All posts by Guest Contributor

The debate continues in the banking industry -- Do we push the loan authority to the field or do we centralize it (particularly when we are talking about small business loans)? A common argument for sending the loan authority to the field is the improved turnaround time for the applicant. However reality is that centralized loan authority actually provides a decision time almost two times faster than those of a decentralized nature.  The statistics supporting this fact are from the Small Business Benchmark Study created and published by Baker Hill, a Part of Experian, for the past five years. Based upon the 2008 Small Business Benchmark Study, those institutions with assets of $20 billion to $100 billion used only centralized underwriting and provided decisions within 2.5 days on average. In contrast, the next closest category ($2 billion to $20 billion in assets) took 4.4 days. Now, if we only consider the time it takes to make a decision (meaning we have all the information needed), the same disparity exists.  The largest banks using solely centralized underwriting took 0.8 days to make a decision, while the next tier ($2 billion to $20 billion) took an average 1.5 days to make a decision.  This drop in centralized underwriting usage between these two tiers was simply a 15 percent change. This means that the $20 billion to $100 billion banks had 100% usage of centralized underwriting while the $2 billion to $20 billion dropped only to 85% usage. Eighty-five percent is still a strong usage percentage, but it has a significant impact on turnaround time. The most perplexing issue is that the smaller community banks are consistently telling me that they feel their competitive advantages are that they can respond faster and they know their clients better than bigger, impersonal banks.  Based upon the stats, I am not seeing this competitive advantage supported by reality.  What is particularly confusing is that the small community banks, that are supposed to be closest to the client, take twice as long overall from application receipt to decision and almost three times as long when you compare them to the $20 billion to $100 billion category (0.8 days) to the $500 million to $2 billion category (2.2 days). As you can see - centralized underwriting works.  It is consistent, provides improved customer service, improved throughput, increased efficiency and improved credit quality when compared to the decentralized approach.   In future blogs, I will address the credit quality component.

The way in which you communicate with your customers really does impact the effectiveness of your collections operation. At the heart of any collections management operation is the quality of the correspondence and, in particular, the tone of voice adopted with the debtor. In short, what you say is important, but how you say it has a critical impact on its effectiveness. To help guide best practice in this area and provide areas for consideration when designing and implementing customer letters within a collections strategy, Experian commissioned a study to explore how consumers react to the words used to communicate with them about their debt. Key findings:An appropriate tone, clear detail of the consequences and a conciliatory approach are effective in the early phases of collection  Fees and charges and negative impacts on credit ratings were key motivators to pay Charges applied to an account for issuing a letter is disliked and likely to encourage many to contact the organisation to express their frustration After 3 months a strong emphasis on serious action is appropriate, including reference to legal action or debt collection agency involvement  Support should be offered, wherever possible, to aid those in difficulty  Letters should avoid an informal and patronising tone Lengthy letters have a low impact and are often not fully read, resulting in important messages being missed Use of red to highlight and focus on a specific point is effectiveUse of red to highlight more than one point is counter-effective To download the entire paper* and view other best practice briefings, follow the link below to the global Experian Decision Analytics collections briefing papers page: http://www.experian-da.com/resources/briefingpapers.html * Secure download account required. You can sign up for one today - FREE.

2007 and 2008 saw a rapid change of consumer behaviors and it is no surprise to most collections professionals that the existing collections scoring models and strategies are not working as well as they used to. These tools and collections workflow practices were mostly built from historical behavioral and credit data and assume that consumers will continue to behave as they had in the past. We all know that this is not the case, with an example being prioritization of debt and repayment patterns. Its been assumed and validated for decades that consumers will let their credit card lines go before an auto loan and that the mortgage obligations would be the last trade to remain standing before bankruptcy. Today, that is certainly not the case and there are other significant behavior shifts that are contributing to today's weak business models.   There are at least three compelling reasons to believe now is the right time for updates: It appears that most of the consumer behavioral shift is over for collections. While economic recovery will take many years, more radical changes in the economy are unlikely. Most experts are calling for a housing bottom sometime in 2009 and there are already signs of hope on Wall Street.   What is built now shouldn't be obsolete next year. A slow economic recovery probably means that the life of new models will be fairly long and most consumers won't be able to improve their credit and collections scores anytime soon. Even after financial recovery (which at this point is not likely over the short term for many that are already in trouble), it can take two to seven years of responsible payment history before a risk assessment is improved.   We now have the data with which to make the updates. It takes six to12 months of stability to accumulate sufficient data for proper analysis and so far 2009 hasn't seen much behavioral volatility. Whether you build or buy, the process takes awhile, so if you still need a few more months of history in will be in hand when needed if the projects are kicked off soon.

