Credit Management 2008

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					Credit and Debt Management – 2008 Survey




         Credit and Debt Management
         Survey 2008
         Credit Management Research Centre,
         Leeds University Business School




                                                                                                      2008




Research and analysis by the Credit Management Research Centre, University of Leeds Business School          1
Credit and Debt Management – 2008 Survey




                                             CONTENTS

1.      Executive Summary
        1.1   Consumer and Household Debt
        1.2   Commercial Lending and Insolvency
        1.3   Debt Collection Agents and Debt Sale
        1.4   Survey of DCA’s
        1.5   Large Volume Debt Management

2.      An Overview of Consumer and Corporate Lending
        2.1. Categories of Lending
        2.2. Consumer Lending and Indebtedness
        2.3. Consumer Credit and Indebtedness
             2.3.1. Subjective Evidence
             2.3.2 Statistical Evidence
        2.4. A Summary of Lending Trends
             2.4.1. Secured Lending
        2.5  The Over-Indebtedness Debate
             2.5.1 Arrears
             2.5.2 Trends in Write-offs by Major Lenders
        2.6  Personal Insolvency: bankruptcy and Voluntary Arrangements
             2.6.1 Bankruptcy Modelling – Key Drivers
        2.7  County Court Actions
        2.8  Factors Affecting Indebtedness
        2.9  Fraud

3.      Commercial Lending and Trade Credit
        3.1    Business Growth and Insolvency in the UK
        3.2    Forecasting Corporate Insolvencies
        3.3. Commercial Lending
        3.4    Trade Credit
               3.4.1 Credit Terms and Credit Management Practice
               3.4.2 Motives for the Supply of and Demand for Trade Credit
               3.4.3 Credit Management: The Impact on Corporate Performance
               3.4.4 The Use of Trade Credit and Payment Behaviour:
                      The Demand Side Motivation
        3.5    Late Payment and Bad Debt
        3.6    Late Payment Trends
        3.7    Impact of the Late Payment Legislation
        3.8    Use of Third Parties in Credit Management
               3.8.1 Factoring and Invoice Discounting
               3.8.2 Credit Insurance and Related Services
4.      Large Volume Debt Management – Case Studies
        4.1    Introduction and Objectives
        4.2    Background to the Credit Account Life-cycle
               4.2.1 Customer Life-Cycle




Research and analysis by the Credit Management Research Centre, University of Leeds Business School   2
Credit and Debt Management – 2008 Survey



                 4.2.2 Account Life-Cycles
        4.3      Elements of ‘Best Practice in Collections’ and Implications
                 4.3.1 Credit Information and Scoring Technologies
                 4.3.2 Customer contact and Customer Retention and Collection
                 4.3.3 Collection department practices
                 4.3.4 Use of external debt collection agencies for telephone, letter and doorstep contact;
                        litigation
                 4.3.5 Benchmarking
        4.4      Summary
        4.5      Short Case Interviews 2007
                 4.5.1 Collections Department Medium Sized Bank
                 4.5.2 Commercial Credit Card
                 4.5.3 Consumer Credit Card
                 4.5.4 Medium Sized Retail Bank
        4.6      Large Volume Collections: Interview Survey 2003
                 4.6.1 Delinquency Cycles
        4.7      Case Studies 2003: large volume collection activities
                 4.7.1 Case A: Debt Recovery Division of a Major Bank
                 4.7.2 Case B - Credit Card Provider
                 4.7.3 Case C: Large Volume Lender Retail Card, Personal Loans
                 4.7.4 Case D: International Bank Collections and Recovery
                 4.7.5 Debt Management and Collection in the Utilities Sector
                 4.7.6 Best Practice in Collections and Recovery: Evidence from US Utilities
                 4.7.7 Key Performance Indicators Used in Debt Management
                 4.7.8 Best Practice in Collections and Recovery: The Water Sector
                        4.7.8.1 Areas of Disadvantage
                 4.7.9 Credit and Debt Management Practice in the Water Industry
                        4.7.9.1 General Information
                        4.7.9.2 Direct billing and other methods
                        4.7.9.3 Telephone Contact
                        4.7.9.5 Scoring and Customer Profiling
        4.9      Use of Debt Collection Agents
                 4.9.1 DCA: Case Study
        4.10     Debt Sale and Purchase: Trends and Developments
                 4.10.1 Case Study: Debt Buyer

5.      A Survey of Debt Collection Agents and Debt Buyers

        5.1      Debt Collection Services
        5.2      The Market for Debt Collection Services
        5.3      Market Size
        5.4      Value and Volumes in the Debt Collection Market
        5.5      Quality and Volumes in the Debt Collection Market
        5.6      Debt Purchase
        5.7      Litigation and Bankruptcy

References




Research and analysis by the Credit Management Research Centre, University of Leeds Business School      3
Credit and Debt Management – 2008 Survey




                 CHARTS AND TABLES

Table 2.1 – Categories of Measurable Lending in the UK (Source:             Chart 2.5.3 – Debt to Wealth Ratio (source: ONS and Bank of England

Keynote Ltd)                                                                2007)

Chart 2.3.1.1 – Debt Client Characteristics 2006 (source: Citizens Advice   Chart 2.5.4 – Credit Card Lending (source: ???

Bureau Survey 2006)                                                         Chart 2.5.5 – Other Unsecured Lending (source: ???

Chart 2.3.1.2 – Consumer Credit Outstanding (source: Bank of England)       Chart 2.5.6 - SecuredLending (source: ???

Chart 2.3.1.3 – Consumer Spending Growth (source: Bank of England)          Chart 2.5.7 – Ratio of Write offs to Credit Card Lending (source: ???

Chart 2.3.1.4 – Total Personal Debt July 2007 (source: Bank of England)     Chart 2.5.8 – Major UK Banks Annual Write Off Rates (source: Bank of
                                                                            England 2007

Chart 2.3.1.5 – Total Lending to Individuals Per Month (source: Bank of     Chart 2.5.9 – Personal Bankruptcies and Individual Voluntary

England)                                                                    Arrangements (source: DTI 2007)

Chart 2.3.1.6 – Mortgage Equity Withdrawal 1970-2006 £M (source: Bank       Chart 2.5.10 – Personal Bankruptcy Ratio (Source ???)

of England)                                                                 Chart 2.5.11 – Consumer County Court Judgements 2002-2007 (Source:

Chart 2.3.1.7 – Mortgage Equity Withdrawal as a % of Disposable Income      Registry Trust)

(source: ?????                                                              Chart 2.9.1 – Fraud Trends 1997- 2005 (Source: CIFAS 2007)

Chart 2.4.1.1 – Approvals for Secured Lending to Individuals                Chart 2.9.2 – Fraud Trends 1997- 2005 (Source: CIFAS 2007)

(thousands) (source: Bank of England 2007)                                  Chart 3.1.1 – Register Size in Great Britain (1992-2006) (Source:

Chart 2.4.1.2 – 12 Month Growth Rate of Secured Lending Approvals to        Companies House)

Individuals (source: Bank of England 2007)                                  Chart 3.1.2 – Company Birth Rate (2001-2006) (Source: Companies

Chart 2.4.1.3 – Monthly Value of Approvals for Secured Lending to           House)

Individuals (source: Bank of England 2007)                                  Chart 3.1.3 – Company Insolvencies (1975-2006) (Source: Companies

Chart 2.4.1.4 – 12 Month Growth Rate of Value of Approvals for Secured      House)

Lending to Individuals (source: Bank of England 2007)                       Chart 3.1.4 – The Relationship between Insolvencies and the Write-off

Chart 2.4.1.5 – Monthly Number of Approvals for Secured Lending to          Rates of Banks (Source: Bank of England)

Individuals (source: Bank of England 2007)                                  Table 3.2 – Variables used to Forecast Insolvencies (Source: CMRC)

Chart 2.4.1.6 – 12 Month Growth Rate of Number of Approvals for             Table 3.3.1 – Bank and Building Society Lending to Industrial and

Secured Lending to Individuals (source: Bank of England 2007)               Commercial Companies 1996-2006 (Source: Bank of England)

Chart 2.4.1.7 – Monthly Value of Approvals for Secured Lending to           Chart 3.3.1 – Contributions to Annual Growth Rate from Non Financial

Individuals (source: Bank of England 2007)                                  Corporations (Source: ?????)

