How much is IFRS9 really changing the collections landscape?

Before we get into the detail, it is important to understand I’m not a qualified accountant. My area of expertise is the data, software and insights that facilitate customer interactions and collections strategies and by my very nature I am a practical person. In my day-to-day work I look for real tangible solutions to changes in legislation and reporting requirements and hopefully I’ll achieve this in the article below.

Time and time again, my colleagues and I are asked about what the real impact of IFRS9 is in the collections space. For those of you not familiar with this particular financial reporting standard, it comes into force at the beginning of 2018 and arguably, fundamentally changes the way many businesses will have to record credit losses (and potential credit losses).

One of the features of IFRS9 is that it will require banks and other lending institutions to recognise impairments differently. Whereas under the current regime recognised losses from a default are based on expected losses over the next 12 months, under the new standard if there is a significant increase in credit risk, the allowance is measured as the present value of all credit losses projected for the instrument (e.g. a loan or a credit card balance) over its full lifetime. This can turn a potentially modest accounting loss into a much larger one, in effect pulling forward when and how it is recorded.

“So what?” I hear you say, “…it won’t change the way we try to help customers who are in financial difficulty. It won’t influence my contact strategy or workflows, it’s just a technical accounting rule.” WRONG! If you haven’t already, you may well soon be getting a tap on the shoulder from your FD or CFO. The new rules mean they have to report potentially much bigger losses in a given period as well as tie up capital they could be utilising more effectively elsewhere (i.e. in new lending).

Sell early vs manage early arrears more effectively

Many lenders have already started to consider IFRS9 and have taken action. Against this backdrop, we are hearing of two practical solutions businesses are looking at. Some are opting to sell non-performing loan portfolios earlier in the cycle, removing the financial burden from their balance sheet. Here, capital is released and value realised from what is potentially a loss making asset. Many of the larger debt purchasers have already observed this trend in their commentaries around their own results statements, reporting ‘younger’ and higher quality books coming to the market.

The second solution, and perhaps less publicised, is better initial early arears and pre-delinquency management. By helping customers tackle a potentially problem debt earlier in the cycle, collection managers can help businesses avoid recognising the loss at all (either via sale or in their accounts under IFRS9).

Implementing early arrears management

The case for early arears management is a simple one; it is the right thing to do and very much fits with the principles of TCF (treating customers fairly). It helps the customer better manage their finances and avoids the lender having to recognising the loss. 

On the face of it, you would think it was the first and most logical approach – preventing customers falling into arrears in the first place, or helping them avoid becoming more than one payment down is the best outcome for everyone. A consistent and well thought out contact and segmentation strategy can help with this and will have a big saving on potential impairments. It’s only when you dig a little deeper to understand the barriers do you begin to realise why it’s not the default strategy. Often, contact details are out of date or inaccurate preventing the lender from engaging with the customer in the first place. Sometimes, the customer is only in the early stages of realising the true extent of their potential financial difficulties and is unwilling to engage. Equally, the customer may not consider one or two missed payments as a particular problem, instead hoping things will sort themselves out and come back into good order without any intervention.

These are points the FCA thematic review for early arrears management also identified. It observed that many organisations had to speak with customers several times to identify that they were in debt stress, at which point they would then write to them and signpost free debt advice.

Identifying those in pre-delinquency or who may soon be likely to experience financial hardship is often difficult, with organisations either lacking the expertise, insight and analysis to recognise them in the first place.

At a practical level, cleaning contact data and gaining a better understanding of customers’ potential financial issues is easily done but is often a missed opportunity that can have a significant negative impact on customers and lenders alike. 

Something as simple as updating contact information for addresses and telephone numbers within pre-delinquency will reduce roll rates and the potential impact of IFRS9.

It is also worth thinking about the technology and platform you use to contact customers. Much has been written about having a true single customer view or offering the same experience across multi-channel customer interactions. Often legacy systems fail to integrate, with communication via one channel being captured on one system and not updated on another, leading to duplication of effort or inaccurate or incomplete customer records. Our own Cosmos platform seeks to overcome this and it is clear that the age and functionality of legacy systems is no longer an excuse, technology has evolved to the point where it can overcome these issues and in many cases extend the life of existing systems and infrastructure.

Selling earlier in the cycle

Portfolio debt sales are a long established and integral part of an efficient credit market. Often, the sale itself follows an extensive pre-sale in-house collections process. This may include work on settlement campaign or other mechanics. For many institutions IFRS9 will cause them to reconsider the timing of these activities and portfolio sales. However, portfolios coming to market earlier shouldn’t preclude good housekeeping.

From a seller perspective, the simple rule of thumb for portfolio sales is the better the data the higher the price. Again, a simple data cleaning exercise can have a significant impact. On a recent financial services unsecured loan portfolio sale we assisted with, a simple cleanse of contact data saw us update over half the records. Similarly, on an aged utilities portfolio, cleansing the data doubled the price offered.

Simple, sensible and achievable steps

Whatever your job title in the collections and recoveries space (risk, credit or collections manager) no one is expecting you to become an expert accountant. However, with a basic understanding of IFRS9 and by performing some basic tasks, either at the pre-arrears or portfolio sale stage, you can have a significant impact on the strategy, customer outcomes and financial performance of your business.

James Connolly, Head of Debt and Utilities, Callcredit Information Group