Lenders, like all businesses, in the weeks immediately following the outbreak of COVID-19 have been in fully fledged crisis mode. In an unprecedented crisis like this, long-term plans are immediately dropped, and everyone is rallied solely around solving the immediate problem. To survive this crisis, lenders have been focused primarily on four areas:
1. Business Continuity
Transitioning an entire workforce to Work-From-Home overnight is no small feat. There is added complications with third party service providers like collection agencies whose internal privacy controls are not portable. What I have observed is a lot of creative means being deployed to get operations back up and running as quickly as possible.
2. Emergency Relief
Lenders, in concert with the government, have moved quickly to offer emergency relief to their customers who have been impacted by the shutdown. Over 10% of mortgage owners have taken advantage of the programs offering up to 6 months of deferred home loan payments. Most lenders also ceased outbound collections activity and have worked with the credit bureaus to ensure the way they report loans with deferred payments will not negatively impact credit scores.
3. Extreme Pullbacks
In normal times, lenders make thoughtful plans to expand or contract credit policy as we move through the economic cycle. In the case of a Black Swan event such as this, it is all about moving fast and forcefully. Lenders have pulled back almost entirely on performance marketing; credit card advertising on Facebook, which is usually one of its larger spend categories, has dropped basically to zero. Blunt force changes have been enacted by raising score cut-offs and instituting new hard cuts. New credit card acquisitions were down over 60% in April as a result of these changes.
Lenders have also had to scramble to conduct scenario analyses and estimate their new funding requirements given the impact of the crisis on their financials. For transactor portfolios, revenue has been hit hard; credit card spending was down over 30% in April. It has been trickier to forecast credit losses with all of the deferred payments, but all lenders are forecasting some degree of a loss bubble in the latter half of the year. The double whammy impact of lower revenue and higher loss provisions is dramatically lowering earnings forecasts and putting pressure on securing additional lines of funding, especially for smaller lenders that are reliant on external financing.
All of these steps were necessary given the massive uncertainty and the sweeping economic impact of the worldwide shutdown. The decisions made and the actions taken were done with the emphasis on speed, not optimization. It always amazes me how much faster decisions can get made when you have a burning platform.
Now, it seems like things have stabilized just a little bit and the attention is starting to shift more to the future. While we are far from being out of the crisis, the conversation has started to shift from, “what do we need to do right now?” to, “what is our plan going to be for getting back into the market?” This is a really interesting conversation for a few reasons:
- The situation is still rapidly evolving each day and there are so many unknown variables as to when the virus will be fully under control;
- The resulting recession (whether it meets the technical definition or not) is very different by nature from prior ones and past heuristics may not be applicable;
- The world we will re-enter into will be different to some degree: some things will be different for a period of time, and some things will be permanently changed.
All of which means that the traditional approach to strategy – creating precise predictions of the future to chart a course – will not be effective given the uncertain environment. A new approach is needed.
Planning for Uncertainty
In the latter half of last year, I wrote an article on Preparing for the Downturn. That was based on my belief that we were nearing the end of an historically long bull market and things would eventually turn, as they always do in the Economic Cycle. I had never even heard of the term “coronavirus” at that time. Needless to say, this is not your typical cyclical recession, where economic indicators slowly bubble up over a number of years. To illustrate, we can look at the number of days for the S&P 500 to go from peak to trough: in the 2001 recession, it was 929 days. With COVID-19, it was 33. A recession caused by the unforeseen sudden shock of a global pandemic is very likely to have a dramatically different recovery pattern from prior recessions.
There is a lot of debate about whether this will be a V-shaped recovery (a sharp decline followed quickly by a sharp rise) or a W-shaped recovery (a second decline after the initial recovery, otherwise known as a double-dip recession). The stock market is clearly pricing in the former; as of today, the S&P has roared back to a level less than 10% from its peak (which I would argue was already overvalued). On the other hand, we don’t know what the lasting impact will be from record high unemployment, even if the majority of it is temporary; there are now over 40 million jobless claims in the US, with a 5% decline in GDP in Q1 (and that is a quarter where the majority occurred pre-crisis!). And, of course, the biggest wildcard is whether governments’ plans to re-opening their regions will be timed correctly or will lead to a second wave of coronavirus.