Chart 2.4.1.8 – 12 Month Growth Rate of Value of Approvals for Secured      Chart 3.3.2 – New Leasing and HP Business Finance by Client Size and

Lending to Individuals (source: Bank of England 2007)                       Business Investment

Chart 2.4.1.9 – Monthly Amount of Total Sterling Secured Gross Lending      (Source: FALA and ONS)

to Individuals and Housing Associations (in sterling millions) (source:     Chart 3.3.3 – Small Business Borrowing and Deposits at Year End (£

Bank of England 2007)                                                       Billions) (Source: Bank of England)

Chart 2.4.1.10– Monthly Amount of Sterling Repayments of Secured            Chart 3.3.4 – Changes in Sources of External Finance for SME’s

Lending by Individuals (in sterling millions) (source: Bank of England      (Source: ESRC Centre of Business Research)

2007)                                                                       Chart 3.3.5 – Aggregate Capital Gearing of UK companies

Chart 2.4.2.1– Monthly Amount of Total Sterling Unsecured Gross             (Source: ONS and Bank calculations)

Lending to Individuals (in sterling millions) (source: Bank of England      Chart 3.3.6 – Aggregate Capital Gearing of UK companies

2007)                                                                       (Source: ONS and Bank calculations)

Chart 2.4.2.2– Monthly Amounts Outstanding of Total Sterling Net            Chart 3.3.6 –Capital Gearing/Total Debt/Total Assets (Source:

Unsecured Lending to Individuals (source: Bank of England 2007)             Creditscorer)

Chart 2.4.2.3– Monthly Amount of UK Resident Banks’ (inc. Central Bank)     Chart 3.3.7 –Income Gearing/Operating Profit (Source: Creditscorer)

Sterling Credit Card Repayments by Individuals (in sterling millions)       Chart 3.3.8 – The Importance of Trade Debtors to the Balance Sheet

(source: Bank of England                                                    (Source: Creditscorer)

Chart 2.4.2.4– Monthly Amount of UK Resident Banks’ (inc. Central Bank)     Chart 3.3.9 – DSO and Creditor Days Trends (1982-2004)

Sterling Credit Card Repayments by Individuals/Monthly Amounts              (Source: Creditscorer)

Outstanding of Total Sterling Net Credit Card Lending to Individuals        Chart 3.3.10 – Net Trade Credit Trends

Chart 2.4.2.5 - End Month Weighted Average Interest Rate, Bank &            (Source: Creditscorer)

Building Societies (source: Bank of England 2007)                           Table 3.4.2.1 – Motivations for Trade Credit Extension (Source: CMRC)

Chart 2.5.1 – Debt to Income Ratio (source: ONS and Bank of England         Chart 3.4.4.1 – The Use of Trade Credit and Payment Behaviour – A

2007)                                                                       Strategy Map

Chart 2.5.2 – Income Gearing (source: ONS and Datastream 2007)              (Source: CMRC)




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                 4
Credit and Debt Management – 2008 Survey



Chart 3.6.1 – % of Accounts Paying beyond the Due Date (Source:          Chart 4.7.5.1 – Entire Billing Process (Source SAP Business Intelligence)
CMRC)                                                                    Chart 4.7.5.2 – Factors Impacting on Debt in the Utilities Sector
Chart 3.6.2 – % of Companies Paying on Time (Source: CMRC)               Chart 4.7.6.1 – Revenue to Recovery – Customer Impact
Chart 3.6.3 – % of Invoices Paid on Time – Sector Analysis (Source:      Chart 4.7.8.1 – A Guide to Good Practice
CMRC)                                                                    Chart 4.7.8.2 – Number of Customers using Prepayment Meters
Chart 3.6.4 – % of Invoices Paid on Time – Sub Sector Analysis for the   Chart 4.7.9.1 – % of Directly Billed Customers
Manufacturing Sector (Source: CMRC)                                      Chart 4.7.9.2 – % of Directly Billed Customers – by size
Chart 3.6.5 – Average Debtor Days (Source: CMRC)                         Chart 4.8.5.1 – A Large Volumes Collections Operation
Chart 3.6.6 – Payment Beyond the Due Date (Source: CMRC)                 Chart 4.8.5.2 – A Credit Management Model (1)
Chart 3.6.7 – Debtor Days - Size Analysis                                Chart 4.8.5.2 – A Credit Management Model (2)
Chart 3.6.8 – Debtor Days - Turnover Analysis                            Chart 4.8.5.3 – Recovery Paths and Steps
Chart 3.6.9 –Debtor Days – Sector Analysis                               Chart 4.9.1 – Collections: An Integrated Approach
Chart 3.6.10 – Debtor Days – Sub Sector Analysis                         Chart 4.9.2 – Turnover Trends in UK Debt Collection market
Chart 3.6.11 –Interest Charged on Overdue Accounts                       Chart 4.9.3 – Net Worth Trends in UK Debt Collection market
Chart 3.6.12 – % Firms Affected by Late Payment                          Chart 4.9.1.1 – Example of DCA Collections Process
Chart 3.6.13–Receivables Beyond 30/90 Days                               Chart 4.9.1.2 – DCA Service Optimisation
Chart 3.6.14 – Accounts Beyond 30/90 Days - Sector                       Table 5.1   Debt Collection And Other Services Offered By Respondents
Chart 3.6.15 – Accounts Beyond 30/90 Days                                Chart 5.1   Client Base Trends For The Debt Collection Market
Table 3.6.1 – Profile of firms suffering from Bad Debt                   Chart 5.2   Number Of Debts Placed In Market
Chart 3.6.16– Types of Customer who are Slow Payers                      Chart 5.3   Market Size For Consumer Debt
Chart 3.6.17– Assertions about Late Payment                              Chart 5.4   Market Competitiveness For Consumer Debt
Chart 3.6.18– Possible Policy Measures                                   Table 5.2   Number Of Debts Worked Per Month – Whole Sample
Table 3.6.2– % of Companies Pursuing Late Payments through the           Table 5.3   Value Of Debts Worked Per Month – Whole Sample
Courts                                                                   Table 5.4   Number Of Clients And Debts Worked Per Month – Agency
Table 3.6.3– Awareness of the Late Payment Legislation                   Size Breakdown
Chart 3.6.19– Awareness of the Late Payment Legislation                  Table 5.5   Total Value And Total Number Of Debts Placed – Agency Size
Chart 3.6.20 – Domestic Factoring Trends (Source: FDA)                   Breakdown
Chart 3.6.21 – Domestic Invoice Discounting Trends (Source: FDA)         Table 5.6   Sectors For Debt Collection Activities
Chart 3.6.22 – Export Factoring and Invoice Discounting (Source: FDA)    Table 5.7   Growing And Declining Sectors For Consumer Debt
Chart 3.6.23 – Firms using Invoice Finance (Source: Bank of England)     Table 5.7   Value Of Debts From Largest Client
Chart 3.6.24 Growth in Demand for Factoring (Source: FDA)                Chart 5.5   Quality Of Consumer Debt
Chart 3.6.25 – Credit Insurance Growth (Source: ICISA)                   Chart 5.6   Age Of Consumer Debt
Chart 3.6.26 – World Market for Credit Insurance (Source: ICISA)         Chart 5.7   Number Of Clients Worked For
Chart 3.6.27 – Use of Credit Insurance by SME’s (Source: ICISA)          Chart 5.8   Debt Purchase Market Growth
Table 3.6.4 – Reasons for not using Credit Insurance (Source: CMRC)      Chart 5.9   Growth In Prices Paid In Debt Purchase - 2007
Table 3.6.5 – Reasons why companies use Credit Insurance (Source:        Table 5.8   % Of Purchased Debt Sent For Collection
CMRC)                                                                    Table 5.9   % Of Purchased Debt Sent For Collection
Table 3.6.28 – Traditional Benefits of Credit Insurance (Source: CMRC)   Table 5.10 % Of Purchased Debt In Litigation
Chart 4.2.1 – Customer Life-Time Management                              Table 5.11 % Of Total Debt Referred To Court
Chart 4.2.2 – The Customer Account Life-Cycle                            Chart 5.10 % Of Agents With Accounts Operating Under An Iva
Table 4.2.1 – Account Management Functions (Source: CMRC)                Table 5.12 Number Of Iva’s Agreed To In Last 12 Months
Chart 4.2.3 – Scoring in Account Management                              Table 5.13 Number Of Iva’s Agreed To In Last 3 Years
Chart 4.2.4 – Applications to Collections                                Table 5.14 Number Of Iva’s Agreed To In Last 3 Years
Chart 4.2.5 – Debt Management and Collection Trends                      Table 5.15 Defaults Which Have Been Rescheduled In Last Year
Chart 4.2.6 – Scoring to Determine Collection Strategies                 Table 5.15 Number Of Iva’s Agreed To In Last 3 Years
Chart 4.3.1 – New Debt Management Approaches                             Table 5.16 Bankruptices In The Last Two Years
Chart 4.3.2 – Motives for Credit Scoring in Consumer Credit
Chart 4.3.3 – Modelling for Collections Strategies
Chart 4.3.4– Behaviour Scoring: Principles
Chart 4.3.5 – Behaviour Scoring
Chart 4.3.6 – Example Behaviour Score Card
Chart 4.3.7 – Behavioural Scoring and the Account Life-cycle
Chart 4.3.2.1 – Champion vs Challenger Strategies in Collection
Chart 4.3.3.1 – Lender Time Horizons
Chart 4.6.1.1 – Delinquency Cycles
Chart 4.7.3.1 – Computer Systems Sued from Application to Collection




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                             5
Credit and Debt Management – 2008 Survey



1.       Executive Summary                                          directly related to the growth in the number and type of
                                                                    credit card products available to consumers. Increased
1.1      Consumer Lending and Household                             competition in financial services has fuelled the increase in
         Debt
                                                                    available credit products and the degree of product
                                                                    differentiation. Households owe sums equivalent to 160%
The growth in household debt, both in absolute terms and
                                                                    of disposable income.
The growth in household debt, both in absolute terms and
relative to household income, continues to cause some
                                                                    There are increasing signs that many households are
concern. As the economic climate changes servicing debt
                                                                    struggling to service their debts judging by the growth in
may become more problematic for a larger proportion of
                                                                    the use of private sector and voluntary sector debt
the UK household sector particularly as mortgage
                                                                    management services. The record levels of personal
repayments rise and the opportunities for refinancing and
                                                                    bankruptcies as well as the steady rise in the indebtedness
restructuring current debt decline with the tightening of
                                                                    of households, the dramatic increase in the number of fraud
lender credit policies. Increases in financial distress and
                                                                    cases, and excessive bad debt losses have prompted the
insolvency in the corporate sector could threaten jobs and
                                                                    industry as well as the government to once again examine
household income in an already fragile economy.
                                                                    the fundamentals of the consumer lending business.


