This article will appear in the March 2009 issue of Collections & Credit Risk.
The fever pace of change in the economy has challenged credit card issuers – rendering many risk management tools, strategies and methodologies ineffective while creating a demand for quality risk analytic methods and responses.
To survive and grow, issuers must adopt new risk approaches to forecasting, line management, acquisitions and delinquency strategy.
Traditional forecasting methods were characterized by a long time horizon (annually, semiannually, quarterly) and a fairly narrow focus – often looking at a single factor affecting losses rather than building a multivariate model to identify and rank performance drivers. As the rapid changes in the market in the past year have shown, a new forecasting discipline is imperative and meaningful changes must be added with little delay.
First, not only should the scheduled period between forecasts be narrowed from semi-annual to quarterly, but forecasts also should be event-triggered. This would enable rapid identification and speedy response to the first sign of a market change.
Along with increased frequency, forecasting must consider each aspect of the product's lifecycle and risk functions. New tools, data sources and market assumptions should be considered to create a multi-faceted model that helps the issuer understand how to influence future portfolio performance. These should revolve around the goals of mitigating risk and taking advantage of hidden opportunities for prudent growth.
But the real change to be made involves attitude. Until now, the ideology behind most issuer forecasting has been to identify the most likely scenario and plan accordingly. In a stable economy, the most likely event often was the one that occurred. What issuersnow must do is model for the unexpected event as well as the expected, and to use forecasting as a tool to respond immediately to the "outlier" scenario.
In today's high-risk environment, line management decisions are critical to protect against loss and maintain customer loyalty. Yet issuers who react too quickly to market conditions – by shutting down credit limits, for example – not only risk the loyalty of profitable customers, but may miss out on opportunities to build portfolio performance.
What many issuers forget is that profitable customers can be found in all portfolios across many categories.
The problem is that what might once have been a sign of danger may have less to do with the long-term status of the customer than with a sudden turn of the environment.
Traditional credit capacity metrics alone will not be enough to distinguish customers whose credit lines should be raised from those whose should be lowered.
Here, too, issuers will need to both expand their analyses to include a wider range of data to more accurately segment their customers, and increase the frequency of those analyses, along with evolving management decisions.
The issuer should consider measured risks: looking at real-time data, developing hypotheses, testing segments of the portfolio and using the real-time results as the basis for refining the hypotheses and strategies. The issuer must be ready to absorb losses – the cost of doing business while charting new growth avenues. But only this kind of dynamic approach to line management will help identify and grow the profitable accounts.
It may seem that the issuer that does well is the one that keeps out of trouble. Indeed, the primary focus should be more on growing relationships with existing customers than acquiring new prospects. But those financial institutions that duck the challenges of the new environment will fail, while those with the analytical and visionary capabilities will prevail. Acquisition efforts must continue, albeit more prudently where the concern is shifted from quantity to quality.
In identifying and targeting customers, risk scores should not be the only criteria. Geographical and regional economic data can be used where there are homogenous populations and industries. Again, the issuer will want to use as broad a set of data as possible to identify and segment different kinds of customers. A reliable risk evaluation will enable an aggressive initial line assignment for the stronger customers, which will drive profitability. But even riskier segments can be profitable if the exposure is accurately captured in a way that leads to appropriate origination, management and collection strategies.
Once a card is issued, early-stage analysis should begin almost immediately to track usage, purchase patterns and velocity of balance growth in relation to the initial profile. This enables an almost seamless connection between acquisition and line management.
Delinquency strategies – along with acquisition and line management – should be understood as aspects of a holistic approach to portfolio management. Evolving with the realities of the economy and customer behavior, delinquency management should include customer retention, education and even financial counseling in addition to collection of monies owed.
Rather than waiting until an account is past due, identification and treatment strategies should begin once there is an observed change in performance.
A variety of delinquency management treatment actions should be leveraged when manageable to hold the loyalty of customers who may have a capacity issue because of a temporary setback, but will prove to be profitable in the long term.
This multi-pronged approach is based on several considerations. Primary is the difference between customers who cannot pay because of income issues and those who will not pay (as indicated by behavior history). There is also a difference between those whose condition can be expected to improve and those whose condition is more or less permanent. Accordingly, new segmentation schemes must be developed to consider external factors, capacity and the customer relationship, along with the traditional measures of days past due, dollars at risk and credit scores.
Also, because collection activity can be a lengthy process, options including selling delinquent debt, debt acceleration and settlement programs may be more cost-effective in the short run. At the same time, using off-shore collection and call centers can pose risk to issuer reputation, as public concern over job losses in the U.S. gains media attention.
With no way to escape the economy's challenges, the approaches outlined herein – including using a range of data to drive strategies that are constantly evaluated, and adopting an outlook that plans for the unexpected – issuers can be better equipped to not only survive the crisis, but be ready for growth. CCR
Edmund V. Tribue is senior vice president and global practice leader at MasterCard Advisors. He can be reached at firstname.lastname@example.org.