Due to the recent economic events, increased collections workloads are straining client infrastructures and resources. Most clients in North America operate their delinquent accounts on legacy collections systems that are inflexible and expensive to manage and maintain. A recent and abrupt spending shift has drifted toward collections tools, data, operational, efficient workflow and decisioning systems.On the information technology front, the collections workflow software industry is on the brink of a technology shift from legacy systems to modern next generation offerings that are typically coded in Java. Very few collections software vendors have actually released and implemented their next generation products and are preparing to do so over the next six to 12 months. Clients are aware of this technology shift and the interest of many end users has been heightened and many are actively researching and shopping.Reducing operational costs is an urgent priority for most financial institutions and utilities. Legacy systems do not allow management to change strategies or flows quickly or in a cost effective manner, which leaves most collections departments unable to keep up with rapidly changing environments and business objectives. Clients also have critical business needs to reduce losses, improve cash flow and promote customer satisfaction. Many clients maintain multiple systems and it is common that these disparate systems do not communicate with each other. Consolidating collections operations and databases into one central system is strongly desired and presents an opportunity for significant financial gain. 

Our current collections management landscape is seeing unprecedented consumer debt burdens: Total consumer debt o/s is at $14 trillion as of Jan ’09 Revolving debt o/s has reached $1 trillion The unemployment rate is at 7.6% and is expected to continue to rise Credit card and Home Equity Line Of Credit issuers reduced available credit by approximately $2 Trillion last year and more reductions are expected in 2009 There is a continuing rise in delinquencies and chargeoffs.  Here are some examples from our recent research: 8.5% of Prime Adjustable Rate Mortgages are now delinquent which shows an increase of 491% over this time last year 25% of all sub prime mortgages are now 60+ days delinquent Delinquencies for prime bankcard customers have increased 286% over the last 2 years 34% of all scoreable consumers (those who have sufficient trade information to calculate a score) now have a collection account. Compound these by a decline in the relative collectability of these accounts and you see: 9 million households now have negative equity 20% of 401(k) accounts have been tapped for loans (usually at a cost of 45% in penalties and fees to the account holder) According to the Federal Reserve, in late 2006 – at the height of the sub prime mortgage boom - the U.S. experienced a negative savings rate for the first time since the Great Depression.  

Understanding the Champion/Challenger testing strategy As the economic world continues to change, collection strategy testing becomes increasingly important. Champion/Challenger strategy testing is performed using a sample segment and the results provide a learning tool for determining which collections strategies are most effective. This allows strategies to be tested before rolling them out across the entire portfolio. The purpose of this experimental element to collections strategy management is to observe the effectiveness of new strategies, support continuous improvement of collection approaches and facilitate adaptability to changes in consumer behavior. The methodology behind testing is simple. First, the current environment should be assessed to identify specific areas for potential improvement. Then, a test plan is designed. The test plan should, at a minimum, include well-defined objectives and goals, proposed strategy design, determination of sample size, operational considerations, execution approach, success criteria, and evaluation timetable. After the framework for the test plan has been outlined, running “what if” scenarios will improve refinement of the collections strategy. In the next phase, implementation occurs following the directives of the test plan. Evaluating strategies commences after implementation and continues throughout the duration of the test. This includes analyzing metrics established during the test plan phase to identify trends and changes as a result of the new challenger strategy. The challenger strategy is declared the new champion if the test achieves or exceeds expectations. However, before proceeding with the new champion strategy over the entire portfolio, carefully consider any operational constraints that might hinder the success of the strategy on a grand scale. Once these operational constraints have been identified and their impact assessed, the new champion strategy should be executed.