Increases in arrears levels, bad debts and      insolvencies        Gauging the extent of the ‘household debt problem’
have peaked historically during and/or at the end of                requires balancing the evidence provided by objective data
recession due to losses of income. What is particularly             from national statistics and the Bank of England with the
striking about the recent growth in bankruptcy and other            vast amount of quasi-subjective information provided by
indicators of financial stress is that the trend increase           debt advice groups, lobbyists and surveys of the opinions
occurs against a background of generally good macro-                of debtors and lenders.
economic and monetary conditions, GDP growth, low
interest rates, high levels of employment and strong asset          There has been much, often alarming, press and media
prices. The 90’s peak occurred against a backdrop of                coverage that suggests something of a crises in household
economic decline and nominal interest rates in the region           finances. These headlines are often fuelled by surveys of
of 13-14% .                                                         individuals that are in ‘financial difficulty’ and the
                                                                    apparent increase in debt related problems being reported

The rise in household debt in Britain gained headlines in           to counsellors, debt advice groups, the Citizens Advice

2005 when, for the first time, it rose to over £1trillion. By       Bureau and varies consumer lobbies.

the first quarter of 2007 the level of outstanding debts was
around £1.4 trillion. This total figure includes secured            The increased availability of credit products and the

lending, the majority of which is first mortgages and               competition for customers has facilitated a considerable

additional ‘equity release’. This amounts to around 80% of          market for the ‘restructuring of debts’ i.e. moving debts to

the total consumer lending. Unsecured lending, ‘consumer            lower interest rates (balance transfers) or more typically

credit’, however, has grown rapidly over the past decade            extending the time period of the debt with lower monthly




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            6
Credit and Debt Management – 2008 Survey




repayments but, ultimately, at a significantly higher rate          ‘credit active’ population then, in 2007, households are
(consolidation loans).                                              spending around 30% of their income servicing debt, up
                                                                    from around 20% 10 years ago.
There is considerable evidence of households ‘juggling’
finances via balance transfer, the use of loan consolidation        The Council for Mortgage Lenders report that the number
products, making payments on instalments of secured                 of mortgages in short-term arrears rose to 125,100 in June
credit agreements with unsecured credit (e.g. mortgage              2007 which was slightly down on the previous year. The
payments with credit card cheques). The Credit Reference            Bank of England’s Financial Stability Report (2007,
Agency, Experian reported that 8.2 million individuals are          October) concludes that arrears will be concentrated in a
in serious debt; 2.1 million are struggling with repayments;        small proportion of households with low income/high debt
2.5 million are concerned about their ability to manage             and that “the number of arrears spanning the majority of
debt and 2 million do not know the extent of their debts.           the income and debt distribution is small” but with changes
                                                                    in interest rates and growth in indebtedness “there is a
A notable feature of borrowing in recent periods, since             growing tail of vulnerable households”
around 1998, is the extent of mortgage equity withdrawal
as a source of borrowings. This primarily concerns                  The ratio of write offs-to-amounts outstanding for credit
releasing funds tied up in property for expenditure outside         cards is also increasing steadily with a remarkable peak in
of the housing market (i.e. not used for house purchase of          the first quarter of 2002. The secured lending write-offs
home improvements). The considerable growth in property             show a considerable increase in 2005 and 2006 with a peak
prices since 2000 has created significant amounts of                similar to the end of 1999. They have started to decline in
‘equity’ relative to initial mortgage. Clearly, households          2007.
have been able to finance consumption (and unsecured
debt re-payments) on the back of rising house prices.               The levels of personal insolvency as gauged by the number
                                                                    of bankruptcies and individual voluntary arrangements
                                                                    show a quite spectacular increase since 2000. The
The buy-to-let and sub-prime (self-certified) mortgage
                                                                    beginning of this upward trend pre-dates the changes in
market appears to be particularly vulnerable in the UK as
                                                                    bankruptcy law introduced in April 2004 although there is
well as the US. The quality of lending in these areas is
                                                                    a clear acceleration in the levels of declared insolvencies
suspect. The terms ‘Liar Loans’ and ‘ninanj’ (No Income
                                                                    post-2004. The Act appears to have encouraged individuals
No Assets No Job’) are phrases used to describe such
                                                                    on the path to bankruptcy to declare early.
lending in the US press but the quality of sub-prime
mortgage portfolios in the UK is equally a risk to the
                                                                    The number of CCj’s against consumers has grown rapidly
housing market
                                                                    since 2004 and reached a ten year high by the end of 2006
                                                                    with 843,853 judgment orders. The growth has continued
Reported statistics on debt servicing vary considerably and
                                                                    in 2007 with almost 250,000 judgements in Q1 and
are, of course, sensitive to the sample selected. Although
                                                                    therefore the total could reach 1 million judgements by the
the ‘average household’ is spending around 12% of its
disposable income on interest payments if we take only the




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                          7
Credit and Debt Management – 2008 Survey




end of the year compared to just over half a million in             The number of company insolvencies (compulsory and
2004.                                                               creditors’ voluntary liquidations) in the England and Wales
                                                                    was 3,194 in the last quarter of 2006, nearly half of the
Registry Trust estimates that around 70% of judgements              figure that was observed in the third quarter of 1992.
are ‘credit related’ the remaining 30% being for unpaid tax,        Although the trend fluctuated around 3,500 insolvencies
utility bills and motor tax. Interviews with major lenders          per quarter between 1995 and 2007, the figures have been
found that county court action in order to gain a ‘charge on        much lower than the levels of the early 1990s’ recession.
the assets’ of a debtor were becoming common practice.              The seasonally adjusted figures provided by the Insolvency
                                                                    Service show 3,032 liquidations in the second quarter of
The Credit Industry Fraud Avoidance System (CIFAS)                  2007, representing a 4.2% decrease on one year ago.
report an escalation in fraudulent behaviour in the use of
financial products. Recent data released by CIFAS
                                                                    A forecasting model of aggregate corporate insolvencies
(October 2007) suggests that fraud trends continue
                                                                    shows that in the long term insolvency rate increases when
upwards. Application fraud increased by 23% from 2006-7
                                                                    income gearing or real CCJ values increase, and when the
with 57,321 detected cases reported to CIFAS and identity
                                                                    employment rate or real money stock decrease. The
fraud, although slightly down had 57,302 reported cases.
                                                                    Growth in Real Short Term Loans and Business
Recent   international   banking    regulations   (Basle    II
                                                                    Confidence are the short-run dynamics of the insolvency
agreement) have drawn much attention to the re-evaluation
                                                                    rate. That is, whereas short term increases in the growth in
of consumer credit risk (default probabilities) and portfolio
                                                                    real short term loans are likely to create short term
risk management.      The Basel II rules have given an
                                                                    increases in the insolvency rate, short term increases in
impetus to banks to move debt more quickly from their
                                                                    business confidence are likely to create short term
books to external debt collection agents and debt buyers.
                                                                    decreases in the insolvency rate.


1.2      Commercial Lending and Insolvency                          The relatively high levels of indebtedness in the corporate
                                                                    sector coupled with recent interest rate increases and a

There has been a trend increase in the number of active             decline in business confidence suggest that corporate

companies registered with Companies House. The stock of             insolvencies are set to increase by over 20% in the next 2

active businesses approached 2.3 million in 2006.                   years. More recent data derived from an analysis of UK

According to Companies House the number of new                      Company accounts suggests that the ratio of total debts to

incorporations has been growing rapidly year on year e.g            total assets has risen quite sharply since 2004.

