Use a 'No Regrets' Approach to Frame Your COVID-19 Response
If you’ve been keeping up with the AQN blog recently, you’ve likely noticed a recurring theme: COVID-19 has the world of lending facing unique, unprecedented challenges. We were virtually catapulted into the next recession, one that will impact the lending landscape much differently than any other we’ve previously faced. Some have said the economic fallout resulting from the pandemic will more closely resemble a natural disaster (think Hurricane Katrina) at the national level than it will the 2008 banking crisis. With little solid data readily available and a whole lot of uncertainty, banks are scrambling to respond to the crisis.
As a consulting firm specializing in consumer and small business lending, we’ve had ongoing crisis-related discussions with dozens of clients and experts across the industry. The question at the center of these conversations is always “How badly will this impact lending?” Both sides of the debate are offered up without meaningful stances taken, as if lenders are balancing weights on both sides of a scale. Well, unemployment is off the charts, but so is government assistance. The country is starting to open back up, but some businesses have closed their doors permanently. A single party can find themselves arguing both positions, ultimately ending up back at square one with a “wait and see” approach.
The current economic crisis is largely driven by the health crisis, and there are many parallels worth noting. When the virus first made its way outside of China, world-renowned epidemiologists couldn’t even agree on the magnitude of the impact – will it impact 1% of the world’s population? 10%? 25%? Economic experts leading the world’s largest financial institutions have forecasted a similarly broad range of GDP impacts – as low as 6% and as high as 24% in the second quarter with a GDP rebound as soon as this year and as far out as 2022. The outcomes don’t suggest much reason to believe in these forecasts either. Economists had predicted a loss of 7.5 million jobs in May, only to see payrolls increase by 2.5 million instead. This brings me to the only logical conclusion – it’s impossible to know what the next few months will hold.
With the lack of consensus among industry experts and a wide range of seemingly probable outcomes, it can be difficult to build a path forward with confidence. Unfortunately, I’m not here with a bulletproof go-forward plan – if I could predict the future, I’d be nestled away on my own private island living off of the millions I made from betting against the world economy earlier this year. Unfortunately, Amazon does not yet sell a reliable crystal ball.
What I can offer is a list of no-regrets actions you can take today to be ready for the future. In recent discussions and engagements with clients from across the lending spectrum, we’ve focused not only on managing their businesses today but also on preparing for tomorrow. These steps, regardless of how many unknowns there currently are, will help ensure that your lending business is well-positioned to hit the ground running and thrive in the post-COVID world.
Figure 1 — Diagram of the continuous integration cycle for a unit economics approach to lending.
Figure 2 — Results from a Credit Line Increase test where different CLI amounts were tested across various segments.
Unit Economics and Monitoring: Strengthen your building blocks. In sports, the ability to execute sophisticated techniques or strategies relies on good fundamentals. Lending is no different and requires the same commitment to building out core capabilities before you can reliably deliver against larger challenges. If you haven’t done so already, developing an understanding of your unit economics supported by a comprehensive monitoring suite should be your starting point. It will enable strategic, data-based decision making and drive the ability to implement a test-and-learn approach (Figure 1), develop horizontal economics, and understand segment sensitivities to different treatments (Figure 2). An investment in these will pay dividends through the crisis and beyond. For further information, check out AQN’s unit economics case study
Economic Outlook: Take a (dynamic) stance. Decisive leadership is more important now than ever, and it begins with having a determined stance on what the coming months are going to bring. While we discussed that many lenders are shying away from developing a strong opinion on this topic, leaders in a time of crisis need to take their stance. Having a projection of where the world is heading is necessary to drive decision-making in the coming months. Every action you take – the decision to restart originations, alter your pricing, or increase training of collections agents – should be informed by what you believe will be happening on a macro-level.
This stance should also be dynamic. We encourage you to reevaluate your outlook as the world evolves and more data becomes available. A great leader in these challenging times will embrace both of these elements – the ability to provide a stance that gives broader direction to the organization while remaining adaptative. A great organization will understand this and recognize that frequent change is a means of incorporating the best available information and not the result of flippant leadership.Learning Agenda: Know your limits (and how to monitor them). The availability of data, both within lending and the world more broadly, has never been higher. The increased amount of data available creates nearly endless opportunities to leverage new and unique sources of information in creative ways to gain a competitive advantage. However, this volume of data can often become a distraction, diluting “what matters” beneath an endless pile of Tableau views.
In this new world, your lending business will have to be more focused than ever, and that requires honing in on key performance indicators. In order to make timely decisions in a rapidly changing environment, you need to know what data will drive those decisions, the frequency at which it is available, and any relevant constraints. You need to develop a learning agenda – a cohesive understanding of the strategy you are executing, the potential risks, and how you will monitor those.
Your learning agenda should inform incremental views you develop for your monitoring suite and will likely change during and after the crisis. For example, you may want to start monitoring delinquencies weekly, rather than monthly. You may want to take a closer look at autopay turn off rates to better identify which customers are struggling. Once we’re through the crisis and acquisitions begin to ramp up again, you should keep a close eye on performance of newly acquired accounts to ensure your models don’t have any blind spots that can be improved.Credit and Modeling: Get back to basics. The benign credit environment of the last ten years has allowed lenders to evolve into incredibly sophisticated machines. Credit policies are informed by models with hundreds of variables and valuations span an equally large number of segments. Even the sharpest minds in credit would struggle to articulate the logic behind some of the nuances in different product offerings for these segments. All of that is no longer relevant. Your credit policy, your segments, and all of that hard-earned data is no longer viable. The world has changed in a meaningful enough way that it is going to require a significant restart in approach by lenders everywhere.
Get lean and comfortable with the uncertainty. Credit policies will look much more like first passes, guided heavily by intuition. Old models can be thrown out the window, and new ones will take time to develop, leaning on data that does not yet exist. Product offerings will have to be simplified and more conservative in some instances. This isn’t downgrading or losing an edge – it’s adapting. For more information on this topic, check out Rapid Credit Model Degradation.
Beef up your Collections practices. As mentioned in our most recent blog post, a strong Collections practice will differentiate lenders throughout the crisis. With the rising delinquencies and higher competition from lenders to collect on debt from the same customers, you’ll want to ensure you stay top of mind for customers who are behind on payments. Developing strong digital servicing and varying your approaches (contact frequency, channel, and offering) for struggling customers based on thoughtful segmentation can both develop goodwill and prevent customers from charging off before they’ve been able to recover financially.
We hope these no-regrets actions help you build a path forward. If you have any questions or would like to discuss implementation of these items, please don’t hesitate to reach out. AQN is here to help our clients survive the crisis and thrive in its aftermath.