The Future of Consumer Lending: Big Need Means Big Opportunity

A significant market segment is emerging as a result of the financial crisis. According to a recent survey conducted by the Deloitte Center for Financial Services, 22 percent of Americans with bank accounts experienced a serious negative credit situation during the last two years, and 11 percent were first-time defaulters — consumers who had never fallen into delinquency before.

Tune into this episode of Deloitte Insights to learn more about the survey and the opportunity this new consumer segment represents for banks that can help them with their credit needs.

Guests:

• Andrew Freeman, Executive Director of Deloitte Center of Financial Services
• Deron Weston, Principal, Deloitte Consulting LLP

Transcript:

Sean O’Grady: Hello and welcome to Insights. Today’s topic is the future of consumer lending, we’ll discuss how banks may change their lending habits and the results of a recent consumer expectation survey. Our guests for this program are Andrew Freeman, the Executive Director of Deloitte Center of Financial Services. And Deron Weston a Principal in Deloitte Consulting and a man with over of 15 years of commercial banking experience.

To begin how has the retail banking industry changed since the start of the recession since 2007, Andrew?

Andrew Freeman: Well it’s changed a lot and you’ve used the key word, which is recession. You know America has been through a very difficult time, unemployment has risen, the banking system has been through a wrenching shock and life is just pretty tough. It’s been pretty tough for consumers. It’s pretty tough as the banking industry tries to serve those consumers. I think that, that the real dimension of change has been around the economy and the conditions that have kind of caused people the kinds of problems we have seen.

Sean: And Deron you agree?

Deron Weston: I do agree but with every challenge there is always an opportunity, and some of the work we’ve done. We found there is a pretty big opportunity for banks to take advantage of some of the things that have happened in the market with their competitors and some of the consumers.

Sean: So tell me a little bit about this survey, why did we conduct it?

Deron: So the survey originated with a small group at Deloitte. That we were trying to think about what’s going to be the next evolution of consumer banking. What are going to be the big opportunities, what are going to be the big threats or the risk to the industry? And we came up with a hypothesis that there’s going to be a dramatic change in something and we kind of zoned in, and had a hypothesis that there is a group of customers, bank customers that are experiencing trouble for the first time in their credit history, their credit lives.

And we really want to explore that and understand how big and how significant that was going to be. And surprisingly, well actually the results were not that surprising but the magnitude of the results were pretty surprising to us. What we found is 22 percent of the entire population based on our sample size of bank customers had experienced a negative credit event in the last 24 months. And that’s pretty significant, that’s a very large number.

And what was even more dramatic was 11 percent or 1 in 10 of those customers this had happened for the first time in their credit careers. So we, that was very surprising to us, and we looked a little deeper and it became even more surprising where this group of 11 percent you know, about 60 percent had a credit score of 620 or above when this event happened. And this is a pretty negative situation, [unint.], and if you know anything about the banking industry, a 620 credit score is usually considered a pretty low risk customer. A very low probability of default. So it’s pretty dramatic what we found in this survey.

And it really shaped what we think is probably an opportunity for retail and commercial banks going forward.

Sean: And Andrew your initial thoughts on this survey?

Andrew: Yeah, I think what we were really trying to test in general too was just what kind of experience have consumers been having? That bank customers have been having as the country went into recession, and then has been coming out. What’s the customer experience been like and how have they been varying? I think this discovery, that quite so many of them are actually faring, having a pretty tough time. There in some kind of default or delinquency, and in some kind of workout situation with their bank is pretty striking.
I mean it’s such a large proportion of bank customers. So that takes us back to thinking about the impact of the recession around, these are people who maybe lost their jobs, in a surprising number of cases, it’s people struggling to pay medical bills. So there are lots of different that can cause even like prime customers to get into the kind of trouble that we identified.

Sean: Just for clarification that person who runs into problems for the first, that’s called a first-time defaulter?

Andrew: Right. If they’ve never had a credit problem in their history until the last 24 months, we’re calling them a first-time defaulter. So for every one of them there’s another defaulter who perhaps may have defaulted 4 or 5 years or further back in their financial history. It’s the striking thing about, is how quickly this extra population of first-time defaulters emerged once the recession began.

Sean: Now how big is that population and how is that population changing the way these banks are doing business?

Andrew: So if you step back and just think about those numbers, we’re saying that across the bank customer population as a whole, one in 5 of them is in some kind of trouble. And half of that group are in trouble for the first time, well out of all the bank customers and we’re talking millions of people across America, and one way of thinking about that is to think about all the millions of people who are in some kind of trouble with their mortgage for example. They’re either late on payments or at the extreme end of the spectrum, they’re in maybe in foreclosure or some kind of foreclosure with their lender. So it’s a really significant population.

Sean: Deron, your take on this?

Deron: Right like I said earlier, you know it’s a challenge in the industry. But it really is an opportunity. It’s an opportunity for banks to help these consumers to repair their credit. It’s an opportunity for them to take share or to take market share from their competitors that are not necessarily focused on this group. And it’s also an opportunity for banks to help us through this economic recovery by targeting these customers and helping them with their credit needs. You know the banks are going to have change the way they do business in a couple of different ways. If you think about in the origination side which is how they acquire and make decisions of credit risk on customers.