As a lender, predicting the future can be a futile exercise even in a non-coronavirus world. Now, it seems impossible. What is a more effective strategy is to plan for multiple scenarios and continually reassess which is most likely as new information presents itself, and then you adjust your marketing and credit strategy accordingly. That might lead to turning the taps back on for a period of time only to have to pull back again if we do experience a second wave of the virus or a slower economic recovery. But given the wide range of potential outcomes, it is a better approach than going all in on a best-case or worst-case scenario.
Adjusting to the “New Normal”
As lenders start to plan for re-entry, it is not simply an exercise in tightening or relaxing credit this time around. For many, there will be fundamental changes to their business model – the “new normal” – that will likely persist for some time. Those lenders relying on face-to-face sales channels will feel this impact the most. Traditional lenders have been trying for years to transition their acquisition strategy from one driven by branch or in-store traffic to online, with limited success. Many of them have struggled to meet their targets for volumes and cost-to-acquire (CTA) through digital channels. Now, the stakes will be even higher to develop expertise in digital marketing, as many of their traditional vehicles for new account generation will be severely impacted from social distancing and changing consumer habits from the pandemic. For some, this might actually be a silver lining if it is what finally forces them, out of necessity, to invest in digital marketing optimization and they can finally crack the nut on how to make online a highly scalable and profitable marketing channel for their lending products.
Organizing for Success
For any re-entry strategy, there is both a “What” and a “How” component – what decisions you will make, and then how fast you can get those decisions into market. Market timing is critical; as a lender, you want to be the first to pull back before credit conditions deteriorate, and the first one back in market just before credit conditions improve. This agility is especially valuable in the unique case of COVID-19, where the situation is evolving so quickly.
What factors typically impede the ability of lenders to implement decisions quickly? The first is technology; many are still in the process of transitioning from legacy systems to modern architecture. The second, and often overlooked, is organizational design.
Traditional lenders have historically been organized by function, such as product, risk, operations, marketing, technology, and finance. This design works well for creating checks-and-balances but not so well for business agility. Trying to coordinate a cautious re-entry into the market requires making orchestrated changes to marketing, credit policy, operations, and technology. It can really slow you down if you need to coordinate with different functions for approvals and resources. Not to mention that functional design often leads to teams with very different goals and objective functions.
More and more companies are recognizing this and starting to organize by customer journey, with cross-functional teams that are aligned with shared goals. A good example of this is having a Customer Acquisition team, with representation from each of the key functions, that has shared and balanced goals, including growth, risk, profit, and customer experience. This creates incentive to re-enter the market using integrated decision-making, rather than one-dimensional views on maximizing accounts or minimizing credit losses.
Lenders that aren’t organized this way today should consider using this as an opportunity to start. Creating a “Cautious Re-entry” SWAT team of cross-functional team members, focused on the customer acquisition journey, will not only elevate the importance of the initiative, but also lead to more holistic decision-making and faster implementation.
Getting Started Today
Dwight D. Eisenhower famously said, “What is important is seldom urgent and what is urgent is seldom important.” This perfectly encapsulates why lenders will struggle with the shift from crisis mode to long-term planning for re-entry. Dealing with a crisis is not fun: these have been incredibly stressful times for many, with long hours and tough decisions to be made. But prioritizing it was easy – you had no choice. Now, we need to start stretching the planning horizon, to be ready to get back into market in a thoughtful way. And that means prioritizing the re-entry strategy to give people permission to spend the time and mind-space on planning for the future.
At Payson Solutions, we have experience with this and have been helping lenders with their re-entry strategy. We have deep expertise in consumer and business lending and can help lenders think through the design and approach for re-entry, as well as how to leverage their own data to better inform their strategy.
The most amazing thing this crisis has highlighted is the resilience of the human spirit, as people have rallied together to support their colleagues, friends and family members during the difficult transition. This leads me to believe that we will come out on the other side of this stronger than before. And now is the time to start preparing for that.