43% 2003-6. In total, unincorporated businesses and
SME’s account for a significant proportion of the business          When we analyse ratios reflecting the ability of firms to

stock. This is estimated to have grown by more than 1.4             cover their interest repayments on debt we observe a

million since 1980. The stock of small businesses is                similar rise since 2004. This suggests that there are a large

estimated at 3.8 million. SME’s account for 52% of                  number of companies that are not generating sufficient

aggregate business turnover and 56% of private sector               profit to cover their interest payments. The considerable

employment according to the SBS.                                    growth in private equity-backed leveraged buyouts has




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            8
Credit and Debt Management – 2008 Survey




increased the role of debt in capital structures. It is             of centralised in-house collection and recovery functions
estimated that value of investments LBO’s in 2007 was               and the development of technology and information
around £22 bn. Of course, financial distress and insolvency         systems devoted to account management; the speed of
in the corporate sector threatens jobs and household                response of the major lenders in dealing with delinquent
income in an already fragile economy.                               accounts and a shortening of the time period to write-off.
                                                                    Basel II rules have encouraged the lenders to shift debts off
The late payment of commercial debt as a phenomenon is              of their books more quickly and to opt for debt sale rather
enduring. The CMRC Quarterly Review monitors payment                than commission-based collection since the former
behavior across a sample of 2000 enterprises. Accounts              mechanism transfers ownership of the debt.
which pay at or near the due date are currently reported at
54% by sales value. This leaves 46% of all sales accounts           The Credit Services Association reported that their member
being reported as overdue by our panel of respondents. In           organisations handle around £15 billion of debt on a
terms of the number of customer accounts, the proportion            commission basis which consisted of over 20 million
of customers paying at or near the due date is slightly             individual cases. This represents a rise of £10 billion since
lower. 46% of our survey panel state that customers at an           2000. The CSA membership bought around £6 billion of
account level pay on time. This equates to 54% of all               debt in 2007 making of total of over £21 billion being
customer accounts currently being paid late. Recent survey          passed to the DCA sector. The CSA estimate that their
statistics show a deterioration in B2B payment behavior.            market will be worth over £24 billion in 2008.
This trend is likely to continue since smaller firms rely
increasingly on trade credit when bank credit is restricted.        A source of potential revenue growth for the DC industry
                                                                    is as a provider of a wider range of out-sourced business
The Late payment of Commercial Debts (Interest) Act has             services   across    the   credit   life-cycle.   Outsourcing
had an impact of the extent of outplacement to the DCA              receivables management has increased, particularly for
sector. The fact that DCA’s can impose an interest charge           commercial debt. Government and the public sector are
and recover some collection costs has made out-placing              beginning to utilise the services of DCA’s. The growth in
debt more cost effective for the commercial sector and              the internet B2C and B2B has translated into more
particularly SME’s.                                                 collection activity on a global scale.


                                                                    There has been and continues to be a general trend
1.3      Debt Collection Agents and Debt
         Sale                                                       amongst the large volume collectors to streamline and
                                                                    rationalise their use of 'external' collection agents alongside

A number of trends and industry dynamics have impacted              their 'in-house' collection agents. Debt Collection Agents

on the out-placed debt collection and debt purchase sector.         have turned to buying debt as an alternative to collection

These include: the surge in consumer debt and increase in           on commission in 2004 there were over 60 debt buyers

the volumes of delinquent debt that have to be processed;           although the DBSG suggests that currently there are

the increased emphasis on cost effectiveness and                    around 40 regular buyers in the market. The growth in the

performance benchmarking; the continued re-engineering              market has been facilitated by the supply-side.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                              9
Credit and Debt Management – 2008 Survey




In the UK it is difficult to estimate the total size of the debt    A problem that is probably hampering the growth of the
sale market since the market continues to evolve quite              debt sale market is that of ‘pricing’. Interviews with major
rapidly. The market size in 2005/6 was around £6bn face             lenders suggested that there is some lack of ‘trust’ in the
value selling at an average price of around 8p in the pound.        market as a result of extant price variations. If debt is to be
By 2006/7 this had increased to £7bn and commentators               sold at earlier stages and /or segmented by ‘quality’ then
are expecting the market to peak at around £10bn. Debt              there has to be a mechanism for pricing the individual
sale is still dominated by ‘distressed debt’ portfolios i.e.        debts and the debt portfolio. The development of a ‘broker’
debt that the financial sector would normally write-off             market for debt sale and purchase has provided some uplift
and/or is severely delinquent is sold to the highest bidder         in prices.
for collection/recovery. It is clear that lenders have
developed an interest in selling younger debt as a means of
                                                                    1.4          Survey of DCAs
improving cash-flow and because of the costs of servicing
the debt collection sector when debt is placed on a                 In terms of Debt Collection services offered by agencies in
commission basis.                                                   2007 significant differences can be seen since 2003 in
                                                                    Repossessions (up 25%) and Tracing (down 15%), The
The major lenders and the majority of financial services are        offering of Process Services and Investigations/Status
now selling debt and developing specialist departments to           Reports has declined between the two time periods. The
deal with debt sale and respond faster to debt sale                 largest difference between services offered in 2003 and
opportunities. The bulk of sales are distressed debt which          2007 is in Debt Purchase which is up by 27% among the
can attract only 2-5% of face value but there is evidence of        sample. 46% of all agencies offer this service in the
sellers selling debt earlier, as in the US, typically 90-180        marketplace.
days past due. The changes in accounting rules, Basel II
and resultant changes in internal default definitions and           The statistics suggest a healthy growth in the market for
capital requirements have had an impact on the propensity           debt collection with 75% of agencies indicate that market
of lenders to sell debt. A further development is the sale of       size is increasing in 2007. This compares to just 45% in
debt that has already been managed to achieve an                    2003. 99% of agencies believe market competitiveness to
‘arrangement to pay’ via a debt management company.                 be increasing.
This type of debt can attract 30-40 pence in the pound. The
development of a reseller market is expected to create              The number of debts worked by agencies each month
further growth in the market.                                       across the entire sample has increased dramatically from
                                                                    between 1,200 in 2003 to 19,000 in 2007. Among the
The main sources of debt sale are credit cards, loan and            larger agencies this increase is most significant with
overdrafts, retail credit, motor finance and increasingly           agencies with over 100 employess reporting a rise from
mortgage arrears. Further growth in the Debt Purchase               1000 debts per month to 40,000 debts per month. Overall
market is likely to come from the sale of non-delinquent            in the sample, the average value of a debt placed across the
receivables, reselling and from commercial debt.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            10
Credit and Debt Management – 2008 Survey




entire sample has increased from less than £1000 in 2003            receive 38p in the pound under an IVA and would accept a
to £2400 in 2007.                                                   minimum of 32p.

There appears to be growth in a number of sectors. The
                                                                    In terms of default rates collection agents were asked to
sectors that are generating a faster growth for the out-
                                                                    state the the percentage of IVAs which had defaulted over
placed debt industry are the fixed line telephone sector and
                                                                    the last 3 years. The default rate has more than tripled
broadband providers. Collections within the retail sector
                                                                    during the last three years and now stand at 13%.
show the second largest growth among respondents with
85% of collection agents indicating this to be a growing
market. The credit card industry has continued to grow              1.5        Large Volume Debt Management
with 72% of respondents indicating this to be a growth
market.                                                             Organisations faced with large volume debt management
                                                                    operations are setting up sophisticated customer focused
In 2003 43% of respondents thought that the quality of out-         operations aimed at 'reforming' debtors, if possible, so that
placed debt was generally worsening. This figure in 2007            the relationship with them can continue and generate future
is 51% in the sample. 18% of respondents indicated that             profits. This has been partly a response to increased
the quality of consumer debt was improving.                         competition    amongst     lenders,    the   emergence      of
                                                                    'consolidation companies' and recognition that changing
Over 60% of collection agents generate their business from          life-styles and patterns of work have precipitated periods of
under 50 clients and generally collection agents are dealing        'over-commitment' by debtors which need be managed
with fewer clients than in 2003.                                    longer-term.


The largest buyer of debt purchased a face value of £458            The introduction of enterprise wide data sharing has arisen
million compared to just £28 million in 2003. Of the total          because of the emphasis being placed on having a
debt purchased in 2007 an average of £30 million was                'customer-level' and/or ‘customer-life cycle’ view of each
collected during the last year.                                     customer and detailed management information systems.
                                                                    The expansion of data-sharing closed user groups in the
In the sample prices paid for debts varied between 5p to            UK and the development of ‘indebtedness indices’ means
18p in the pound. The average price paid in the pound is 8p         that lenders have access to better information on other
in 2007.                                                            lenders experience of a debtor, and can include this in their
                                                                    decision making process. The differences in information
The collection agents were asked if any of their collectable        costs of in-house and out-placed debt collection are thus
debts were operating under an Individual Voluntary                  reduced.
Arrangement. 78% of the agencies responding to the
survey had accounts which were linked with an IVA.                  Collection cycles have become much shorter in financial
The average length of time for an IVA is among the sample           services but opened opportunities for debt buyers. Basel II
is 4.75 years. Agents also indicated that they expect to            rules have resulted in reclassification of debtor portfolios
                                                                    in financial services with the development of new default




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                             11
Credit and Debt Management – 2008 Survey




probability models. Internally lenders have moved to a              buyers in the future. A increasing role for debt brokers is
‘time-based’ rather than ‘event-based’ view of the debtor           expected to increase the scale of the broking market.
and emphasise re-aging or rescheduling debt away from
collections and back into account management where
possible and transferring ownership of delinquent debt.



