingly used to screen job applicants.  The individuals who have been out of work the longest are more likely to have negative accounts on their credit report.  The individuals who are most in need of a job to restore financial stability to their household may have another strike against them.

 The Society for Human Resource Management conducted a study in 2006 and found forty-three percent of the employers are pulling applicant credit bureaus during the pre-employment screening, up from 25 percent in 1998.  A surplus of job applicants in 2009 has most likely expanded the percentage of employers checking credit well beyond the 43 percent reported in 2006.

 Banks, finance companies and the federal government where the only employers historically who pulled credit bureaus on job applicants.  Individuals who had responsibility for handling money or making decisions regarding the extension of credit were screened for past fraud, judgments, and bad debt as an indicator of the individual’s character.  The thinking went, stay away from prospective employees whose past shows a lack of judgment or even worse, criminal intent to defraud.

 Employers who check credit references for positions other than cash handling and credit extension may use your credit history to determine if you are fiscally responsible. In some circumstances, the credit report may serve as a character reference.  The conventional wisdom states an employee may be prone to poor decision-making, lack sound judgment and integrity, and be less reliable if they have a derogatory credit history.  Company presidents and executives may hesitate hiring a Director or Senior Manager to positions of substantial authority and budget responsibilities if there is credit evidence the individual has consistently miss-managed his or her personal finances.

 After the World Trade Center bombings of September 11, 2009, many employers felt a heightened duty to perform diligent background checks on new employees, including checking the credit bureau.  Identity theft is on the rise and the credit bureau is one way to verify previous residence and employment information.  The credit bureau has increasingly become a part of the complete screening process.  Less thought is given to the actual necessity of pulling a credit bureau report when it is packaged with the other facets of the pre-employment screening process.

 The Fair Credit Reporting Act (FCRA) allows employers to pull a credit report as a part of the new hire screening process as long as the report is not used selectively as a tool to exclude certain individuals from employment.  Employers are prohibited from pulling a credit report without obtaining the job applicants signature authorizing the employer to use the credit bureau as a part of the screen process.  When the applicant is denied employment based in part or in whole due to information contained in the credit report, an adverse action letter must mailed to the applicant.  The adverse action notice states employment was denied due to information found on the credit report.

The prevalence of the credit screening practice became known to me when an individual I met through a professional career-networking group stated an employer asked him about a bankruptcy he filed in 1984.  He was surprised the question came up and questioned its relevance.  This individual is not alone in asking has the pre-employment credit check gone too far.

 A young adult who acquired debt during the course of his or her college career may be adversely selected due to their high debt ratio.  A seasoned professional who was laid off from a 20-year career as a manager and struggled to meet her obligations during a nine-month job search may be passed over due to current delinquent credit cards.  The practice of pre-employment credit checks for individual’s not involved with handling cash or extending credit may not be fair but is the reality of today’s market place. The wise job hunter would be well advised to address the issue.

 In the future, there may be relief in the form of the Equal Employment for All Act (HR 3149) which was introduced on July 9, 2009.  The bill is currently with the House Committee on Financial Services.

Equal Employment for All Act – Amends the Fair Credit Reporting Act to prohibit a current or prospective employer from using a consumer report or an investigative consumer report, or from causing one to be procured, for either employment purposes or for making an adverse action, if the report contains information that bears upon the consumer’s creditworthiness, credit standing, or credit capacity. http://www.washingtonwatch.com/bills/show/111_HR_3149.html

   If HR 3149 becomes law, potential employers who pull an applicant’s credit report as a part of the pre-screening process would have to show that credit history is related to the position. Until HR 3149 is made law, the prudent job seeker would be wise to develop a strategy explaining negative credit:

1. Upon signing a form authorizing a potential employer to run a credit check, ask the hiring manager if credit quality is important to the hiring decision.
2. If the hiring manager states the job applicant’s credit history is a factor in the job decision, decide how you will explain the situation.
3. The applicant who takes the pro-active approach will be able to create another opportunity to sell him or herself to the potential employer.
4. Explain your financial situation leading up to your credit problems and the steps you took to mitigate the problem.  Outline the steps you will take to resolve the bad debt once you have the financial ability to do so.  Show the employer your long-range planning and strategic thinking ability.
5. The most important step is to equate your current financial plight with a situation that you successfully navigated in the past.  Many managers have successfully led the turn around of a failing business or office by solving a problem that was not part of their making.  Show the employer your negative credit is a bump in the road that will be smoothed over.

By relating a challenging situation you managed with your leadership and decision making skills you minimize an employer’s impression of your negative credit.  Whether you choose to pro-actively address negative credit with a potential employer or allow things to play out, the benefits of developing a forward-looking narrative may make the difference between landing your next job and continuing your search.

Consumer Debt is Key to Recovery

As the Great Recession drags on, there are very few positive signs for the American consumer.  Manufacturing may have had a slight bump due in large part to inventory replenishment.  The stock market and commodities such as precious metals continue their climb for reasons unrelated to the United States Consumer.

The consumer market drives approximately 70 percent of the United States economy and its turn around will be the key to sustained economic recovery.  Unemployment rose to 10.2% in October and home values were flat or declining in most markets.    Neither of these barometers of the individual consumer’s financial situation suggests an authentic recovery is at hand.

The most striking statistic is the report of total consumer debt through September 2009.  The Federal Reserve has been tracking total consumer debt since 1943.  Every year since 1944 total consumer debt has risen from one year to the next.  Even during the severe recession of the early 1980’s that spanned the months between December 1980 and November 1982, consumer debt rose, albeit at a slow pace.

