Responding to the new environment: Credit risk looking to the future – [FULL INTERVIEW]

0:01
So hi, everyone. I’m here with Damien Burke today, and Damon’s our partner at foremost, and he’s specialising in credit risk modelling. You know, another sort of insight in really, across the credit industry. So, Damien, thanks very much for joining me today. No problem. So, so I thought would be interesting, you’d have quite an interesting perspective, just given what your background is, in terms of what you’ve seen from taking from a credit risk point of view and some of the thoughts with a modelling point of view over the last sort of 18 months. I mean, how have you sort of seen that changed, and we were chatting a little bit earlier around, you know, the fact that it just seemed like it really busy at the start operationally, and then it’s sort of like, but then there’s been a lot of sort of, like, credit risk kind of questions, I suppose.

0:41
Yeah. So I think our clients real initial focus was was operationally you know, how do we get people working from home? How do we make sure that we’re able to sort of service our customers, and there was a lot of expectation from the FCA on that in terms of, you know, making sure that that those banking facilities were still operational. I think probably after about four to six weeks that that kind of changed a little bit. So some of it was driven, obviously, by the PRA, and FCA guidance on the moratoria, payment, holidays, and that sort of stuff, the kind of upshot of all of that was, you know, there was then kind of more guidance around what does it mean for provisioning, for example, so what my, you know, traditional kind of sage to trigger for those that aren’t living and breathing IFRS nine, effectively means that there’s been a significant increase in the credit risk of the underlying assets. So the loan itself may not be a trigger, in COVID times a payment holiday, it could even have been a forbearance trigger, and a stage three or default trigger. And obviously, that wouldn’t be appropriate going forward. So there was a lot of kind of operational changes, and actually just just getting some of that kind of tied up. And there was also an awful lot of change around the kind of customer interaction. So frankly, they had to spend the time initially on EMI, they wouldn’t have to consider before or, you know, sort of, you know, sort of more online self service tools so that the customer could input some of that information without necessarily speaking to a customer services or collections agent, for example.

2:32
So I didn’t notice that. I mean, there was a lot of sort of, like extra revisions that were basically put in as a result of, I suppose, the payment holidays that came in, and it seemed like there’s a lot of uncertainty in the early days. And I saw some reports in the recent bank results a lot. That seems like that’s got released, you know, in recent times. I mean, is that thing did we just like overcautious? Also with that? I mean, are we under cautious now? I mean, is there any kind of risk in terms of where we sit today?

2:56
I think the level of cautiousness really came around from from the level of uncertainty, right? The whole way through the pandemic, we’ve never really been able to say, with any, any real confidence. So what’s going to happen in the next, even three to four weeks? So you talk about, or you think about, rather than situation at the moment, I think it’s on the 21st of June, everything’s supposed to open up. But yeah, we’ve had different variants, being present, and, you know, different levels of vaccination across the country and all of those. So, you know, probably today, we would say, I would say personally, and that, you know, I’m 90% sure that that things will open up in the three quarters away to through June, but it might not. So anytime you introduce uncertainty, in terms of those financial results, it’s going to introduce caution it has. And the financial reporting isn’t supposed to be about being proven, you know, it’s supposed to reflect expected losses. But there’s ways of uncertainty in how you calculate those things. So, again, for those that haven’t been living and breathing, IFRS nine is based on, you know, multiple economic scenarios and different degrees of severity of those economics scenarios, and different theories of likelihood of those scenarios. So those are all things that people will have been dealing with and trying to understand. The other thing we’re seeing that and probably what’s changed more over time, both from an operational perspective. So a regulatory perspective is that these lenders are looking to understand what these changes mean. So, you know, IFRS nine was introduced in 2018. And you know, not firms had at time to do some some level of parallel running. Others maybe didn’t, you know, and with as with any, any project, you have to make assumptions along the way. So, you know, I think some of our clients would probably say, if they looked back today versus, you know, what they did in sort of 2018 2017, in the run up to IFRS, nine implementation, some of those assumptions may not have borne out and they need to take another look at, well, what does, you know, what’s the impact, say of it taking, I don’t know, two days to run your IFRS, nine calculations in 2018, that might have been? Well, that’s fine. Because effectively, we start the process on working day two, and we need to report by working before so to more than acceptable, if it’s two days, but you also need to run five different scenarios, because 2021 is so much more uncertain. Maybe that’s not acceptable anymore. Yeah. And I think, you know, the other things that they’d be looking at, and indeed, we’re working with clients at the moment is the DMI that comes out of it. So, you know, we can all predict for people may want to see from a, you know, an accountancy perspective, or a credit performance perspective. And that once you live with something over the course of three years or so, you’re going to start finding that actually, there’s other pieces of information that would be burning. And there are other pieces of information that that actually would drive private, different also, kind of operationally it’s a learning process. And I think, you know, regardless of the pandemic, people would still be looking at their solutions now and saying, Well, actually, where can we make changes? Where can we make this more useful advice? I don’t, I don’t think necessarily there’s there’s a lack of caution in any current results. And I think, actually, you know, probably a number of auditors would have maybe a thought there was an abundance of caution in previous results. But, you know, firms, obviously, you know, in the round, it’s probably better that firms are more cautious than less cautious, particularly with

