Loss Mitigation Requires Going Beyond Delinquency Rates

MBA (2/22/2008 ) Palaparty, Vijay
Financial organizations strive to minimize future losses considering current economic conditions and overall uncertainty in the road ahead. However, financial executives should look beyond delinquency rates to forecast future losses, according to an Atlanta-based Benchmark Consulting International report, Reducing Credit Losses in 2008.
“Collection and risk professionals generally believed delinquency rates could forecast future charge-offs and subsequent losses,” said Brian King, senior vice president and consumer, mortgage and retail practice executive at Benchmark. “As a result, many collection managers developed strategies, calling campaigns and organizational structures focused on reducing delinquencies. Contrary to this thought, low delinquency rate does not necessarily guarantee low losses and vice versa.”

Delinquency rates and losses are begging to grow apart, a departure from conventional collection theory, King said. “Strategies and technologies can be implemented that allow completely front-end or early stage collections from those found in the back-end or late stage (and beyond). The existing of independent strategies logically suggests independent results could emerge.”

In mortgage lending, delinquency rates and losses have been company-specific—also depending on different loan product offerings, King said. The rates were associated more with the company and their strategies, technologies and processes.

In small business lending, however, a true inverse relationship exists with charge-off rates being the lowest when delinquency rates were highest—a trend especially evident in the late 1990s when gaps were huge, as seen in the 2007 Risk Management Association/Benchmark Small Business Risk Management Study.

The credit loss report advocated a balanced approach with focus on minimizing delinquencies alongside implementing loss mitigation strategies. “The challenge that many organizations face in the near future is the negative impact of the current economic cycle and whether the strategies, processes and controls in place are adequate to best mitigate future losses.”

As part of the strategy, organizations should measure more than the dollar delinquency rate, the report said. Additional measurements such as account workload and dollars charged-off as a percent of dollars as delinquent could help manage losses.

“You have to measure it in order to manage it,” King said. “Due to the new relationship being exhibited between delinquency and losses, collection and risk professionals need to understand what the best indicators for losses are within their organization. Without measuring the appropriate performance indicators, it is very difficult to truly understand the root cause of your losses.”

In the 2007 study, more than 90 percent of companies reported collecting dollar delinquency rates while a declining number of companies actually accounted for the delinquent accounts per collections and other factors such as amount of dollar charge-off per delinquency and gross losses. All factors except the dollar delinquency rate and net losses rate measures declined by more than 10 percent between 2006 and 2007 alone.

“A critical success factor in the performance management area is to assign each account to the right resource—a resource that possesses the highest probability of success for resolving the current situation,” King said, speaking on process management approaches within the default management function. “It is important to understand the people, processes, policies and technologies being used for each collection activity to ensure you are maximizing the probability of success.”

Using human capital to potential is also a critical success factor, the report said. “Staffing levels and incentive plans must align appropriate skill sets and collector behavior with desired results.” For lenders with different products across lines of business, organizations should also measure and appropriately staff according to demand.

Organizational alignment is also important in loss mitigation strategy, the report said.

“Alignment includes the overarching risk management strategy, tracking and reporting/trend analysis,” King said. “The actual results of the default management areas should be inputs back into the credit scoring, pricing and profitability models. By having this closed loop feedback approach, other functional groups such as originations will be more closely aligned with the impact of actual default results on the entire organization.”