Be prepared, a wave of bad debt is on the way

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ross SME lending in the first three quarters of 2020 was more than double that of 2019, reaching £54bn, according to figures published by banking industry trade body UK Finance.

There’s certainly a lot of debt, but how much of it is bad? It’s hard to say. A recent PwC debt survey of 400 British executives found 55 per cent anticipating a liquidity shortfall in the next 12 months with a similar number reporting they’d struggled to service debt payments within the past year, according to a 17 May Bloomberg.com report.

However, unlike the Global Financial Crisis (GFC), there’s a great deal more variety among the customers in debt – both commercial and household. The sources of their funding are also more varied, and in many cases, more secure.

Covid-19 has made this the most unprecedented of times.

As a result, lenders will see a full cast of characteristics across their portfolios:

• From zombie companies and the seriously vulnerable,
• To people who have managed to save more than they usually would,
• To those who have used government loans to pay down existing debt.

But there are other variables fast approaching. The withdrawal of furlough will have an impact, as will the requirement to pay temporarily deferred VAT. Many customers who took out Covid-specific support have not yet been called on for repayment, so the outlook will remain murky for some time yet. And if the economy rebounds, as many believe it will, then new lending will become a tremendously important accelerant.

While it’s unclear whether bad debt will overwhelm the market, what is certain is that a wave of collections is on the way. Lenders need to recoup on all their business-as-usual lending that legislators paused, while simultaneously beginning to collect on the business loans underwritten by the government.

But lenders need to tread a fine line:

• Regulators have made it clear that customers are to be considered vulnerable unless proven otherwise.
• A tough push too soon could cause serious problems for companies that would otherwise have survived given more time.
• Lenders may not have the information they need to understand the true position of many customers.

The attitude lenders have towards collections and the strategies they implement will greatly determine how big the wave will be and how long it will last.

For example, a customer with a car lease might appear on paper ready to repay. But what their lease information doesn’t show is that their partner died. That’s a situation that lenders need to consider, and information that can really only be extracted during the course of a conversation. Failing to speak with your customers could cause real pain for them, create unnecessary bad debt, and expose you to censure from the regulator – not to mention bad press.

Or perhaps a business is looking at two consecutive years of losses – usually the trigger for an asset repossession. But the business has also planned and started a successful pivot and is starting to make money again. Repossessing assets could bring a sudden end to the company’s nascent revival.

Even in the case where asset repossession is fair, do you know the market for the resale of that asset? Some assets like tour buses aren’t fetching much at auction. But there is equipment that’s now scarce and more valuable. Just stepping in and repossessing as a matter of course may not end well. And you may be able to offset extending the period for some customers by selling assets that are worth more right now. Lenders must take a pragmatic view of the asset, and augment that with a full view of the sector. Lenders must take a pragmatic view of the asset, and augment that with a full view of the sector.

Roundtable participants described how they had been blindsided by the pandemic. They said that customers panicked and requests for forbearance flooded in. So, lenders flexed the workforce and moved staff to man the phones and used a jumble of legacy systems and new processes or solutions like chatbots to handle massive spikes in customer contact. They knew instinctively that making customers wait four days for a call-back could have serious knock-on effects. 82 per cent of lenders believe the current crisis will have varying degrees of impact on their need to scale the collections process. The message is clear: exuberant lenders want the next surge to look different. So how can they prepare?

1. Segment
Put technology and processes in place to segment customers. For example, if you lend or lease to the food industry, consider what the business actually does. If they’re a supermarket wholesaler, then they’re probably good to repay. If they provide food for restaurants, then maybe they need a bit more time. Ringfence the customers whose positions you consider dangerous, identify the customers who deserve special treatment and apply exceptional strategies – like extending their repayment terms, and encourage those with higher bank balances to start repaying early.

Training staff is a vital part of the segmentation approach. Sometimes it can be hard to identify vulnerability, particularly within corporates. So any automation, machine learning, or artificial intelligence you use needs to provide your collections team with more information and equip them to have what is likely to be a very sensitive conversation.

A blend of technology and empathy is key here. Lenders are being asked to do a lot, and they can emerge from this crisis as either pariahs – as they did after the financial crisis – or heroes. Many customers currently have a good view of lenders who have paused repayments, extended support, and gone the extra mile to provide information.

Sustaining this goodwill requires personalised responses, flexibility, and empathetic communication.

2. Leverage technology
Technology can also be used to streamline customers, meaning that you get to that empathetic conversation quicker. And you can use it to harvest useful information along the way, so that the conversation can be more in-depth and the eventual collections plan more personalised and flexible.

Most roundtable participants (85%) already consider collections either a critical or somewhat important factor when purchasing technology. They should ensure that the technology they have in place helps them retrieve, process, manage, and easily use the information they need.

Technology can also provide the comfort lenders need to enact their strategy. If you have the right information, then accepting an increase in the repayment period (in return for eventual repayment) rather than forcing customers into the red, is a considered risk that can be quantified. Repayment periods that are extended based on real and detailed data rather than guesswork or goodwill will only mean better long-term revenues and increased loyalty from a battered customer base.

Lenders can use their company reporting to explain their collections strategy to stakeholders, who will then be unlikely to impart penalties for taking the long view in a volatile market. Nursing accounts through a difficult period

may literally pay dividends. But it is important that lenders base their approach on detailed information: an increase in rates may naturally offset the risk of extending repayments – but an increase in rates brings its own consequences.

Lenders need to be wise to the first, second, and third-order effects of their collections strategy, and the only way to do this is to collect and synthesise more data.

3. Seek balance across the business
Lenders may also want to consider altering scorecards. In ordinary times, what happens in collections – such as expected defaults – goes straight into the scorecard that allows you to underwrite new lending and leasing business. But experiences early in the pandemic showed lenders that the standard scorecard approach meant customers were being rejected en masse, and often unfairly, because the scorecard system wasn’t sufficiently nuanced. Many moved to manual underwriting as a matter of course because a significant proportion of business was being automatically referred.

But this time, if the economy booms, underwriting staff can’t be used to man the collections hotline, and they won’t have time to manually consider each case. Lenders should consider adding pertinent questions to their scorecards that extract the information they need from customers ready to borrow. The variables at play in the economy suggest that performance scorecards need to change if lenders aren’t going to miss out on new business. One of the simpler starting points is to look at a sample of current referrals:

• Why are they happening?
• Is it occurring in a particular sector job profile or on a specific issue?
• Or is it affecting a particular region or chain of dealers?

• Using large amounts of data in this way can help lenders drill down to the reality.

The lending lifecycle – a virtuous circle
In summary, ultimately lenders need to get closer to customers. If you are not talking to them now, you need to be, and in detail. Collections staff must be engaged. And lenders need to take both the long and the broad view.

There’s a lot of debt, sure. But the appetite for credit is likely to bounce back. Mishandling collections will rule you out of a piece of the recovery.

Collections is just one part of the lending lifecycle. Many lenders believe that collections may change permanently because of the pandemic – and that’s a good thing. Lending is becoming an increasingly competitive business. The regulator expects sensitivity, and customers expect exceptional service. While there may be a wave of collections coming, there is also an opportunity for lenders to cement bonds with their customers, play a huge part in the recovery, and thrive financially. But doing so will require a unique blend of technology, empathy, and strategy.