The centralisation of collections activity in organizations
has produced an environment in which more sophisticated
decision   support   systems    including   statistical   and
propensity models, such as behavioural/collection scores,
can be used to formulate the most effective collection
strategies by encapsulating the company's previous
experience of what works for customer segments and
creating variability in collection sequences. A range of
propensity models are employed to score the propensity to
‘self-cure’ (i.e. the customer will pay without being
chased) through to the likelihood of successful litigation.
Champion challenger methodologies coupled with activity-
based costing facilitates the evaluation of collections
effectiveness.


Sophisticated credit management in-house will inevitably
reduce the 'quality' or 'collectibility' of debt that is out-
placed. Many debts passed to debt collectors will already
have been through telephone and letter based collections
procedures, and may even effectively have already been to
one debt collector, if the company has a debt collection
subsidiary. In future it may be that such firms will only
want to make use of a sub-set of the debt collectors service
which they cannot provide for themselves, for example
outsourced services through to door-step collection.


A trend towards using debt sale as an alternative to
commission-based collection and using fewer agents with
closer contact and integrated information systems suggests
that there will continue to be rationalization with
fewer/larger and more sophisticated collection agents/debt




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                         12
Credit and Debt Management – 2008 Survey



2.       An Overview of Consumer and                                      The banks, building societies, finance houses, retailers,
         Corporate Lending                                                local authorities and insurance companies make various
                                                                          forms of lending to both commercial and personal
In this section, we analyse the main trends in consumer                   borrowers.
lending in the UK by examining aggregate time series
statistics. First, we provide a categorisation of the types of            Commercial organisations extend trade credit to their
lending activities by the major financial institutions and the            commercial customers and may make sales on deferred
corporate sector.                                                         payment basis or credit accounts to individual households
                                                                          (e.g. Utilities, Cable TV). These debts are the potential
2.1.     Categories of Lending
                                                                          source of business for the 'out-placed' debt collection
                                                                          industry.
The following table (2.1) adapted from Key Note Ltd
attempts to list all the categories of lending in the economy
by the source (lender) and ultimate borrower (debtor).




                                   Table 2.1 – Categories of Measurable Lending in the UK
                                                         (Source: Keynote Ltd)

                     Lender                          Class of Lending                 Debtor(s)

                     Banks & Building Societies      Commercial                       Other financial institutions
                                                     Commercial                       Industrial & Commercial
                                                                                      Organisations
                                                     Personal                         Secured on Dwellings
                                                     Personal                         Consumer Credit, including
                                                                                      Credit cards
                                                     Personal                         Unincorporated and non-
                                                                                      Profit-making bodies

                     Finance Houses                  Personal                         Secured and unsecured
                                                                                      revolving credit
                                                     Commercial                       Motor finance
                                                     Personal                         Motor finance

                     Retailers and finance
                     houses                          Personal                         Retail instalment lending
                                                     Personal                         Store and credit cards
                                                     Personal                         Mail order credit

                     Local Authorities               Personal                         Various

                     Insurance companies
                     and others                      Commercial                       Various

                     Industrial and Commercial       Commercial                       Trade Credit – on invoice
                     Businesses                                                       Business to Business
                                                     Personal                         Sales on deferred payment
                                                                                      (utilities, cable & satellite TV)

                     Source : Adapted from Key Note Ltd




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            13
Credit and Debt Management – 2008 Survey



2.2.     An Overview of Consumer Lending                            policy. Initiatives and issues relating to Sub-prime lending,
         and Indebtedness: Trends
                                                                    ‘Affordable Lending’, The Survey of Low Income Families
                                                                    and ‘Credit Constraints’ have attracted some prominence
The growth in household debt, both in absolute terms and
                                                                    in    government.     The    Competition      Commission’s
relative to household income, continues to cause some
                                                                    investigation into the lack of competition in the ‘Home
concern. Much of the growth in consumer debt has
                                                                    Credit’ market highlighted asymmetries in available
occurred within a confident economy with economic
                                                                    consumer-level information and the pricing of sub-prime
growth, high levels of employment, growing asset prices,
                                                                    products. The Data Protection Act raised many issues and
easy access to credit and low interest rates and inflation.
                                                                    problems for consumer lenders. Recent international
Despite obvious signs of some financial stress within the
                                                                    banking regulations (Basle II agreement) have drawn much
household sector most households have managed to service
                                                                    attention to the re-evaluation of consumer credit risk
their debts. The economic climate appears to be changing:
                                                                    (default probabilities) and portfolio risk management. The
financial markets have highlighted the potential fragility of
                                                                    Basel II rules have given an impetus to banks to move debt
some lending portfolios that appear to be riskier than was
                                                                    more quickly from their books to external debt collection
anticipated; lenders have tightened credit policies and
                                                                    agents and particularly debt buyers.
borrowers are becoming more cautious; interest rate rises
are impacting on both the household and corporate sector;
                                                                    At the consumer level, there are increasing signs that many
confidence in the housing market continues to falter; oil
                                                                    households are struggling to service their debts judging by
prices are rising. Servicing debt may become more
                                                                    the growth in the use of private sector and voluntary sector
problematic for a larger proportion of the UK household
                                                                    debt management services. The record levels of personal
sector particularly as mortgage repayments rise and the
                                                                    bankruptcies, as well as the steady rise in the indebtedness
opportunities for refinancing and restructuring current debt
                                                                    of households, the dramatic increase in the number of fraud
decline with the tightening of lender credit policies.
                                                                    cases, and excessive bad debt losses have prompted the
‘Trading out of trouble’ and’ buying time’ are not going to
                                                                    industry, as well as the government, to once again examine
be options. Any uncertainties about future income and
                                                                    the fundamentals of the consumer lending business.
property values exacerbates the problem.
                                                                    Gauging the extent of the ‘household debt problem’
                                                                    requires balancing the evidence provided by objective data
It is estimated that consumer credit has been rising by over
                                                                    from national statistics and the Bank of England with the
to £1 billion per month with total outstanding debt in the
                                1                                   vast amount of quasi-subjective information provided by
region of £140 billion in 2007 . Households owe sums
                                2                                   debt advice groups, lobbyists and surveys of the opinions
equivalent to 160% of income . Since 2000, consumer
                                                                    of debtors and lenders. In the next section we examine the
credit and debt has been the subject of several high profile
                                                                    statistics.
government investigations and regulatory initiatives. The
accumulation of household debt, defaults and arrears has
made headlines in the UK and other OECD economies. In
the UK, the “Task Force on Over-indebtedness” has
produced reports that raise many issues relating to lending
practices, risk management, debt management and social




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                          14
Credit and Debt Management – 2008 Survey



2.3.        Consumer Credit and Indebtedness                        These headlines are often fuelled by surveys of individuals
                                                                    that are in ‘financial difficulty’ and the apparent increase in
The rise in household debt in Britain gained headlines in           debt related problems being reported to counsellors, debt
2005 when, for the first time, it rose to over £1trillion. By       advice groups, the Citizens Advice Bureau and various
the first quarter of 2007, the level of outstanding debts was       consumer lobbies.
                       3
around £1.4 trillion. This total figure includes secured
lending, the majority of which is first mortgages and               In early 2005, lenders saw a surge in payment arrears,
additional ‘equity release’. This amounts to around 80% of          particularly, but not exclusively, on unsecured lending
                                4
the total consumer lending . Unsecured lending, or                  products. The Financial Services Authority, in its Financial
‘consumer credit’, however, has grown rapidly over the                           5
                                                                    Risk Outlook , reported that average outstanding balances
past decade, directly related to the growth in the number           on unsecured debt had increased quite substantially for a
and type of credit card products available to consumers.            large proportion of households. They suggested that around
Increased competition in financial services has fuelled the         53% of households had average unsecured debts of £7,065.
increase in available credit products and the degree of             The average balance on secured debts was reported as
product differentiation. Lenders are concerned to cover all         £67,662 for around 40% of households. There were, at the
segments of the personal credit market from ‘platinum’ to           time, reported cases where individuals had over £100,000
‘sub-prime’ with offerings tailored to attract all types of         of outstanding credit card debts set against annual income
borrowers and interest rates (APR’s) priced to reflect the          levels of around £20,000 and examples of relatively low
differing risks in each segment. The scramble for market            income individuals who had large unsecured debts spread
share has led to a considerable increase in ‘balance                                                                6
                                                                    across as many as 20 different credit card lines .
transfer’ activity where consumers are offered low or zero
interest rates for a period of up to 12 months if they                                                       7
                                                                    A survey by the National Consumer Council , in 2007,
transfer the outstanding balance from one card to a                 concluded that the majority of households are managing to
competitor. Moreover, the increased availability of credit          service their debt commitments. They suggested that 57%
products and the competition for customers has facilitated          of households have no problems in meeting financial
a sizeable market for the ‘restructuring of debts’, i.e.            commitments, that 31% ‘struggle’ from time to time, that
moving debts to lower interest rates (balance transfers) or         12% have difficulty managing their commitments and that
more typically, extending the time period of the debt with          a subset of 1.6% of households are in serious difficulties.
lower    monthly    repayments     but,   ultimately,   at   a
significantly higher rate (consolidation loans).                    Converting      these     figures     into     numbers        of
                                                                    households/individuals, 3 million are struggling to keep
2.3.1.      Survey and Subjective Evidence                          payments up to date; 1.5 million are falling behind with
                                                                    payments; and 0.5 million are in serious financial
There has been much, often alarming, press and media                difficulty, i.e. serious arrears. The trends were of concern.
coverage that suggest something of a crises in household            The NCC suggested that mortgage arrears had increased
finances.                                                           4%; repossessions had increased 32%; credit cards arrears
                                                                    had increased 8.5% from an already high level; and contact




