As of June 2022, Americans held $16 trillion in debt. Nearly 3% of this amount, roughly $500 billion, was in some stage of delinquency – a sum that exceeds the entire GDP of countries like Austria and Norway. Despite this, many organizations still view collections as an afterthought, disconnected from the rest of the customer experience.
But we see the world differently.
We believe that both creditors and borrowers will benefit if collection activity is viewed as an extension of the customer lifecycle. Where creditors approach collections as an expression of their brand voice with the same attentiveness they paid to origination the loan. In this article we will outline why this approach leads to higher revenue and happier customers, and 4 concrete strategies your collections team can use today to improve their effectiveness.
Why should I care about delinquent loans?
Delinquent loans refer to borrowers that have missed anywhere from one to many payments. Creditors use delinquency "buckets" to understand what stage of delinquency a borrower is in. Where the first bucket means a borrower has missed one payment, the second bucket is two payments, and so on. The longer a debt has been in delinquency, the lower the likelihood of repayment.
When a consumer stops making payments on a loan obligation – whether that payment comes from a credit card, personal unsecured, or any other type of loan – creditors lose future revenue in lost interest and principal payments. While lenders accept the inherent risk of delinquency at origination, it is possible to reduce operating costs and increase the expected revenue of individual accounts by focusing on reducing delinquencies.
One way to assess the impact of delinquencies on a creditors' larger business is to analyze the lifetime value of the consumer (LTV), the cost to acquire (CAC) that consumer, and the relationship between the two. Simply put, the further a borrower moves into delinquency, the faster their LTV drops. A borrower in good standing will not only generate the full expected value of a single loan, but they are more likely to access future products, generating incremental revenue and thereby driving up their LTV.
That’s why delinquent borrowers represent so much opportunity. The rehabilitation of delinquent borrowers both increases the likelihood of initial repayment and the likelihood of accessing more of a lender's products in the future, driving the lender's near- and long-term profitability.
The rehabilitation of delinquent borrowers is not just a smart business model, it’s also the right thing to do. Often delinquent borrowers are people that have fallen on hard times and need their creditor to work with them to get back on track.
How to Collect Delinquent Debt
Creditors typically pull a combination of the three levers below to collect on consumer debt:
- Work with an external collection agency (digital agencies, traditional agencies, and law firms)
- Sell accounts to a debt buyer
- Run the collection activity in-house
This remainder of this post focuses on how to collect debt in-house, applying many of the lessons we've learned as a third-party debt collection agency. We cover four topics:
- Analyzing the state of delinquent accounts.
- Identifying which borrowers are most likely to pay.
- Determining a contact strategy.
- Tailoring financial arrangements based on a unique borrower's circumstances.
1. Analyze Current State of Delinquent Accounts
Shepherding delinquent borrowers back into good standing starts with strong data practices.
While delinquency buckets can serve as a reliable proxy for risk level, traditional means of bucketing are extremely reductive. Within each of those thresholds, there are borrowers in different circumstances with different needs when it comes to rehabilitation. More data leads to improved empathy and consequently better engagement with borrowers' unique financial situation Consequently, creditors have the ability to collect, store, and analyze data in order to interpret key trends around who have the best prospects for collection.
Analyzing the state of delinquent accounts requires two core competencies: (i) a reliable, centralized source of truth, and (ii) the tools to query and visualize data. With these competencies, creditors can evaluate where in the borrower lifecycle they are engaging successfully; where there is room for improvement; and how things like seasonality and macroeconomic factors are impacting delinquencies and recoveries.
These analyses can be open-ended, or designed to answer specific questions around the relationship between an intervention (like outreach over a certain medium or at a certain time) and an outcome (like reinitiation of repayment). We recommend conducting both of these kinds of analyses:
- Exploratory analysis: This is where creditors investigate the data without any preconceived notion, looking for trends that stand out. It can help creditors identify previously unknown, overlooked, or undervalued drivers of desired outcomes. For example, in one exploratory analysis our team conducted we found that borrowers with larger loan balances are less likely to make a payment on their loan, but more likely to successfully complete a payment plan if they set one up.
- Hypothesis-driven analysis: This is where you ask, investigate, test, and validate specific questions. It can help creditors corroborate and prioritize drivers of desired outcomes. For example, one hypothesis we validated recently is that borrowers that need more time between setting up their payment plan and when they make a payment are more likely to have payment failure.
2. Identify Which Borrowers are Most Likely to Pay
After creditors build a strong data and analytics foundation the next step is segmentation. We’ve found it useful to segment borrowers into groups based on their likelihood to pay, which represents the intersection of willingness and ability to pay. By focusing on borrowers with simultaneously high willingness and ability to pay, creditors are more likely to be successful in their collection efforts.
Creditors can evaluate willingness and ability to pay by looking at factors such as payment history, collections history, or proactivity in resolving the account. Treating these data points as inputs into a broader segmentation methodology minimizes wasted resources on collection efforts of uncollectible accounts. Instead, it allows creditors to focus on accounts with the highest possible returns and, most importantly, engage with those accounts in a way that creates the highest probability of successful repayment.