First they’re going to have to identify these customers, which is not that big of a challenge. There’s lots of data out there, credit bureau data, which they can use to find these customers, which have defaulted or had a bad credit experience in the last 24 months for the first time. So that’s not that, that challenging. They can solicit these customers through mail or you know internet or phone type of marketing campaigns that’s very consistent you know, traditional marketing campaigns.

Now where it gets challenging in the origination front is how do banks underwrite? Or what the industry calls deciding if that is a high risk or a low risk customer. That’s a challenge and it’s not a new challenge for the bank. But it is kind of new at this point because they have a different type of customer. This is somebody that’s defaulted for the first time and it may have been for things just beyond their control.

Things like you know loss in job or real estate plummeted in their particular market and it just may not be something that’s going to be permanent in their credit history. So banks may want to think about that and underwrite or manage that risk or assess that risk in a much different way than they have in the past. Instead of forward, instead of backward looking they may want to now think about forward looking metrics or predictive modeling to help understand which of those customers is going to be a tolerable risk versus somebody who is not. So that’s a major change they may have to make when it comes to thinking about how they’re going to retract and retain and target this customer.

Sean: Now this survey also showed that consumers are open to the idea of getting multiple services from the same bank, how does that change the way the banks are doing business Andrew?

Andrew: That’s less of a change than you might think. Banks have been to trying, what’s called cross sell, sell more than one product to their customers for a generation. It turns out it’s a really tricky business challenge. First of all the market is extremely competitive, particularly on things like credit cards, and products which are really national markets. It’s proved a pretty tough challenge. One of the things we have found, again it may be a feature of how people are feeling as a consequence of the recession is they may be more willing. They may be slightly more willing to narrow the number of different financial relationships that they have. So again there is an opportunity for banks there who get their marketing right, who get that customer experience right, may be to form deeper relationships with their customers. And I think this goes back a bit to the question about how banks are going to changing how their managing their customers. So in the traditional model if you had a customer who went into default, you probably had a pretty blunt way of how you dealt with them. And one of the features of the first-time defaulter population is it’s so big you don’t want to treat them all the same way. You want to really work hard to figure out which ones might recover and which ones therefore are, you really want to work with and deepen the relationship with as opposed to which ones that may look like they are stuck in credit trouble for an extended period of time. So it’s really thinking about your customers in a kind of more subtle way and with an eye to the longer term relationship with in which it links to the questions if you want to sell them more products, you also just want to have a better relationship with them.

Sean: Deron your take on services?

Deron: Well I have to agree that, you know the banks in this situation when they have customers that are in the default situation may have a tendency to use that blunt force or they call it loss mitigation where their primary goal is really collection. You know they’re trying to recover the money that they have loaned to this individual before it gets even worse. And that’s a tendency that may not reflect well on customer experience or customer service as you can imagine. But that really creates an opportunity again for the institution or the bank, you know, the company that can understand that this group of customers may not be a permanent credit risk. If they can potentially shape their customer service strategies to understand really what the needs of this customer segment are and not alienate them and push them away from their institution they could potentially retain those easier and also they may have a better competitive advantage over their competitors when they’re pushing these type of customers out of their banks.

Sean: So I was going to say, so rounding out on this idea of customer service that you just touched on, what does the survey say about satisfaction and loyalty? Andrew?

Andrew: I suppose the clearest thing it said that in general the customer base of banks according to our study is not a happy bunch. And is not surprising again given that we’ve come through a recession. I think within that overall levels of satisfaction there is a difference between kind of smaller and regional. According to our study, the regional and local banks tend to have higher satisfaction than the very big, the super regionals, and the very big nationwide banks. And I guess you kind of expect that in a way just because the whole or a big part of the appeal of those smaller and local banks is usually predicated around their local characteristic, their local nature. They tend to have kind of smaller product sets and a different position in the market.

I guess they tend, because they’re often community based to be a bit more trusted to the people that they’re lending to. So those findings were pretty clear from the survey that we did, they’re not as striking in terms of the something, real development in the market as the first-time defaulter segment which I think was the real, the real kind of surprising finding from the survey that we did.

Sean: And Deron you get final thoughts on loyalty and satisfaction.

Deron: Right. So I’ll focus on loyalty. But if you think about this group of first-time defaulters, right. They were having trouble, they are in a default situation. If the bank will help them through that situation, I’m not speaking in terms of you know principle reduction or anything that dramatic. We just help them understand, maybe give them access to a different type of credit, maybe an alternative product like a secured credit card or some type of credit counseling they have a chance to make a lifelong customer.

I mean retail banking is usually described as a commodity based business and it has been for many years. But this is a chance to differentiate a bank or a lending institution for a customer, and keep that customer and their family potentially for many, many years to come. This again, I want to stress as an opportunity for organizations that recognize this segment and target it and understand how to deal with it.

Sean: So customer service is key. Gentlemen thank you very much. We’ve been talking about the future of consumer lending with Andrew Freeman the Executive Director of Deloitte Center for Financial Services and Deron Weston a Principal in Deloitte Consulting. If you’d like to learn more about Andrew, Deron, or any of the topics that we’ve discussed on this broadcast you can find more information on our website, It is www.deloitte.com/insightsus

For all the good folks here in Insights, I am Sean O’Grady. We will you see next time.