By: Tom Hannagan Beyond the financial risk management considerations related to a bank’s capital, which would be directly impacted by Troubled Asset Relief Program (TARP) participation, it should be clear that TARP also involves business (or strategic) risk. We have spoken in the past of several major categories of risk: credit risk, market risk, operational risk and business risk. Business risk includes a variety of risks associated with the outcomes from strategic decision making, corporate governance considerations, executive behavior (for better or worse), management succession events (Apple and Steve Jobs, for instance) or other leadership occurrences that may affect the performance and financial viability of the business. Aside from the monetary impact on the bank’s capital position, TARP involves a new capital securities owner being in the mix. And, with a roughly 20 percent infusion of added tier one capital, we are almost always talking about a very large, new owner relative to existing shareholders. The United States Department of the Treasury is the investor or holder of the newly issued preferred stock and warrants. The Treasury Department says it does not seek voting rights, but none-the-less has gotten them in at least some cases. The real “kicker” is embedded in the Treasury’s Securities Purchase Agreement – Standard Form. The most interesting clause, that appears to represent a very open-ended business risk to management decision making, is one relatively small paragraph, named Amendment, in the middle of Article V - Miscellaneous, just ahead of governing law (which is federal law, backed up by the laws of the State of New York). Amendment begins normally enough, requiring the usual signed agreement of each party, but then states: “provided that the Investor may unilaterally amend any provision of this Agreement to the extent required to comply with any changes after the Signing Date in applicable federal statutes.” Wow. My reading of this is that if in the future Congress enacts anything that Treasury finds applicable to any aspect of the previously signed TARP Agreement, the bank is bound to go along. Regardless of whether the Treasury negotiates any voting rights, once the TARP Agreement is executed by the bank, management is not only bound by what is in the document to begin with, it is subject to future federal law as long as the TARP shares are held by the government. As a result, many banks have said no thank you to TARP. At least four banks have recently paid back $340 million to repurchase the government’s shares. And, apparently another bank has offered to pay back $1 billion but, according to Andrew Napolitano at Fox Business Channel, the offer was turned down and the bank was threatened with adverse consequences if it persisted in its attempt to get out. More pointed and public, and much larger in size, is the dance taking place now between Chrysler Corporation, Fiat, the UAW, four lead lenders and, you guessed it, the federal government. The secured loans in question total almost $7 billion and the government wants J.P. Morgan Chase, Goldman Sachs, Citicorp and Morgan Stanley to exchange $5 billion of the loans for Chrysler stock. The banks know they would do better (for their shareholders) by selling off Chryslers assets. This is an example of why bankruptcy exists. The stakes are large and so is the business risk of the influence from the government. It will be interesting to see how things turn out. So, this new major owner does have a voice. If Congress wants certain lending volumes or terms, or they want certain compensation levels, it needs to be enacted into federal law. Short of having to pass a law, there is the implied threat of the big stick in the TARP agreement. The Purchase Agreement covers what the new owner wants now and may decide it wants in the future. This a form of strategic business risk that comes with accepting the capital infusion from this particular source.  

In addition to behavioral models, collections management and account management groups need the ability to implement strategies in order to effectively handle and process accounts, particularly when the optimization of resources is a priority. While the behavioral models will effectively evaluate and measure the likelihood that an account will become delinquent or result in a loss, strategies are the specific actions taken, based on the score prediction, as well as other key information that is available when those actions are appropriate. Identifying high-risk accounts, for example, may result in collections strategies designed to accelerate collections activity and execute more aggressive actions and increase collections efficiency. On the other hand, identifying low-risk accounts can help determine when to take advantage of cost-saving actions and focus on customer retention programs. Effective strategies also address how to handle accounts that fall between the high- and low-risk extremes, as well as accounts that fall into special categories such as first-payment defaults, recently delinquent accounts and unique customer or product segments. To accommodate lenders with systems that cannot support either behavioral scorecards or automated strategy assignments a hosted collections software decisioning system can close the gap. To use these services master file data needs to be transmitted (securely) on a regular basis. The remote decision engine then calculates behavioral scores, identifies special handling accounts and electronically delivers the recommended strategy code or string of actions to drive treatments.  