Why You Should Segment Borrowers, and How
Segmenting borrowers into groups based on willingness and ability to pay makes it possible to select appropriate communication methods based on effectiveness and cost.
The most straightforward framework is Value at Risk (VAR). VAR predicts the probability of a borrower moving into more serious delinquency/default relative to the size of the outstanding balance. The highest priority borrowers are those with high charge-off probability and high balance exposure. VAR segmentation also permits complementary analyses: for example. McKinsey discusses bolstering VAR segmentation efforts with behavioral segmentation, whereby creditors build quantitative profiles of customers within each segment – providing further clues into receptivity to different communications.
Accordingly, VAR is not just informative, but it’s also pragmatic. By allowing creditors to successfully sort and prioritize high- risk accounts, it helps determine optimal collection strategies, including how to best allocate resources, like top performing agents. Conversely, it can also help determine which lower risk and lower priority accounts – including those that can be resolved through digital communications alone.
3. Determine Contact Strategy
An effective contact strategy outlines communication channels, communication frequency, and how to improve communication effectiveness over time.
Having a coherent and deliberate contact strategy in place can increase recoveries, reduce cost of collections; increase right-party contact rates; and create a more personalized and compliant experience for borrowers. Through segmentation, creditors can optimize channels and outreach frequency, which reduces costs while maintaining effectiveness. Meanwhile, supplemental stratification – such as behavioral segmentation – can help lenders iteratively improve their communication effectiveness.
Using Email and SMS
Traditional debt collection practices have relied heavily on resource-intensive strategies like outbound calling and letters. Increasingly, collection agencies and creditors are leveraging digital channels to contact consumers about their outstanding debt. This change has accelerated due to behavioral shifts we’ve seen during COVID-19.
The shift towards digital and customer-centricity was further codified in November 2021 by the Consumer Financial Protection Bureau (CFPB) through Regulation F, which prescribed rules giving customers the right to specify how and when they want to be contacted.
Digital channels offer many benefits: they are low-cost, scalable, personalizable, and drive borrowers to self-serve without wasting resources. The data produced from sending digital communications also lends itself to experimentation and A/B testing, allowing teams to build strong product feedback loops. Email and SMS enable real-time monitoring of metrics like deliverability, open rate, and click rate, creating a deeper understanding of how borrowers engage or do not engage with communications.
However, digital channels are not a panacea.
There are considerable compliance concerns: creditors must capture and monitor borrower consent and preference. There are also technical challenges: for example, there are email-specific nuances like getting flagged as spam and managing sender reputation that creditors must attend to.
While email and SMS are the two most prominent digital channels, the use of web chat, direct voicemail drop, and even social media are also growing. These channels present additional heady and unique challenges from the compliance and technical perspectives alike.
At the end of the day, there must be a cohesive and integrated strategy across all digital channels for a contact strategy to work effectively. One such strategy is omnichannel debt collection, which offers tremendous potential as creditors juggle ever-proliferating options for outreach and rehabilitation.
4. Meet Borrowers Where They Are
All of that said, successfully analyzing, segmenting, and contacting borrowers is only half the battle. Because every borrower is different, creditors must also have the tools in place to provide a personalized, transparent and frictionless experience to actually facilitate payment once a borrower has engaged with a communication.
In other words, creditors must meet borrowers where they are.
Meeting borrowers where they are starts with respect. InsideArm talks about borrowers’ understanding, effective language/tone, and clear explanations of available options as the key components of an empathetic experience. It’s not just about how contact is made, but how it’s done. And it’s about the nature of communication engagement – not just the fact that an engagement occurred.
One particularly important strategy for meeting borrowers where they are is helping borrowers make payment arrangements suited to their individual circumstances.
We know that payment preferences vary widely. For example, some borrowers prefer paying online while others prefer paying over the phone; some prefer paying in small amounts, while others prefer paying in large ones; some prefer paying via debit, while others prefer paying via ACH. As such, flexibility and personalization should extend not only to payment frequency but also to payment channels; payment mechanisms; payment size; and payment duration.
Ideally, creditors can offer flexible payments through a centralized portal. These platforms, when well-functioning and thoughtfully-designed, can offer massive two-sided benefits. We’ve seen benefits
For borrowers, a portal can give them the relevant information, debt collection FAQs and even settlement offers to determine how to best resolve their unpaid debt – all through the click of a button. That’s important because, for borrowers, debt is personal, and they may well prefer to avoid addressing debt altogether than to speak with a human about it. Which means taking humans out of the loop is a need-to-have for creditors, rather than a nice-to-have.
Meanwhile, for creditors, offering robust self-service functionality can reduce inbound volume, scale operations more quickly and improve overall unit margins and capacity. In other words, it’s about sustainability – something that’s critical for successful debt collection and delinquency rehabilitation over the long-term.
These mutual benefits to borrowers and creditors alike make centralized portals a true win-win.