7:21
uncertainty. And I mean, a raise levels have been fairly benign, actually, I think, because of the mean, really, because of the government support. I mean, what’s, what’s your kind of view on that sort of looking out? As we stand here today? Sort of, you know, six, nine months? What, what’s your view on a raised level,

7:37
what we’ve done to a degree is, is is, you know, squash that some rare, it may mean me slightly lower, and slightly more spread out. And, you know, I know your, your, your backgrounds heavily in collections, as was mine, you know, a lot of the time when we were dating, we were dealing with customers, it wasn’t necessarily that they needed a one specific action would fundamentally change their prospects in the short term. Typically, people needed time to recover. So as an example, if you lose your job, and that that’s fairly unexpected, whether that’s, you know, fired individually, or whether that’s because your company is closed down, you need time to find another job. And a lot of people we see in collections again, as you well know, and their income generally, is fairly irregular. Yes, yeah. They might rely on on overtime, for example, or they might rely on bonuses.

8:47
It does feel as if like, I mean, at the start, we were almost like, everything was very sort of gloomy, and it was pretty doom and gloom to sort of happen. I mean, the government stepped in with the support schemes, which definitely move things on, but then we’re waiting for that to almost like finish. And then it was like, well, that doom and gloom is still going to happen, we’re expecting a large wave to come through. And it does feel like it’s almost like being kicked down the road or it keeps keeps being moved down the road. And I think the question for me is just well, if it was going to be a big issue back in October last year, is it It now looks like it’s going to be sort of like well, even even what June September, but is it going to be a much smaller issue than it was back in back in back in October? And that the answer that feels to me for people, I suppose feels like that’s yes, it’s going to be less of an issue than it than we thought it was going to be because of the squashing, I mean, I think

9:33
ya know, exactly that. So, I mean, you will have seen loads of kind of industry papers going out and loads of, I guess, conferences or or whatever. And, you know, probably if you did a word search on tsunami, and bit of, you know, got lots of monster hits, I think people were expecting it to be you know, Have a massive wave of people eventually rolling into arrears and needing that collection support. My personal view is that probably that is going to be less of a less of a problem. And actually, I think a number of the participants in the industry have done a level of hiring. So you know, that they’re kind of dealing with the situation, I would say more traditional means, in terms of, you know, taking a few more people on board, train them up, whatever. But, but, you know, my initial expectation was that the only way you’re going to deal with this is, is throwing a lot of technology at it, I still think there’s a lot of benefit in doing that, not only is it a more effective way, to maybe efficient way to deal with customers, we also feel that, you know, actually, there’s a lot of customers that respond well to that, you know, difficult situation, sometimes talking about when things are difficult, and maybe you would get a better response through, you know, self service apps or text messaging to a textbook, or whatever it happens to be. But I think there’s also the other element of it, which is very kind of fundamental to us as a firm is the data you’re able to gather. By doing that, you know, it’s very difficult to capture good information only based on conversations that you’re having with your customers. And, you know, I know there’s firms out there that do kind of almost like voice identification around vulnerability and stuff. But, you know, it’s still a very difficult thing to do. Whereas if you are capturing information through some sort of standardised form, or whatever else, you would learn much more about those customers and all

12:01
that how much how much on the on the data side is talking about picking up on the data piece? And how much do you think we’re using or maximising the use of data captured through ticket digital journeys, but also your voice journeys as well? Yeah, I mean, I mean, how much further can we can we go? I mean, just thinking about the almost like the credit risk and the collections industry? I mean, have we gone far enough? Or that I can go further?