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            15
Credit and Debt Management – 2008 Survey




with advice agencies and debt management plans had                  A recent report suggests the number of house repossessions
                                                                                                                        9
increased by 43% and 48% respectively. A survey in 2006             have increased 50% in the last year to around 45,000 . As
by the Citizen’s Advice Bureau, “In Too Deep” analysed              borrowers reach the end of fixed interest deals taken out
567 cases of debtors seeking advice. They suggest that              when interest rates were low, the number of repossessions
“debt is a continuing and often debilitating problem for an         could well increase further. New mortgage lending has
increasing number of people, with its effects often felt            fallen rapidly along with activity in the housing market.
most strongly amongst the most vulnerable members of                Most of the major lenders have reported increases in bad
society”. The CAB report an average increase in household           debts in the period 2005-7. Calls to the National Debt line
debt of 30% between 2003 and 2006 with the average                  have more than doubled since 2005 and stand at more that
                                                                                                10
outstanding of over £13000, twice the figure reported by            300,000 per year. The CAB reported that 1.7 million
the FSA. Debts were, on average, 17.5 times the average             people sought debt counselling last year; 40% of whom
monthly income. The majority of individuals in the survey           had credit card and unsecured debt problems. They
were young (25-44) and single.                                      reported a 30% rise in cases of individuals struggling to
                                                                    pay energy bills. There is considerable evidence of
                                                   8
The average household debt reported by Creditaction in              households ‘juggling’ finances via balance transfer, the use
November 2007 was £8,681, which rises to £20,189 if only            of loan consolidation products, making payments on
households with some unsecured debt are included in the             instalments of secured credit agreements with unsecured
denominator. The average outstanding mortgage was                   credit (e.g. mortgage payments with credit card cheques).
reported as £98,571.




                                   Chart 2.3.1.1 – Debt Client Characteristics 2006
                                     (source: Citizens Advice Bureau Survey 2006)




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                         16
Credit and Debt Management – 2008 Survey




Attractive refinancing deals are currently harder to find as        loans.     Wilson and Summers (1998) suggested various
lenders tighten credit policy and interest rates rise. The          factors contributed to this, including:
                                   11
Credit Reference Agency, Experian last month reported
that 8.2 million individuals are in serious debt; 2.1 million       •      High inflation in the late 1970s and early 1980s. This
are struggling with repayments; 2.5 million are concerned                  made buying on credit more attractive when compared
about their ability to manage debt; and 2 million do not                   with saving for consumer goods, and also had a
know the extent of their debts.                                            negative effect on attitudes to saving which continued
                                                                           even when inflation dropped;
                                                                    •      The de-regulation of financial markets and controls on
2.3.2     Statistical Evidence                                             hire purchase;
                                                                    •      The 1986 Financial Services Act in the UK and
In the UK, the most recent statistics suggest that the value               similar trends across Europe, which allowed building
of consumer credit outstanding on mortgage loans exceeds                   societies to compete with banks, and changes in the
£1150bn and around £215bn is outstanding on other forms                    regulation of building societies allowing them to get a
of consumer credit (Bank of England, 2007). The trend in                   higher percentage of funds from sources other than
consumer credit (excluding mortgages) has shown a                          their members;
substantial growth, particularly since 2000. Consumer               •      An increase in divorce rates across Europe which has
credit is defined as borrowing by consumers, i.e. the                      left more families needing credit to cope financially;
household     sector    excluding     sole    proprietorships,      •      Government policies encouraging home ownership.
partnerships, and non-profit making bodies, to finance
current expenditure on goods and services. Figures from             Since 1994, however, the total amount of consumer credit
the Central Statistical Office (on the value of consumer            outstanding (excluding mortgages) has almost quadrupled.
credit outstanding) suggest over £215 billion outstanding           Much of this increase has arisen in the credit and retail card
on forms of consumer credit. These figures exclude credit           market. Competition has been fierce in the UK plastic card
where the balance has to be paid off at the end of each             market. It has been reported that there are over 1300
period such as utility bills, but will include balances on          different credit cards in the UK (standard, gold, charity,
credit cards which are paid off on a monthly basis and              affinity, co-branded etc) with around 33 card issuers
therefore do not, in the strictest sense, represent credit. The     including the major banks. Estimates suggest that there are
services provided by the utilities, which are often on a            over 75 million credit and debit cards in circulation with
deferred payment basis, represent a sizeable proportion of                                                     12
                                                                    amounts outstanding around £67.25 billion . The credit
total consumer debt.                                                card     market    experienced    unprecedented     levels      of
                                                                    competition largely as a result of new entry by US issuers
Chart 2.3.1.2 below shows the strong trend increase year            that dramatically increased the choice of card rates and
on year in consumer credit from 1994 to 2007. As the chart          benefits. The trend growth in consumer credit appears to
illustrates, the 1980s saw a consumer credit boom; between          have slowed in 2007-7.
1979 and 1989 the volume of consumer credit outstanding
(excluding mortgages) more than doubled, and there was a
similar movement in the amount outstanding on mortgage




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                              17
Credit and Debt Management – 2008 Survey




                                                                                                                    Consumer Credit Outstanding
                                                                                                                             (excluding mortgages)
The growth in credit outstanding is clearly closely linked to                               250




the level and growth in consumer spending over the time                                     200


period. The chart to the right demonstrates the continued
                                                                                            150
and strong growth in consumer spending in every period
since 1994 and a continued but slowing growth in 2007.                                      100




Chart 2.3.1.2 – Consumer Credit Outstanding                                                 50



(source: Bank of England)
                                                                                             0




                                                                10%
                                                                                                                             Consumer Spending Growth
                                                                          8%

                                                                          6%




                                                                Consumer Spending y‐on‐y 
Chart 2.3.1.3 – Consumer Spending Growth                                  4%

                                                                          2%
(source: Bank of England)
                                                                          0%

                                                                  ‐2%

                                                                  ‐4%
                                                                                            1984
                                                                                            1985
                                                                                            1986
                                                                                            1987
                                                                                            1988
                                                                                            1989
                                                                                            1990
                                                                                            1991
                                                                                            1992
                                                                                            1993
                                                                                            1994
                                                                                            1995
                                                                                            1996
                                                                                            1997
                                                                                            1998
                                                                                            1999
                                                                                            2000
                                                                                            2001
                                                                                            2002
                                                                                            2003
                                                                                            2004
                                                                                            2005
                                                                                            2006
                                                                                            2007
                                                                                                            Total Personal Debt – £1.355 bn, July 2007


In the context of total consumer borrowing, credit card
                                                                                                                       12%
                                                                                                           4%
debt forms only 4%, with mortgages and personal loans
having the major share.                                                                                                                                   Mortages
                                                                                                                                                          Credit Cards
                                                                                                                                        84%               Loans etc
Chart 2.3.1.4 – Total Personal Debt July 2007
(source: Calculated from Bank of England statistics)




The chart to the right shows the relative shares of lending                                                     Total Lending to Individuals Per Month
                                                                                                                       August 2005 –August 2007
broken down as secured (mortgages) and unsecured (cards and                                       30 000



unsecured loans) over the recent period. Thus, the growth in                                      25 000


debt is associated predominantly with asset accumulation and
                                                                                                  20 000


house price growth rather than consumer spending.                                                                                                         total
                                                                                                  15 000                                                  secured
                                                                                                                                                          consumer


                                                                                                  10 000

Chart 2.3.1.5 – Total Lending to Individuals Per Month
                                                                                                   5 000

(source: Bank of England)
                                                                                                      0

                                                                                                            Totals Outstanding       £  1364742  (100%)
                                                                                                                       secured       £ 1150247  (  84%)
                                                                                                                       consumer   £    214495  (  16%)




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                   18
Credit and Debt Management – 2008 Survey




A notable feature borrowing in recent periods, since around                                                     As a percentage of disposable income Chart 2.3.1.7 shows
1998, is the extent of mortgage equity withdrawal as a                                                          a sharp upward trend since 1998, reaching almost 9% by
source of borrowings. This primarily concerns releasing                                                         the end of 2003. The previous high of 7.7% in 1988
funds tied up in property for expenditure outside of the                                                        coincides with the beginning of the last major UK
housing market (i.e. not used for house purchase of home                                                        recession. The sharp decline in 2005 coincides with a
improvements). The considerable growth in property prices                                                       tightening of credit policy amongst the major lenders as a
since 2000 has created significant amounts of ‘equity’                                                          result of record high levels of arrears on credit products at
relative to initial mortgage. The figures in Chart 2.3.1.6                                                      the beginning of 2005. However, the growth in equity
below examine the total additional amounts borrowed                                                             release in relation to income continued to grow in 2006,
against properties and the percentage of disposable income                                                      reaching 7% at the end of 2006, but has fallen again in
withdrawn against existing equity and reveals a marked                                                          2007 to around 4.5%. This, however, is more likely to be a
upward trend throughout the period and, after a sharp                                                           supply constraint, as a result of the tightening of lending
decline in 2005, further growth in 2006/7. Clearly,                                                             terms, rather than a fall in demand.
households have been able to finance consumption (and
unsecured debt re-payments) on the back of rising house
prices during this period.