This post continues the feature from my colleague and guest blogger, Mark Sofietti, Associate Process Architect in Advisory Services at Baker Hill, a part of Experian. In today’s market, the banking industry seems to be changing at a very rapid pace.  The current crisis that we are in, as an industry and as a nation, is forcing institutions to revisit risk management policies and procedures to make the appropriate changes needed to remain healthy and profitable.  However, the current crisis is not the only reason why institutions should focus on change management.  Change management needs to be appropriately handled in bad and good times.  Understanding change management is always a necessity to a well-run organization.  Whether it is a reorganization, a new software system, a new policy or moving to a new building, change can cause a great deal of stress and uncertainty -- but it can also cause benefits. So, as managers, you may be asking, “What can I do to ensure that positive changes are happening within my organization?  What are some of the items that I should consider when I am bringing about organizational change?” There are four necessary steps that need to be taken in order to improve the success of an initiative that is causing change to an institution. I covered two in my last post. Here are the additional steps. 3. Consider methods of change One method of change is the education of individuals about new ways of operating.  This method should be used when there is more resistance to change and when individuals lack a clear understanding or knowledge of the change being made.  Education may cause the implementation to take longer, but those involved will better understand the effects of the change. A second method is gathering participation from different levels and skill sets within the organizations.  Building a team should be used when there is the highest risk of failure due to change resistance and when more information needs to be gathered before an effective implementation can be completed. Negotiation is a method that is used when a group or person is going to be negatively affected by the change.  This method could alleviate the discomfort by giving the person or group some other benefit.  Negotiations could allow an organization to avoid resistance, but it may be very costly and time consuming to implement the change. The coercion change method is when a change is implemented with little room for diversion from the plan.  Employees are told what the change is going to be and they have to accept it.  This method should be used when speed is of the utmost importance, or if the change is not going to be easily accepted.  Most employees do not like this approach and it may cause resentment or it might cause staff members to leave. The final method of change uses manipulation, the conscious decision to share limited information about the change that is taking place.  This method should only be used when no other tactic will work, or if time or cost is major issues.  This approach is dangerous because it can lead to more problems in the future. 4. Create plan of action A plan should be created for the implementation of change to clearly address reservations and define the change strategy.  It should include internal and external audiences who can be affected by the change.  It is common to forget those who are indirectly impacted by the change -- and these audiences (customers, for example) may be the most important.  Objectives of the change need to be clearly outlined in the plan in order to understand how the new future state of the organization will look and operate.  The plan needs to be communicated to all those involved so that the transition can be understood and everyone can be held accountable.  The plan should be periodically revisited after implementation in order to review progress.  Creating a plan of action is a very important step to ensure that those who resisted the change do not revert back to their old habits. Achieving change is not an easy process, especially when time is not on your side.  If you take a second look at the change that you are trying to implement and do the necessary planning, you have a greater chance for success than if you or your organization fails to fully evaluate the consequences. Effective change management should be part of any financial risk management process. Take charge of your institution’s future through a calculated approach to change management and your organization will be in a better position for the next change that is coming around the bend.

Behavioral scoring is one of the most important tools that allow collections management and account management groups to evaluate accounts in an efficient and cost-effective manner. Although behavioral models are developed in a similar manner as new applicant models, there are several key differences that make behavioral models a better choice for many account management applications and collections workflow systems:By using only internal master file data as opposed to external credit bureau data, for example, accounts can be regularly evaluated without incremental cost. The most common practices are to score accounts on a weekly or monthly basis, which allows for quick strategic responses to a customer’s change in behavior. Frequent evaluations can result in automated or manual actions such as the acceleration or deceleration of collections efforts, adjusting credit limits and changing terms and conditions.The performance definitions of behavioral scores are very specific to each strategy and task, and it is typically not advised to use models in applications for which they were not designed. For example, a new applicant model definition of “bad” may be a high probability of charge off during the initial term of a line of credit. For collections strategy, a more appropriate bad definition might be the likelihood of an account rolling to the next delinquency bucket, regardless of the age of the account. Behavioral models also have a much shorter outcome period of three to four months versus new applicant models that forecast over one to two years. Since behaviors with one creditor can typically be recognized more quickly than with all lending institutions associated with a particular debtor, behavioral models provide a unique and timely evaluation of the ongoing risk once the account is already on the books. 