Partner with an Agency
Despite the benefits, developing all of the capabilities outlined above is time consuming and difficult.
It can be an uphill battle for creditors that lack a historical focus on delinquency rehabilitation; dedicated teams to make it happen; or the capacity or appetite to invest the requisite capital. Many creditors opt to work with collection agencies to bolster their strategy.
A debt collection agency is a third party that works on behalf of creditors to recover delinquent or charged-off debts from their borrowers. Working with agencies is less resource intensive and more feasible for many creditors than staffing up and managing a debt collection program internally. Instead, it leverages seasoned, experienced collection agents with deep knowledge of the industry and compliance requirements to engage with borrowers.
But, not all agencies are equal.
Debt collectors generate more fraud reports to the Federal Trade Commission (FTC) than any other industry. While most agencies comply with the Fair Debt Collection Practices Act, which the FTC and CFPB enforce, some bad actors engage in unfair practices and threatening or harassing behaviors that directly oppose federal law. Creditors can find themselves liable in such situations: since borrowers can submit a consumer complaint to agencies ranging from the CFPB and FTC to attorneys general and various state agencies.
The looming threat of liability makes it even more essential that creditors diligently compare potential partners before moving forward.
How to pick an agency partner?
The potential upside of delinquency rehabilitation and potential downside of legal entanglement mean that selecting a debt collection partner is no small task. Creditors care about minimizing reputational, compliance, and operational risk while enhancing net recoveries. Given this performance, pricing, compliance track record, operational oversight, and compassion for borrowers are all important metrics that creditors can use to compare collection agencies.
Performance and Price: Effectiveness of debt collection is an obvious characteristic to screen for when selecting a partner. But this is only one part of determining your overall return – because there are fees on the other side. While there are market fee rates depending on loan attributes (e.g., type, age), the range of feasible fees is a product of each collection agency’s servicing costs. As a result, creditors should not just evaluate gross recoveries (i.e., total dollars collected), but also net recoveries (i.e. gross recoveries, net of fees) because it represents the dollars being returned to creditors. All else equal, the agency with lower fees and higher net recoveries will be a more profitable partner.
Compliance: The compliance practices of an agency partner, and their associated financial/operational/reputational risks, directly impact the creditor. Especially in the wake of Reg F, an ideal agency partner not only has a strong track record, but also can quickly adapt to a dynamic regulatory environment. In that way, compliance is an ongoing battle: in order to minimize complaints, audit findings,and the like, flexibility must be a central element of a collection agency’s standard operating procedure..
Operational Oversight: Partnering with an agency requires management of account placements, communication reviews, ensuring the agency is adhering to all laws and regulations, and understanding the scalability of the agency. Scalability refers to an agency's ability to increase their rate of improvement in debt recovery rate at the same time that they serve orders of magnitude more accounts. Creditors seeking exponential rather than linear returns would do well to evaluate an agency’s scalability: placing a material number of new accounts with an agency should not result in a decline in the quality of outreach and communication, overall effectiveness, and regulatory adherence.
Compassion: In our experience, we’ve found borrowers are much more willing to work with agencies that show them respect and compassion. Moreover – since the boundaries between collection agencies and the creditors themselves can blur from the borrower’s perspective – the level of respect and compassion they’re shown reflects on the lender. Thus, treating borrowers well results in both improving effectiveness and brand protection.
Why work with a digital agency?
Traditional agencies face structural challenges that make it difficult for them to compete with digital agencies against these criteria. They are also more likely to upset borrowers with their intrusive phone calls and human to human interactions.
Since they staff up contact centers to place collection calls to borrowers, their servicing costs are inherently higher due to labor costs. Thinner margins make it difficult to compete on fees, resulting in higher charges and lower returns to creditors.
They’re also less scalable: in order to handle significant increases in accounts, a traditional agency would need to hire and train more collection agents. This would ultimately lead to even higher servicing costs and reduced effectiveness. In contrast, a digital agency can take on orders of magnitude more accounts without staffing up materially. Moreover, more accounts yield more data, which actually makes a digital agency more effective over time.
Finally, with more collectors comes a greater probability of human error, since even protocolized processes deteriorate with increasing degrees of freedom in how an agent conducts outreach or responds to inquiries. Compliance risk grows linearly with the number of agents and borrower phone calls placed. This increases risk exposure, and the amount of effort internal teams will need to take on to oversee the agency.
At January, the self-service capabilities of our platform enable our agents to handle 100x more accounts than a typical agency, as the vast majority of borrowers can resolve their outstanding debts without a human in the loop. This, paired with our automated compliance safeguards embedded in all digital communications, vastly diminishes compliance risk. These efficiencies lead to significantly lower servicing costs and ultimately lower fees for our clients.
And, since January’s portal lets consumers engage with collections on their terms, compassion is literally at the center of our business. That means happier borrowers, more engagement, and higher returns for our clients.
Reach out to our team today to learn more about how January can help your business with our debt recovery services.