                 Chart 2.3.1.6 – Mortgage Equity Withdrawal 1970-2006 £M (source: Bank of England)


                                                                 Mortgage Equity Withdrawal 1970‐2006  £m
                                 20,000




                                 15,000




                                 10,000




                                  5,000




                                        0




                                  ‐5,000


                                        1970                                                       1988                        1998                   2003        2006




       Chart 2.3.1.7 – Mortgage Equity Withdrawal as a % of Disposable Income (source: Bank of England/ONS)


                                                       Mortgage Equity Withdrawal  as a % disposable income
                                 10.0




                                  8.0




                                  6.0




                                  4.0




                                  2.0




                                  0.0




                                 ‐2.0

                                        1970                                                       1988                        1998                   2003        2006




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                      19
Credit and Debt Management – 2008 Survey



2.4.     A Summary of Lending Trends

In this section, we report the more recent trends in lending
on secured and unsecured products that are reported by the
Bank of England.


2.4.1. Secured Lending
                                                                          Chart 2.4.1.1 – Approvals for Secured Lending to

The latest data showed that the number of total approvals           Individuals (thousands) (source: Bank of England 2007)

for secured lending decreased again toward the end of 2007
                                                                                UK Resident Banks                                 Building Societies                                Other Specialist Lenders
after recovering from a bottom in January 2007 once again.
                                                                 450
However, both the bottom and the top peaks failed to reach       400
                                                                 350
the levels of the recent years up to 2004. This may well be      300
                                                                 250
explained by the increased interest rates in 2004. Number        200
                                                                 150
of UK Resident Banks’ sterling approvals and that of both        100
                                                                  50
Building Societies’ and Other Specialist Lenders’ sterling         0   Jan-02

                                                                                         Jul-02

                                                                                                           Jan-03

                                                                                                                       Jul-03

                                                                                                                                Jan-04

                                                                                                                                           Jul-04

                                                                                                                                                         Jan-05

                                                                                                                                                                           Jul-05

                                                                                                                                                                                              Jan-06

                                                                                                                                                                                                          Jul-06

                                                                                                                                                                                                                   Jan-07

                                                                                                                                                                                                                            Jul-07
approvals have all followed the same trend with the
exception of their growth rates. Further increases in interest
rates coupled with a tightening of lending policies have
taken some effect.
                                                                   Chart 2.4.1.2 – 12 Month Growth Rate of Secured Lending
                                                                       Approvals to Individuals (source: Bank of England 2007)
The 12 month growth rates of the number of the total
                                                                                                                    Total                                                     UK Resident Banks
approvals and UK Resident Banks’ approvals followed                                                                 Building Societies                                        Other Specialist Lenders

almost the same route as expected from the majority share        2.00000



of the banks in secured lending. Despite UK resident             1.50000


                                                                 1.00000
banks’ majority and a negative growth rate (-0.5%), in
                                                                 0.50000
August 2005, building societies’ and other specialist
                                                                 0.00000
lenders’ positive rates (both around 15%) were enough to
                                                                 -0.50000
make the total rate positive (4%) as well. However, UK
                                                                 -1.00000
                                                                                                  Jul-03




                                                                                                                                  Jul-04




                                                                                                                                                                  Jul-05




                                                                                                                                                                                                       Jul-06




                                                                                                                                                                                                                                Jul-07
                                                                                Jan-03




                                                                                                                      Jan-04




                                                                                                                                                Jan-05




                                                                                                                                                                                     Jan-06




                                                                                                                                                                                                                   Jan-07




resident banks’ 12 month growth rate is also positive (3%)
in September 2005, which shows an overall rising trend.
However, this stabilized and has shown a steady downward
trend up to July 2007.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                                         20
Credit and Debt Management – 2008 Survey




Similar trends could be observed on the values of                                                                                  This was the same rate of banks for value of approvals was
approvals for secured lending, with the other specialist                                                                           well positive even in July 2005 (2.5%) compared to the
lenders’ increased share in recent years. Although the level                                                                       negative July growth rates of building societies and other
of numbers was relatively lower in 2005 than it was in                                                                             specialist lenders (-15% and -0.8% respectively). The
2003 and 2004, the level of values increased through 2006                                                                          growth of specialist lending shows a sharp peak in early
and 2007 until the last quarter of 2007.                                                                                           2006 compared to the other lenders since this peak all
                                                                                                                                   trends show a steady decline with the Building Societies
                                                                                                                                   being most pronounced.
One of the main differences is that although the 12 month
growth rate of UK resident banks for number of approvals
was still negative in August 2005 (-0.5%).


                                                 Chart 2.4.1.3 – Monthly Value of Approvals for Secured
                                                  Lending to Individuals (source: Bank of England 2007)

                                                   UK Resident Banks                          Building Societies                                Other Specialist Lenders

                        40000
                        35000
                        30000
                        25000
                        20000
                        15000
                        10000
                         5000
                                  0
                                                      Jul-02




                                                                         Jul-03




                                                                                                             Jul-04




                                                                                                                                     Jul-05




                                                                                                                                                                      Jul-06




                                                                                                                                                                                                  Jul-07
                                        Jan-02




                                                               Jan-03




                                                                                           Jan-04




                                                                                                                         Jan-05




                                                                                                                                                    Jan-06




                                                                                                                                                                                        Jan-07




                               Chart 2.4.1.4 – 12 Month Growth Rate of Value of Approvals for
                                  Secured Lending to Individuals (source: Bank of England 2007)

                                                               Total                                                              UK Resident Banks
                                                               Building Societies                                                 Other Specialist Lenders

                        2.5

                          2

                        1.5

                          1

                        0.5

                          0

                        -0.5

                         -1
                                                  Jul-03




                                                                                  Jul-04




                                                                                                                      Jul-05




                                                                                                                                                             Jul-06




                                                                                                                                                                                                 Jul-07
                               Jan-03




                                                                Jan-04




                                                                                                    Jan-05




                                                                                                                                       Jan-06




                                                                                                                                                                               Jan-07




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                        21
Credit and Debt Management – 2008 Survey




Types of Lending                                                                                                                  In terms of the growth rates, remortgaging and other
                                                                                                                                  secured lending follow nearly the same path unlike the
Approvals for House Purchase, Remortgaging and Other
                                                                                                                                  house purchase one.
Secured Lending have followed similar trends in recent
years, all having almost equal shares in the pie regarding                                                                        However, the growth rates of all three have started to show
the number of approvals (112,000, 112,000 and 83,000                                                                              alike trends since the middle of 2004. Although all the
number of approvals in August 2005) that have remained                                                                            three rates had negative values in late 2004 and early 2005,
quite static until the fall in 2007. All types of lending see                                                                     remortgaging had a relatively higher level. The sharp
the bottom peak in January typically.                                                                                             upward trend in house purchase in 2006 has been followed
                                                                                                                                  by a decline into negative growth rates in 2007.