The Federal Reserve Statistical Release on November 6, 2009 reports the United States consumer has reduced their outstanding consumer by $126.70 billion since the 4^th quarter of 2008.  http://www.federalreserve.gov/releases/g19/Current/

At no time since the Federal Reserve, began keeping records has the American consumer paid down their debt.  Total revolving debt decreased by an annualized rate of 10 percent while total consumer debt declined in September by 7.2 percent.

All types and sources of consumer debt has declined expect for debt backed by the federal government and Sallie Mae which has increased 19.5 percent since 4^th quarter 2008.

Individual family budgets benefit by paying down debt but the Gross Domestic Product of the United States needs individuals and families borrowing money to purchase goods and services for the economy to grow.  The consumer finance industry needs the consumer to start borrowing again to stem the loss of jobs in the industry. 

The pundits will continue to speculate when the economy will turn around and the GDP will resume its growth.  Follow the unemployment numbers and then check the Fed’s web site on consumer growth.  When the Fed shows between three to six months of consecutive growth in consumer debt, on its web site, http://www.federalreserve.gov/releases/g19/hist/cc_hist_mh.html, I will finally begin to feel the Great Recession is truly history.

Credit Scoring Models Amplify Loan Defaults

The Great Recession introduced the public at large to a previously seldom mentioned type of bond called Collateralized Debt Obligation or CDO.  CDO’s are asset-backed securities whose purpose was to attract more cash to the market by breaking up loan portfolios into different classes of debt or levels of risk and return. 

 Classifying the bonds according to risk AA to BB and maturity dates of 1, 3, 5 and 10 years the number of options for investors looking to target risk and return coupled with a choice of time lines attracted more money to CDO’s.  Investors saw less risk with an investment that had a predictable cash flow and defaults.

 CDO’s served their purpose in the economy by attracting more capital to the market that was in turn loaned back into the consumer debt market at lower rates.  Credit Derivatives or an insurance policy on the debt helped calm investors nerves if the loans within the asset class began to default at higher rates or an unexpected number of the loans paid out early, the insurance would kick in paying investors their expected return.

 The debt market collapsed as the CDO’s became increasingly complex and the rates of default far exceeded expectations for the class.  Bond ratings on this investment product were increasingly divorced from the actual risk. When the insurers like AIG were overwhelmed by the number of calls on the Credit Derivates that they were the guarantor of, the market froze up. 

 A question the market has to ask itself is how did investment risk deviate so far from its historical ratings and what factors contributed to it. 

 The complexity of the debt offerings and the mixing of assets classes in addition to lack of market oversight were factors but at the root of the cause is the financial institutions move away from basing risk in large part on credit bureau scores to internal scores. 

 Credit Risk profiling/modeling proliferated within the last decade as statistical software such as SAS and SQL developed the capability to allow lenders to extract or mine data from their existing portfolio and determine the likely hood of a particular applicant defaulting on their loan.  The software drills down into the data systematically, detects important relationships, co-factors, dependencies and associations between multiple variables, and assigns values to segments of the loan portfolio.  The analysis can identify profiles of high and low risk loans through a systematic analysis of all available data.

 An auto lender for example  keeps loan records on motor vehicle purchase in its database including default information:  occupation, income; vehicle type, manufacturer, model, year make, price, loan amount, default amount, etc. The lender wishes to know which types of loans for motor vehicle purchases are at the highest risk, i.e., highest default ratio by probability.  The credit bureau score in contrast is looking at the consumer current financial situation and by nature is forward-looking.

 Credit Scoring is backward looking by its nature.  A scoring model analyzes historical data and assumes that current offerings with similar characteristics will behave in the same manner.  The downside rears its ugly head when the market as a whole does not perform according to the criteria assumed in the scoring model.  Scoring models such as a Neural Network can predict either relative default levels or expected default levels with surprising accuracy in presumed non-risky segments of business.  When the old rules no longer apply in a deteriorating economy, scoring models may accelerate default rates when the criteria of the model is assuming a stable or growing economy.

 The investment bankers who packaged debt for sale on the open market with a grade of AA in 2006 and once again bundled loans from the same lender using the same credit risk factors in 2008 in reality offered an AA rating investment that contained a much higher default risk.  Until scoring models are able to foresee the economic future and adjust the modeling criteria accordingly, the ability of rating agencies such as Moody’s to accurately asses the risk of a CDO will be in question.

 Credit Risk modeling is not going away in fact it is being used to decision and price loans throughout the consumer finance industry.  Credit Risk Analysts and Collectors are the primary positions that banks and other financial institutions are currently hiring. 

 Banks and financial institutions have tightened lending activities as delinquency and charge off have increased and the availability of capital to make new loans has shrunk precipitously, especially in light of the market for CDO’s drying up.  What is to prevent the cycle from repeating itself again when the economy stabilizes?  The pressures to grow loan receivables, revenue and earnings per share will not disappear, once again creating a situation where additional risk will be taken for greater returns with the unspoken specter of runaway defaults lurking in the background

 The answer for this quandary will be debated by minds greater than mine but until scoring models are able to adapt to financial conditions, the human element needs to remain an essential part of the loan underwriting decision process.  When the institutional investor does not question whether an AA bond is truly an AA bond, the credit markets will have overcome a significant hurdle and will be on the road to recovery.