12:22
Yes, definitely. We can go further. Right. That’s, that’s, that’s definitely the the right answer. Where do we go further is slightly different. So I think there is probably an awful lot that lenders can do generally to improve the capture of, I would say, more sort of structure traditional data. You know, one of the things, for example, that we think would be very, very valuable, is if you were to keep more up to date records of the type of industry that somebody works in. So so had we captured that information as an industry and try to keep up to date with that, we would had a better view at which customers were at risk, and how do we help them more directly more quickly? You know, we, we could we could have prioritise those customers over over other customers. The other side of it is we would have been able to more quickly get a sense of what does it do to the financial? So provisioning? And what to do for capital or whatever if we were able to identify those customers individually, so, so yeah, so I think there’s definitely a sense of, Well, we could record data much better that is already probably. And there seems to be a slight shift in focus. So we are seeing more and more and, you know, there was a paper out by the FCA recently on it, and more around that kind of, in a customer journey, customer outcomes, all of this sort of stuff. Now, I’ve got to say that there’s always been an element of, and certainly, throughout most of my career, there’s, there’s been some that and but the paper the other day was about consumer duty, I came across it, but it was essentially, you know, putting much higher expectations, I think, on understanding the customer journey, understanding that the kind of customer treatment through that journey, and impact it has on outcomes. So you could apply that to collections, for example, with some clients at the moment where, effectively the questions they’re being asked is, well, actually, how do you know that that was the right treatment? And I would say tricky Additionally, the way lenders might might look at that is, well, let’s look at, for example, complaints like, Yeah, and if we have a number of complaints that we, you know, probably wrap up in the same sort of category, how do we walk back through those kind of customer touch points and say, What? Did we do the right thing by the customer? Right? And depending on the outcome of that, what’s the resolution? I think there’s a bit more of an expectation now that you’re doing that, almost in live almost active. Yeah. Right. So

15:33
in some ways, that’s like that’s almost like that the art that they’ve been going on anything about persistent debt as an example, and those things and Associates, it’s, you know, when you’re having a conversation with a customer, it’s almost like, is the is it sustainable? Is it the right outcome? And I suppose also those sustainability outputs almost like a, so was it wasn’t agreement there was going to be sustainable over the longer term and actually help the customer versus something else then happen. That meant he didn’t if he sort of, does that, is that your kind of sense?

16:03
Yeah. So I think it’s, we’ve seen fines recently. So I think Lloyd’s got fined something like 60 million last year. That that was actually, you know, for practices, going back some, some some years to essentially those, those fines were all about individual customer circumstances and understanding that think it’s another iteration of that is, yes, we can put a ruleset around it. But there’ll be variances in that we need to be able to get the right customer outcome. That’s the policy, right? How do you then deliver that, in a way, which is easy for the collections agent, and then more often achieves the right outcome for a customer. And we’re able to record that outcome in a reliable fashion. Right, and assess it. So I think that’s where that granularity. So are there pieces of information that if we work at about the customer circumstances, we would actually be able to make a better decision? The collections should be less responsible for making that decision? To a degree, right, so if, if I were capturing more information about your circumstances, then I might have found out for example, that whilst your general income is 800 pounds a month, actually, the range of that is 500 to 1300 a month, I mean, payment plans that the 12 month payment plan is almost setting you up to fail. Right. But critically, we don’t capture that information at the moment. Yeah, if I did capture that information, then I might restrict the number of tools that I give to the collector, to be able to offer to the customer. And I’m only offering a different solution. If we’re challenging that if the customer says I can’t do the first one, you know, so it might be a prioritisation as opposed to a complete restriction,

18:20
I suppose. But there is a balance there, I suppose from a company point of view between almost like from a customer friction point of view as well, which is, you’re asking like, you know, you know, 2020 20 questions, 30 questions and the call lengths go up. And that adds cost to the company. But there’s also adds customer friction as well to that interaction. And I suppose it feels like there’s a balance there. I mean, very much. We’ve been told, like, Well, how do you take cost out. But they’re also like, well, this is a model, you actually need to add cost in and actually add friction in as well, to understand the customer better. And it’s like, there has to be some sort of balance, I think,

