With an economic downturn potentially on the horizon, lenders need tools that will assist in mitigating the risk of losses. More sophisticated customer segmentation can enhance the effectiveness of collection strategies and tactics, allowing lenders to prioritize their efforts in targeting the right customers at the right time. Preliminary findings from a joint study on consumer behaviour on credit cards, conducted by TransUnion and SCORE, reveal how customer segmentation on a typical portfolio can be refined in terms of both risk and propensity to pay — giving lenders clearer direction on practical steps they can take to address financially vulnerable customers for better outcomes.
Downturn readiness: defining moments of truth
According to a TransUnion analysis, an average of 15% of consumers’ disposable income currently goes toward servicing debt. This debt-to-income ratio will change as income growth slows, full-time employment gives way to part-time ‘gig’ work, and there’s a rise in insolvency and consumer proposals. The cost of living is on the rise, while home values appear to be decreasing. Add to this the regional impact of declining oil prices and it’s clear that Canadian consumers will be under greater pressure to meet their financial obligations.
The way you treat your customers during times of financial difficulty says a lot about your values as a business — and has implications for customer loyalty and profitability over the long term. Downturn readiness programs are looking at key moments in the downturn cycle as opportunities for competitive differentiation and future growth. When it comes to collections, how could you be addressing customers in financial distress?
Recognizing the lifetime value of a customer and the importance of maintaining a strong relationship over that lifetime, some lenders are placing a greater emphasis on the customer experience at collections stage. They’re viewing it as a form of customer assistance rather than simply a quantitative exercise. This can mean taking several factors into account:
- Broader economic trends
- Multiple lenders and tradelines
- The customer’s payment hierarchy
- Affordability, cash flow and payment options
- Timing and approach
Smarter segmentation for better outcomes
Customer assistance strategies can be important for building long-term loyalty and leveraging a realistic and pragmatic approach to execution can improve their effectiveness. With collections resources likely to be scarce or stretched (or both), effective execution will depend on understanding how to prioritize resources on the right actions, with the right customers.
A framework that considers where risk lies and where timing is most important can assist lenders in balancing their immediate financial interests with a longer view of the downturn cycle and a desire to better assist customers at collections stage.
We looked at how a collections model complemented by bureau scores could help a lender better identify potential defaults and delinquencies to assist with early-stage collections strategies.
As credit cards are a leading indicator of delinquency (they’re generally first in the hierarchy of payments to skip when consumers are in a bind), we selected a random sample of two million national active and current bank card customers, and looked at their behaviour on those accounts over 12 months.
Our analysis combined two models to measure pre-delinquency and propensity to pay.
- Pre-delinquency: TransUnion’s CreditVision® risk scores and other algorithms, to predict accounts that are at risk of going 90 days past due within 12 months.
- Propensity to pay: SCORE’s 30FI bankcard score, a collections score used to determine whether a delinquent account is likely to ‘cure’ (return to its current status, clear arrears or R1) within three months.
The sample was initially ranked and segmented for pre-delinquency risk, as follows:
We then analyzed propensity to pay and moved about 30% of the medium-risk accounts to the high-risk tier. This allowed us to further segment the sample, as follows:
- Major derogatory accounts: likely to become 120 days past due over the next 12 months
- Minor derogatory accounts: at least 30 days past due but not 120 days past due in the next 12 months
- Surprise bankruptcy (BK): either current or 30 days past due and suddenly bankrupt in the following month
Trends, observations and practical applications
Tactics and execution are just as important as the analytics behind understanding a customer’s willingness and ability to pay.
Our analysis showed that major derogatory trades are not only higher in the high-risk tier, they also grow at a much faster rate, which means there may be limited time to act. However, collection strategies for customers in this segment should also consider propensity to pay: for customers identified as high risk, with a low propensity to pay, you’d want a proactive, high-touch collections strategy with tactical considerations that may include triage and assigning highly skilled resources to contact and assist customers (rather than using an automated dialer, for example).
For customers with a high risk and high propensity to pay, an early-engagement strategy — identifying early triggers and taking a ‘soft-touch’ approach, like discussing restructuring options — could be more effective.
In a downturn in particular, your collections team resources are likely to be stretched. It’s therefore even more important to prioritize how you will contact different customers and balance the cost of contact with the recovery of losses.
We also identified other trends and behaviours in the high-risk group that could further assist in determining how best to approach these customers:
- They are twice as likely to move from the minor derogatory to major derogatory group than those in other risk tiers
- They have higher balances and spend on their cards
- They tend to pursue credit more aggressively
- The majority (about 70%) of accounts have a very low open-to-buy (less than $100)
The value of additional segmentation
While our preliminary findings focused on the high-risk tier, this kind of analysis can assist lenders in refining customer segmentation and identifying realistic, actionable next steps in prioritizing touchpoints and customer assistance tactics for customers in other risk categories. The table below provides some suggestions for engagement strategies you could consider.
Engagement strategies and tactical considerations for all risk tiers
To better prepare your organization for a potential downturn, speak to your TransUnion representative about strategies, tactics, and tools for enhancing your collections outcomes, or visit transunion.ca/solution/collections-and-recovery