This article was published in the February issue of Collections & Credit Risk.
Every economic downturn has its own unique characteristics. Accordingly, companies that follow the playbook from past recessions probably will focus too many resources on traditional marketing vehicles and frontline salespeople, which is not appropriate given the market and customer implications of the present. Or, they will take draconian measures in a higher-risk environment by curtailing all marketing activities.
To avoid either of these costly mistakes, marketing and sales executives must dynamically reassess their geographic, customer, channel and sales force priorities, while providing constant attention to the ever-shifting economics of this downturn before determining the correct strategies. To develop the appropriate strategies, executives must answer these foundational questions:
• Current conditions – What does the global economic crisis mean? Is it the same across all markets? What are the impacts to my credit portfolios? Do the impacts vary by product type?
• Customer behavior – How has my customers' spending and payment behavior changed? When did their behavior change and by how much? Has the behavior of all of my customers changed or just that of certain segments? What are the major contributing factors to the various changes?
• Analytical tools – Are my current tools, policies and practices effective in managing portfolio performance? If portfolio performance has been less than optimal, is it because of the tools or is it a result of other factors?
The analytical methods that lenders have come to rely on are no longer adequate for effective portfolio management. The reason is that these methods are based on prior market behavior instead of current customer behavior and market conditions – the latter being more relevant to present circumstances.
It is important to understand that even though the economic crisis is global, there are important differences from market to market and region to region. In the United States, the evaporation of available credit was driven initially by the collapse of the mortgage market and subsequent decline in housing prices. These two factors reduced the availability of home equity and other real estate-based lending vehicles, thereby affecting consumers who have been transferring credit card balances to these vehicles for the past 10 years.
The crisis since has moved to other forms of secured loans, including auto loans and asset-based financing. The mortgage losses that had been fueled by credit quality and capacity issues have led to a surplus in surrendered collateral (voluntary or involuntary). This, in turn, increases the losses carried on the lenders' books.
In Europe, where the markets have relied more heavily on debit than credit-based products, the losses of secured and unsecured loan portfolios accelerated much faster and more severely than in North America, raising concerns with regulators as far back as 2007. Meanwhile, such developing markets as Latin America and the Asia Pacific/Middle East/Africa regions are only just beginning to experience the increasing cross-segment delinquencies as the wave of the global crisis reaches them as well.
For many customers, both consumer and commercial, the economic turmoil has been manifested in a loss of financial capacity, inflationary pressures, a depressed housing market and the general contraction of available credit. In many cases, customers have begun to shift from credit as the prevailing means of financing their major purchases to their savings and earnings to fund such expenditures.
They also are re-evaluating their "repayment hierarchy," thinking very carefully about which obligations to pay based on factors such as the value of the account, available credit line and minimum payment requirements. Some customers also are holding out on some of their obligations, hoping that these vehicles may be part of the overall government relief for distressed debts. An example is the relief proposed for distressed homeowners facing foreclosure.
Though these behaviors do not necessarily indicate increased performance risk, they do lead to deterioration in credit profiles even though a borrower's fundamental creditworthiness may not have changed. Nevertheless, these "can't payers" are still frequently treated as "won't payers" – that is, non-creditworthy customers.
The change in market conditions and customer behavior means that in tandem with a limited supply of funds for lending, the issuer needs to generate greater revenue from existing credit business operation – all the more challenging because it is difficult to identify creditworthy, profitable customers. To complicate matters, issuers are experiencing lower than desired performance from their traditional tools, analytical models and treatment actions to grow and manage their portfolios.
The harsh reality is that today's tools simply were not designed to meet the challenges facing today's issuers. They cannot distinguish between customers who have poor credit scores and customers who are poor credit risks. They cannot anticipate or react proactively to the "won't payer" and they are inadequate in effectively executing line management and/or dynamic re-pricing programs. For example, they don't have the precision to determine the circumstances whereby an APR increase might push an account into default.
The issuer needs tools that will paint an accurate picture of the customer's current profile and long-range revenue potential. And, because there are so many different factors affecting customer behavior, reliable scenario-based forecasting will need to be more sensitive in accurately identifying each of the major contributing factors and the impact that a change in any of these factors will have on individual customer and overall portfolio performance.
New segmentation strategies based on profit potential will be the key to navigating this new landscape and will not only enable the issuer to better manage accounts but will guide decisions as to what products to offer and which segments to attract.
Watch Collections & Credit Risk for our next column, which will feature a discussion of acquisition and delinquency strategies, line management and forecasting techniques in today's challenging economic environment. CCR
Edmund V. Tribue is global practice leader for the Risk Management, Fraud and Operational Efficiency practice of MasterCard Advisors. He can be reached at email@example.com or www.mastercardadvisors.com.