18:51
definitely agree with that. And where I’m talking about taking some of that information. Again, it doesn’t necessarily need to come from the customer. It just doesn’t necessarily need to be open to conversation, you know, we’re trying to identify an income shock to a customer in the short term. And the solution that’s there is, well, we’ll first of all take information that is possibly two or three months out of date, because that can happen with it with credit, reference agency data. And then when we do take the data, we’ll deliberately exclude the thing that we’re trying to identify. So say, there needs to be a little bit more thought about what what are you trying to achieve, and talking about the kind of point in terms of verses that kind of time series type approach. So, you know, in Merlin foremost, I’ve listened to hundreds of collection schools. As I said, That was that was my first job in financial services in terms of actually making those calls and then in terms of, but you know, often Even with those calls, some of those nuances were missed. So you might ask the customer Well, what’s gone wrong? Right? And they’ll say, Oh, I was a made unemployed. Okay, well, that might have been what happened originally. And that’s important to know. Right? That actually, two months ago, you agreed a payment plan with us, which was set at the time to try and consider your current circumstances. And now you fail to make that. So what’s actually happened in the last two months, as well as what happened 18 months ago? And connected, you know, and what, again, what I think is the kind of traditional approach would have been, or has been, what did you do as a customer? That was wrong? Right. So you agreed to me that you’re going to pay 100 pound a month, for the next six months? You’ve now failed to do that? How have you failed? Yeah, I think the the kind of almost call on introspection is how has the plan failed? For example, did I? Or could I, as a collector, made things more clear? Could I, as a organisation, provide more up to date information to the customer about those requirements? I don’t know what your memories like. But if I agreed something three months ago, I’m unlikely to remember what I’m supposed to do next month on it. Yeah, I probably need some some sort of reminder, right? Often, that doesn’t happen, that you’ll get better to say, you haven’t made the payment. You wouldn’t get necessarily a text or a phone call or a letter to say, nobody. Yeah, have to make a payment. And some of those things cost money. Right. So again, that’s the balance side, right? Do we introduce her? So an understanding of whether it costs you more to send a text message reminding, versus the cost of them having to call somebody up, write them a less? Spend some time on the phone? additional provisions? As a result? What’s the balance there? As a method, so push notifications on an app, for example, you know, is that enough to remind somebody, you know, there’s the, I guess that that that kind of introspection is really what I’m driving here, that there’s a lot that could be done. Trying to make an assessment of the value of that to a firm and the value to the collector, or so that the customer experience is really where I think it needs to

22:46
just feel like it’s sort of changing round. Not that it wasn’t before, but it’s definitely that sort of like conscious customer centric and sort of really putting stuff in their mind around that. And how do you do that? Then how do you balance that against what’s right for the for the company as well? And it’s, and it’s like, trying to try to solve that puzzle, almost like they equation to certain extent?

23:05
Yeah, no, absolutely. No, I don’t think I don’t think the regulator is saying, you know, just just forgive all your debt. You know, I think there’s an understanding that there’s a level of customer responsibility, and you know, there’s an obligation to your lender to pay that money back. It’s more about, Well, are you helping the customer to do that? You know, critically, if you don’t capture the information on those customer journeys, how would you even know. That’s the kind of

23:46
just going back to the economy really quickly, I was going to just give a bit of an exercise I was out and about the other day, which is the first time I’ve been out for the longest time I’ve been sort of stuck inside I think feels like a year, which was great to be it was great to be out and about. But one of the one of the things I definitely noticed was how quickly I fell back into old habits. So I bought my Starbucks. I didn’t, I didn’t go to prep, which I normally do. But I went to Cafe Nero, and then a lot of those things, but just that I thought that was quite interesting, just like how quickly I went back to the way I was, rather than as soon as I was allowed to, versus versus what maybe I thought I would do, because things have been very different than last year. And I just wonder if that’s a bit of an insight on the economy and how quickly the economy is going to bounce back. If they sort of the more they take the brakes off to certain extent. That being said, there were one or two places that were closed, and they looked like they weren’t opening and then a couple of places, they go to eight and they just they just weren’t open, you could see that they closed down in there, you know, letters on the floor and all sorts of things. So it just feels like it’s going to be very sort of like sectorial driven in terms of like, like some pieces are going on almost like they either happy minimally impacted, or they they’ll bounce back really quickly. But then there’s going to be this other To like segment that’s going to just, it’s just, it’s going to be insolvent, it’s just going to have a really struggling that sort of, like finding that seems like a bit of a challenge.

25:08
So it’s interesting because I think you kind of hit the nail on the head there, right? You, you’re go back into your slip back easy into those habits, I think of things that you like to do. And you’ll avoid slipping back those habits of things that you don’t like to do. Right. So I personally used to do an awful lot of travel for work, and a lot of international travel as well. Yeah, I will strongly object. If somebody says, You know what, Damien, we’ve got a project in Malaysia, can you go out next week and spend two weeks out there? No, no, fancy that because it’s really tiring, you know, lovely people and had a great time out there generally, but it’s really hard work. Yeah. If somebody said to me, you know, what, Damien, we’re going to pay for you to go out on a holiday in Malaysia for two weeks. Bring your family? Yeah, right. You know, it’s a different thing. Right. You know, I think the the people that are likely to succeed, and the sectors of economy that are legacy are going to be those that appeal to good experience.