Have you ever wondered how your current collections workflow process evolved to its current state?  To start at the beginning, let’s rewind to medieval England … The Tallyman The earliest known collections system was essentially a door-to-door program, as there were no modern day devices to make the process more efficient. The system of record at that time was typically a hardwood stick with carved notches representing loans and payments between a lender and borrower. This door-to-door collector was known as the Tallyman, which referred to the collection of tally sticks he carried to document financial transactions. The beginning of modern times As technology evolved, telephones and letters became the collections management tools of choice, with a personal visit being a last resort action. The process where a collector managed the repayment strategy and relationships for his assigned customers was still in practice. Collections operations were typically in decentralized branches and small teams of skilled collectors were able to effectively manage this “cradle-to-grave” approach. Yesterday When expense management became a priority, the migration to larger, centralized operations became an industry trend.  Many companies found it difficult to hire large teams of highly-skilled collectors in their geographic regions and the bucket system was born. The concept was simple and effective -- let the less experienced staff work the accounts that are the easiest to collect and focus the experienced collectors on the more difficult cases.  Advanced collections tools such as automatic dialers arrived on the market to increase efficiency and were shortly followed by decision engines used to support behavioral scoring and segmentation strategies. Today Current trends in collections include the migration towards a risk-based segmentation and strategy approach. Cutting edge tools and collection management software, designed to address today’s collections business objectives, are hitting the market and challenging the traditional bucket approach most of us are used to. As the economic conditions of the past few years deteriorated, many organizations began shifting their spending focus towards the collections department and this, in turn, has inspired investment and innovation from software, analytics and data vendors. New collections scores were recently unveiled that yield predictiveness that has never been seen and collections data products have become significantly more sophisticated. Modern technology is also empowering collections managers to control the destiny of their business units by freeing them from the constraints of over-burdened IT departments and inflexible systems. There is also an emerging trend to consider the collective power of multiple products working in tandem. Collections experts are finding that the benefit of the complete solution equals much more than just the sum of the parts. Tomorrow Once we all migrate to the next level and employ today’s modern marvels to make our businesses more productive and efficient, what’s next?  It’s highly probable that tomorrow’s collections workflow will consider the entire relationship and profit potential of a customer before a collections action is executed. Additionally, the value in considering the entire credit and risk picture associated with a customer will be better understood and we will learn when each of the holistic view options is most appropriate. There are a number of roadblocks in the way today, including disparate systems and databases and siloed business units with goals and objectives that are not aligned. Will we eventually get there? The business leaders with long-range vision certainly will … just as some unknown visionary had the initiative to embrace emerging technology and abandon his tally sticks. For more information and to read the Decision Analytics newsletter that features one of my previous blogs, "Next generation collections systems", click here.   

We have talked about: the creation of the vision for our loan portfolios (current state versus future state) – e.g. the strategy for moving our current portfolio to the future vision. Now comes the time for execution of that strategy. In changing portfolio composition and improving credit quality, the discipline of credit must be strong (this includes in the arenas of commercial loan origination, loan portfolio monitoring, and credit risk modeling of course). Consistency, especially, in the application of policy is key. Early on in the change/execution process there will be strong pressure to revert back to the old ways and stay in a familiar comfort zone.  Credit criteria/underwriting guidelines will have indeed changed in the strategy execution. In the coming blogs we will be discussing: assessment of the current state in your loan portfolio; development of the specific strategy to effect change in the portfolio from a credit quality perspective and composition; business development efforts to affect change in the portfolio composition; and policy changes to support the strategy/vision.  

They have started to shift away from time-based collections management activities (the 30-, 60-, 90-day bucket approach).  Instead, the focus is migrating towards the development of collections strategy that is based on the underlying risk of the individual – to look at how he is performing on all of the obligations in the total relationship to determine the likelihood of repayment and the associated activities that can facilitate that repayment.  They’ve found they can’t rely purely on traditional models anymore because consumer behavior has dramatically changed and an account only approach doesn’t reflect the true risk and value of the individual’s relationship.

