Author: Eric Steinhoff, Rakesh Lavi
The impact of COVID-19 on the US and world economies has been deep and far-reaching, with economic and financial markets experiencing a historic crunch. Although most governments have announced countermeasures and relief packages, we must be ready for a continued downslide in the coming months.
Moody’s research predict that the post-COVID recovery will be more of a Nike “swoosh” than a v-shaped one. Following the steep drop in economic output that we have already seen, we expect a steady but somewhat slow recovery, leading to a shape similar to the Nike logo, as you can see the dotted line below.
Surge in Unemployment
Widespread quarantines, and the temporary shutdown of all "non-essential" enterprises, factories and travel has led to a substantial loss of income for huge segments of the population. There has been a sharp surge in unemployment in the US to “a Depression-era level of 14.7%” in May 2020, and the true unemployment rate is generally considered to be well north of 20%. Unsurprisingly, consumer confidence nose-dived to 86.9 in April 2020 - the lowest level in nearly six years. (Although there has been a slight rise in May following the stimulus announcement.)
Cashflow Crunch and Rising Delinquency Rates There has been a dramatic impact on the cashflows of many big corporates and SMEs, from retail stores and airlines to hotels. The recovery for small business lending will likely lag that of consumers.
Clearly, we are entering a new era where a significant number of borrowers will have the intent to pay, but not the ability to pay.
Expectedly, financial institutions are bombarded with credit requests to help consumers with payment relief. Bank decisions on how to respond to borrowers’ needs and abilities will significantly impact the economic consequences of the COVID crisis.
Now, the important question for banks is:
Will the Traditional Collection and Account Treatment Strategies Continue to Work?
A “business as usual” approach to credit treatment will not work during this unprecedented crisis. Repeated collections calls to those who have lost their jobs will be ineffective and will only put your reputation at risk. A positive customer experience must be a top priority as we try to navigate this deep recession.
In addition, risk models are breaking down, drifting from expected paths due to the dominant impact of macro elements on payment performance.
There are two key challenges to making lending decisions in a rapidly changing environment like the one we currently face:
Through-the-cycle models have some weaknesses: - They only provide long run estimates, and - They don’t take into consideration the fat tail risk or sudden shocks, and black-swan events like COVID-19.
Reliable delinquency data will take time: For banks that have allowed payment deferrals, this may take 9 to 15 months to appear on bureaus.
There is however an opportunity to win the long game without sacrificing in the short term.
An analysis of modification efforts enacted during the 2017 hurricane season show that modified borrowers are 3x more likely to avoid ultimate defaults than loans that go straight into delinquency. Collection strategies should consider positive impact and assistance to help your customers handle this crisis.
A Paradigm Shift in Credit Management and Account Treatment
We propose a three-step strategy in credit treatment that will give you lower charge-offs and a better experience for your customers.
1. Customer 360 - Incorporate alternative data sources to update your customer financial profile
It is crucial to collate a customer-centric view across products. Start by evaluating your collections processes thoroughly.
a. Are you capturing the right information when on calls?
You should be asking for this info when engaged with customers:
Current job details or employment status
Household income outlook
Equity in Home
Rented or own residence
Time in residence
Loan-to-value ratio (LTV)
Other savings – 401k, stock portfolios, cash, etc.
b. Connect bank accounts and utilities to understand cash flow
Applications like Plaid and Yodlee will let you connect with borrowers’ bank accounts.
Urjanet can give you access to data on utilities.
Several tools enable connections to SMB accounting files.
You will likely have to offer incentives for connecting these applications and to encourage auto-payments. However, if you’re already offering payment relief and/or interest rate relief, then you should try to get this information or account access in exchange for that relief.
Aside from the above, a broader set of data sources should be evaluated to fully understand your customers’ situation and outlook. A non-comprehensive list of potential data sources:
2. Identify and overlay Stability Indicators
The next step should be to identify and overlay stability indicators. This will help you to:
Identify the accounts which are more likely to go delinquent in the current stressed environment
Develop differentiated treatment strategies by stability group within a given score band, product, etc.
Reopen new account originations on a targeted basis, and
Rank order accounts within credit risk score bands for improved forecasting.
Stability indicators can identify those consumers who more likely to default when encountering unexpected financial stress.
3. Update your Exposure Management toolkit
The third crucial step is to update your Account Management processes and tools:
Change your Account Management process to enable your teams to take immediate action upon identification of declining behavior or loss of income
Make reactive credit offers tailored to a customer’s specific situation, and
Reopen or expand originations for certain segments.
Every financial institution will need to make treatment decisions based on both its customer profile and the external environment.
Potential benefits of implementation
Sharper credit decisioning models enable risk-based interventions that maximize business impact while improving customer experience. And better account treatment will position your institution to emerge as a trusted partner to your customers.
Predictive customer segmentation will provide a more intelligent priority list, enabling timely actions
Targeted intervention leveraging a holistic customer view will lower your costs and losses.
By focusing originations on existing customers, you can open up opportunities for new exposure and growth, most rapidly through refinance offers.
Financial institutions should approach customer account management in the COVID era with a clean slate, blending intelligent technologies and improved operating models. You can start by tackling these three steps immediately:
Conduct a customer-level Value-at-risk assessment for your portfolio exposure.
Evaluate available data sources to better understand and segment your portfolio.
Review and remap limit management and collection strategies through the lens of customer stability.