26:24
So so just I suppose just as we look forward, then I mean, what do you think sort of going to be the big developments? Or should we be thinking about now, you know, either from a risk point of view, but then also, just from a future point of view, do you think?

26:35
So there’s a number of areas that I do think are going to be impacted? So you said about COVID, being not completely unexpected, but unlikely, right? Most firms, I would say there were exceptions, when developing their IFRS, nine solution would have gone with three economic scenarios. So a baseline, an upside and a downside. The pra work, we’re pushing already prior to COVID. The probably that wasn’t enough. They did generally promote that the more scenarios were better. So and specifically said, and more severe downside less like. So I think there’s probably going to be certainly much more expectation that that four is the minimum, it may well be that five or six become more commonplace. And again, you know, that partly, that’s well, you know, it’s possible, it’s achievable. Partly, it’s because actually, as we understand those models better, that the thought of having five or six is probably not scary now, as it was back in 2017, when we didn’t have to consider them. But I think the other area and this is directly linked, is EMI and understanding. Right. So again, back in sort of 2017, when, you know, back to the walls in terms of trying to get everything complete in time and trying to make sure that the models were tested and the disclosures were right, and all those sorts of things, I would say probably EMI was was missed, or maybe given, you know, a bit of a second thought. And I think one of the things that, you know, we’ve heard from from our clients is, is actually through, you know, the firms that did invest in that, and did make time for it, either because they started earlier or through more on it or, or whatever else, had a much easier time through COVID explaining some of these things and what’s going on the next items that that maybe didn’t give themselves enough time. And maybe kind of decided to live with it up until up until COVID. So I think the MRA and monitoring and general governance around models has to has to change assessed. And I think the other thing, which is probably less connected in terms of, you know, direct kind of cause and effect, but but probably is, you know, more of that kind of read the room type stuff, right? It’s going to be around that kind of collections treatment. And if and when it does happen, what is the solution, you know, again, coupled with that kind of consumer duty staff, there’s there’s been releases from from the Bank of England, and I think HM Treasury as well around You know, the role of financial services in the recovery? And, you know, thus far we’ve talked an awful lot about consumers, right? Let’s not forget a lot of the government support and a lot of the way that the way the lending firms stepped in was was around the the SMEs and corporates

30:22
received bills and bounced back loans. Yeah.

30:26
So there’s a paper out a couple of weeks ago, where they were talking about, you know, the expectation is not just that financial services will provide effectively loans. It’s support through, you know, the recovery period. I think one of the one of the papers talked about, essentially not letting a viable company fall down. Now, they weren’t talking specifically about symbols and bubbles, but they were talking about sort of general kind of customer or interaction. But the the word they used to say, was viable, funnily enough, a number of firms actually put that into their treatment around what it meant for provisioning. So if if it was considered that you were a viable firm, without COVID, i COVID was the fact that then maybe you wouldn’t have gone into stage two, or stage one, when, when previous, your previous policy would have put you in stage two, based on sort of support you’ve had. Right. So it was an interesting choice of words. I don’t know if that was based on observation of what the industry were doing around IFRS. Nine, but certainly kind of tweaked with me to say, well, actually, there’s probably a lot of work to do in that financial services sector industry to to support more of those businesses. And let’s face it, if businesses fail, then, you know,

32:14
that the whole consumers Yeah, everything crumbles down. Right. So,

32:17
so yeah, so it’s an interesting point. And I do think there’ll be a lot of change in area and, and a lot of focus on the financial service industry. You know, as a result of that, I

32:31
mean, from from my point of view, it sounds like we’ve got to sort of get the infrastructure right in terms of gathering the extra data to be able to inform them what the strategy is that so all those stuff, we talked about treatment, and that I mean, it will happen, but it’s like how do we gather that data now? And make sure we almost like get the the Insight house in order, because then that just helps us down the road? It feels like at

32:53
least anyway. Yeah, no, definitely. Definitely agree. Well,

32:56
Damien, thanks. Thanks very much for making the time. I really appreciate it. And I appreciate the insight has been been fascinating. So thanks very much, and we’ll we’ll chat saying

33:07
no worries. Thanks, Chris.