By: Prince Varma Good day all. My last blog revolved around practical approaches to effective client relationship management. It time to get back to a “risk” type conversation. I recently told my wife that if I hear the phrase “…in this economic environment …” uttered as a caveat one more time, I’m going to scream. I have truly come to anticipate the beginning or introduction to interviews and articles to lead in with this sentiment and it’s driving me nuts. In these economic times (you can tell I’m from the sales side, I cleverly changed the phrase), it is clearly not business as usual within most financial institutions. Conversations with CEOs and bank presidents over the past two months have usually followed the same theme, “I’ve got money to lend, but I just can’t find a decent deal” or “I’ve got applications up the wazoo, but the quality just isn’t there.” So, what is going on? The obvious answer is that we are looking at applications more closely and the credit side (risk management guys) is deliriously happy because everytime they make a recommendation about “reviewing the opportunity further” they also don’t hesitate to mention, “in this economic environment.” Really, what is the scoop and how do we adjust on the front line? Clearly, we know that deeper reviews and management of risk is being undertaken. The problem is that the established standards are no longer valid. Yes, the basics ratios still need to be run, but let’s face it, in this economic environment a company’s historical performance is no longer an effective indicator as to their future performance. The playing field is no longer consistent. The past two to three years of financials are based on circumstances that no longer apply. This means that the analysts are having a difficult time establishing effective benchmarks from which to apply credit policy – and we know that those guys are the paragons of adaptability. We are being asked to evaluate risk in an uncertain circumstance. We are looking at projected revenues and earnings and examining receivables. We are also comparing this business to others in the industry, determining which other market segments have a direct (and indirect) impact on the performance of this one, reviewing business plans and evaluating management depth and experience. And, at the end of the day, either saying no, saying yes but not so much or holding our breath and hoping that divine intervention shows us the way. Does any of this should sound familiar to you? It should. We see these type of deals all of the time and we call them the start-ups. Ok, so what am I recommending? Quite simply, that we take a step back from our typical approach to the established business and engage with them the way we would a start-up. When an opportunity or request presents itself, restrain the urge to go down the garden path. Slow down! No... stop! Take a deep breath, put on your “economic development hat ” and approach the deal the way you would if it were a start-up (and I don’t mean running away at top speed in the opposite direction screaming). You should: look for or help them construct a short term (next four to six month) tactical action/priority plan; help them or review their 12-month business plan; o NOTE: If the business hasn’t realized that they need a short-term survival plan and a mid-term business plan… run! Run far and run fast! examine their market and have them explain why they will make it versus the competition; dig into their management expertise (think AIG); have them explain how their tactical and 12-month business plan will keep the doors open and the lights on (since its coming into summer we’ll cut them some slack on the heat); and finally review and revise their projections. If at the end of this, you still feel that the deal has legs, it probably does, and you’ve done a pretty thorough job building the business case for the credit side. Or, you could just lament that there really isn’t much out there in this economic environment.

By: Prince Varma Part 2 Two additional tactics that you should incorporate into your relationship management penetration strategy include: Conducting relationship reviews in addition to loan reviews; and Identifying and proactively monitoring changes in client behavior. Relationship reviews Relationship reviews are a comprehensive and thorough examination of the client’s business and should be the foundation for your relationship management process. They seek to provide both the client and the relationship manager with a roadmap for the upcoming 14- to 16-month period by identifying specific goals and concerns, as well as constructing a snapshot of the client today. The purpose of a relationship review is to understand the broader direction.  Bluntly put, an annual loan review is not a penetration activity. Its primary focus is to verify the ongoing credit worthiness of an existing deal in the books. More details will come about this topic in a future blog. Monitoring changes in behavior Monitoring changes in client behavior through the use of “activity thresholding” is quickly becoming a mainstay in the financial industry. The idea isn’t new; however, the application of the concept to penetration is. Instead of having changes in credit score trigger an alert related to risk management and mitigation, we would instead look at thresholds related to line usage, number of deposit transactions, changes in average deposit amount and credit card transactions. These kinds of client behaviors and activities provide insight into what is occurring within a clients business and as such, allow us to provide recommendations for products and services that are meaningful and appropriate.