As we go through the traditional Janu-worry season, fretting about how to pay off our December bills, let's take a step back and look at the big picture. What we see, as a company that works with lenders and debt collection agencies worldwide, is that the financial services sector has a lot to be Janu-worried about. In fact, many of them should be Febru-worried as well.
It is interesting that all but one of the top South African banks have dropped in their rankings against the top 500 banks globally. It may well be that FNB (FRG) have held their position, given the ranking is based on capitalisation, as a consequence of both recent increased holdings in some of its group companies and its continued strong performance with regards to NPL (non-performing loans) management. However, all the other main banks have no doubt been adversely affected as a consequence of both continued foreign exchange pressure and the significant increases in non-performing loans (NPL) YoY, costs resulting in large part from the adoption of IFRS 9. (Source: https://brandirectory.com/rankings/banking/table
). Consumers are overindebted
Consumer spending is down YoY as a general trend, with the exception of Black Friday. But even here it is not the case that spend has been through even use of facilities across the banks. Whilst some banks saw 100% increase in spend on Black Friday, others saw a reduction YoY. Credit consumption continues being used to purchase the ‘necessities’ more than the luxuries.
South Africa has for some time been one of the most overindebted markets in terms of consumer debt. The pressure on the household wallet is high — between 30% to 75% of income (for different segments) going towards servicing debt interest alone. That coupled in with increasing fuel prices (15% YoY and all-time highs in 2019), multiple years of double-digit increases in electricity tariffs, lower salary increases (private sector 1.0% growth YoY – all-time low) and increasing unemployment rates (29% in 2019 – all-time high) is placing the consumer in an almost impossible spot to prioritise servicing their debt.
Consumers are increasingly relying on expensive credit from multiple credit providers to simply get by, and debt review/debt counselling companies are receiving increased higher referral volumes. Reports show that the debt-to-income ratios of customers within debt counsellors have been at an all-time high in Q4 2019. When it rains, it pours
Everybody has been expecting an economic downturn for some time and it is finally arriving. The issue with a highly active credit market in a downturn is that everything and everyone is extremely sensitive to slight changes in affordability.
This poses a difficult problem for lenders. Reports show that the NPLs at the major banks have increased from a national average of 2.8% to 3.8% YoY, placing additional focus on the collections and recoveries (C&R) functions.
There are other challenges for the C&R functions:
- DebiCheck means lenders now need to seek customer authorisation for the re-instatement of rejected debit orders. Making contact with clients and negotiating a respectable commitment to pay their debt has become more important than ever and consumers avoiding telephone contact remains an ongoing challenge.
- The financial services industry has been slow to adopt sophisticated collections analytics and customer engagement technologies that can improve management of overdue customers. This will be a critical requirement if creditors are to move from a focus on simply increasing productivity to understanding what truly influences impairment.
Many many firms have seen ‘productivity’ (maximum number of worked accounts) as the key to collections. But here’s the rub: as bank-specific factors (e.g. IFRS9), increased analytic insights and digital channels drive down the cost of collection for the banks, the third-party sector will be challenged to follow suite. That means better use of technology, and first movers will reap significant rewards.
IFRS 9 regulation has increased the cost of debt tolerance, with increased impairments for overdue accounts up by as much as 40%. This puts pressure on the level of financial tolerance a bank can extend to customers, which then increases the likelihood of debt review. Where debt collectors use relatively unsophisticated analytics to both validate and construct a solution that assures a right outcome for the customer, then they slow the ‘return to financial well-being’ of customers who might, with the right instruments and guidance, be able to clear their debt and repair their credit quicker.
- The debt collection industry has not significantly changed its approach to debt collection, and the debt counselling sector has yet to mature. Not-for-profit debt counselling is limited, and debt counselling charges the debtor fees, thus prolonging the period of indebtedness for the consumer.
- The third-party external debt collections (EDC) industry does not seem to be gearing up to be the true strategic partners the creditors will need to release both NPL and NPE (Stage 3) customers through debt sales at a far greater rate than ever before. We are not seeing the amalgamation of the smaller EDCs to create scale, nor the investment in performing loan software and advanced analytics capabilities that is the case in other markets going through similar challenges.
Clearly, there are challenging times ahead. The race to the customer’s wallet
Credit institutions are very aware of these challenges. Most large creditors are exploring the means to enhance their arrears management efficiency and effectiveness. Several are looking to move into digital collections and harness the value of their data for the purpose of meaningful insight from predictive analytics. It’s fair to say some are slow moving and in the current climate, with the punitive impact of IFRS9, the adverse balance sheet impact will be significant for those less effective at collections.
The new lenders have understandably been very focussed on growth but must also make sure that they can manage important back-end processes like collections. Here we see a range of focus, from market-leading through proactive to nonchalant. The last group may well struggle to the point of unsustainable business in the not-so-distant future!
Interestingly, the point-of-sale creditors, which include some of the most sophisticated in terms of credit data science and customer management, are not necessarily recognising the impact that IFRS9 will have on them, as they do not need to adopt the reporting practice. That’s worrying, as the customers of these retailers are also customers of the banks, which do need to change their collections capabilities due to IFRS 9. There is typically only one wallet per customer. If the retailers do not keep up with the banks, they may find themselves last when it comes to securing successful collection. Who will hold onto the economic victims?
One final note: We are also not seeing the drive to identify economic victims, set appropriate policies and adjust treatment where needed. There is plenty of evidence that an economic downturn creates a cohort of customers that are not seen in collections in good times. These people behave very differently from the norm — they don’t ‘know the drill’ of dealing with overdue debt — and in past recessions banks have seen a premature haemorrhaging of these ‘good customers in bad circumstances’.
Severe debtor impact in mature downturn markets typically drives regulatory action to protect the consumer, and this is more likely now in South Africa than ever in the past. However, these protections typically change the payment hierarchy (the order in which people pay their bills) and can even lead to a ‘strategic defaulter’ segment (people who choose to default on a house that is ‘underwater’ — has negative equity — even though they can afford the payments).
The organisations with agile, more progressive collections teams will be able to accommodate such moves, identify strategic defaulters among economic victims and treat the customers in a way that mitigates credit losses, whilst creating loyalty in the future good customers. In a saturated market, this is critically important, as creditors will need to have these profitable customers back when the economy strengthens.
There’s a lot to play for, and the pitch is rough. Creditors and debt-collection agencies that think they can muscle through this the way they have in the past may find themselves on the losing side.