                           Chart 2.4.1.5 – Monthly Number of Approvals for Secured Lending to
                                                           Individuals (source: Bank of England 2007)

                                                          House Purchase                                 Remortgaging                Other Secured Lending

                          450
                          400
                          350
                          300
                          250
                          200
                          150
                          100
                           50
                             0
                                              Jul-02




                                                                              Jul-03




                                                                                                               Jul-04




                                                                                                                                     Jul-05




                                                                                                                                                                      Jul-06




                                                                                                                                                                                                  Jul-07
                                  Jan-02




                                                            Jan-03




                                                                                                Jan-04




                                                                                                                        Jan-05




                                                                                                                                                    Jan-06




                                                                                                                                                                                        Jan-07




                                 Chart 2.4.1.6 – 12 Month Growth Rate of Number of Approvals for
                                          Secured Lending to Individuals (source: Bank of England 2007)

                                                       House Purchase                                     Remortgaging                             Other Secured Lending

                           0.8


                           0.6


                           0.4


                           0.2


                            0


                          -0.2


                          -0.4


                          -0.6
                                                 Jul-03




                                                                                       Jul-04




                                                                                                                         Jul-05




                                                                                                                                                             Jul-06




                                                                                                                                                                                                 Jul-07
                                 Jan-03




                                                                     Jan-04




                                                                                                           Jan-05




                                                                                                                                          Jan-06




                                                                                                                                                                               Jan-07




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                        22
Credit and Debt Management – 2008 Survey




Unlike the similar shares for the number of approvals, a big                                                                     Whereas the 12 month growth rates of House Purchase and
difference is apparent for the value of approvals. The share                                                                     Other Secured Lending were negative from July 2004 (the
of other secured lending was only around 8% in August                                                                            rate for Other Secured Lending was still negative in August
2005. House purchase and remortgaging had analogous                                                                              2005), the growth rate of remortgaging went up to a
shares in August 2007, and after peaking in July 2007 a                                                                          positive by the end of 2005. It is also possible to notice
sharp decline is evident.                                                                                                        here that the rate of remortgaging did not see the negative
                                                                                                                                 levels of house purchase and other secured lending in late
                                                                                                                                 2004 up to mid 2007.


                             Chart 2.4.1.7 – Monthly Value of Approvals for Secured Lending to
                                                          Individuals (source: Bank of England 2007)

                                                         House Purchase                         Remortgaging                  Other Secured Lending

                   40000
                   35000
                   30000
                   25000

                   20000
                   15000
                   10000
                    5000
                             0
                                                Jul-02




                                                                     Jul-03




                                                                                                         Jul-04




                                                                                                                              Jul-05




                                                                                                                                                             Jul-06




                                                                                                                                                                                         Jul-07
                                  Jan-02




                                                           Jan-03




                                                                                       Jan-04




                                                                                                                     Jan-05




                                                                                                                                           Jan-06




                                                                                                                                                                               Jan-07




                                   Chart 2.4.1.8 – 12 Month Growth Rate of Value of Approvals for
                                     Secured Lending to Individuals (source: Bank of England 2007)

                                                House Purchase                                  Remortgaging                             Other Secured Lending

                    1

                   0.8

                   0.6

                   0.4

                   0.2

                    0

                  -0.2

                  -0.4

                  -0.6
                                           Jul-03




                                                                              Jul-04




                                                                                                                  Jul-05




                                                                                                                                                    Jul-06




                                                                                                                                                                                        Jul-07
                         Jan-03




                                                            Jan-04




                                                                                                Jan-05




                                                                                                                                Jan-06




                                                                                                                                                                      Jan-07




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                               23
Credit and Debt Management – 2008 Survey




Gross Lending                                                                                      Repayments

The amount of total sterling secured gross lending follows                                         In terms of repayments of secured lending, repayments on
the trend of value of approvals in a very similar way,                                             redemption, regular repayments, and other lump sum
seeing the bottom in January and increasing towards the                                            repayments had alike trends. Repayments on redemption
summer. Overall, there has been a steady trend increase                                            formed the majority of repayments of secured lending at
since early 2005.                                                                                  around 80% of the total repayments. The amounts have
                                                                                                   increased 2 and a half times since 2002.


                                       Chart 2.4.1.9 – Monthly Amount of Total Sterling Secured Gross
                           Lending to Individuals and Housing Associations (in sterling millions)
                                                             (source: Bank of England 2007)

                      40000

                      35000

                      30000

                      25000

                      20000

                      15000

                      10000

                       5000

                          0
                              Jan-02



                                           Jul-02



                                                    Jan-03



                                                             Jul-03



                                                                      Jan-04



                                                                               Jul-04



                                                                                         Jan-05



                                                                                                       Jul-05



                                                                                                                 Jan-06



                                                                                                                           Jul-06



                                                                                                                                     Jan-07



                                                                                                                                               Jul-07




                                  Chart 2.4.1.10– Monthly Amount of Sterling Repayments of Secured
                                                       Lending by Individuals (in sterling millions)
                                                               (source: Bank of England 2007)

                      30000


                      25000


                      20000


                      15000


                      10000


                       5000


                          0
                              Jan-02



                                           Jul-02



                                                    Jan-03



                                                             Jul-03



                                                                      Jan-04



                                                                                Jul-04



                                                                                          Jan-05



                                                                                                        Jul-05



                                                                                                                  Jan-06



                                                                                                                            Jul-06



                                                                                                                                      Jan-07



                                                                                                                                                Jul-07




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                      24
Credit and Debt Management – 2008 Survey



2.4.2 Unsecured Lending                                                                                                                                  The trend of amounts outstanding of unsecured lending
                                                                                                                                                         shows little fluctuation over time. The amounts outstanding

Unsecured gross lending trend is likely to move in a zigzag                                                                                              of both credit cards and other consumer credit have

manner, having the peaks in each December. Whilst credit                                                                                                 increased steadily except for a short decline in credit cards

card lending has a top peak in December, other consumer                                                                                                  in early 2003.

credit lending tends to have a bottom peak. Furthermore,
the level of the bottom peaks of other consumer lending
has an increasing trend unlike the top peaks of credit card
gross lending.



                         Chart 2.4.2.1– Monthly Amount of Total Sterling Unsecured Gross Lending
                                           to Individuals (in sterling millions) (source: Bank of England 2007)


                 25000



                 20000



                 15000



                 10000



                  5000



                     0
                         Jan-02



                                             Jul-02



                                                               Jan-03



                                                                                 Jul-03



                                                                                                   Jan-04



                                                                                                                     Jul-04



                                                                                                                                       Jan-05



                                                                                                                                                            Jul-05



                                                                                                                                                                          Jan-06



                                                                                                                                                                                            Jul-06



                                                                                                                                                                                                          Jan-07



                                                                                                                                                                                                                        Jul-07




                                           Chart 2.4.2.2– Monthly Amounts Outstanding of Total Sterling Net
                                           Unsecured Lending to Individuals (source: Bank of England 2007)


                 250000



                 200000



                 150000



                 100000



                  50000



                         0
                                  Jan-02



                                                      Jul-02



                                                                        Jan-03



                                                                                          Jul-03



                                                                                                            Jan-04



                                                                                                                              Jul-04



                                                                                                                                                Jan-05



                                                                                                                                                                 Jul-05



                                                                                                                                                                                   Jan-06



                                                                                                                                                                                                 Jul-06



                                                                                                                                                                                                               Jan-07



                                                                                                                                                                                                                                 Jul-07




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                                                       25
Credit and Debt Management – 2008 Survey



                                                                12000


Despite the apparent zigzag shape, credit card repayments       10000


have a rising trend over time with, however, a lower             8000


growth rate recently.                                            6000


Chart 2.4.2.3– Monthly Amount of UK Resident Banks’              4000


(inc. Central Bank) Sterling Credit Card Repayments by           2000


Individuals (in sterling millions)                                     0




                                                                                  Jan-02



                                                                                                       Jul-02



                                                                                                                         Jan-03



                                                                                                                                           Jul-03



                                                                                                                                                              Jan-04



                                                                                                                                                                            Jul-04



                                                                                                                                                                                         Jan-05



                                                                                                                                                                                                         Jul-05



                                                                                                                                                                                                                     Jan-06



                                                                                                                                                                                                                                Jul-06



                                                                                                                                                                                                                                           Jan-07



                                                                                                                                                                                                                                                      Jul-07
(source: Bank of England 2007)




                                                                 0.25
Repayments-to-Amounts Outstanding ratio has started to
decrease since April 2004 and despite some sharp short ups        0.2



and downs it continues to remain quite static.                   0.15


Chart 2.4.2.4– Monthly Amount of UK Resident Banks’               0.1

(inc. Central Bank) Sterling Credit Card Repayments by
                                                                 0.05
Individuals/Monthly Amounts Outstanding of Total
                                                                      0
Sterling Net Credit Card Lending to Individuals
                                                                               Jan-02



                                                                                                    Jul-02



                                                                                                                     Jan-03



                                                                                                                                       Jul-03



                                                                                                                                                          Jan-04



                                                                                                                                                                           Jul-04



                                                                                                                                                                                         Jan-05



                                                                                                                                                                                                         Jul-05



                                                                                                                                                                                                                     Jan-06



                                                                                                                                                                                                                                 Jul-06



                                                                                                                                                                                                                                            Jan-07



                                                                                                                                                                                                                                                        Jul-07
(source: Bank of England 2007)




                                                                                                                                                    Credit Card                                   Personal Loans
Both credit card and personal loan interest rates show
                                                                 18

similar trends recently, especially in 2005. Both have a         16

                                                                 14
decreasing trend very recently followed by a steady              12

increase from the start of 2004 to the second quarter of         10

                                                                  8
2005. Regardless of the time, credit card interest rates have     6

                                                                  4
had a slightly higher level than personal loan interest rates
                                                                  2

in recent years up until July 2007 where they converged.          0
                                                                      Jan-02



                                                                                           Jul-02



                                                                                                                Jan-03



                                                                                                                                  Jul-03



                                                                                                                                                     Jan-04



                                                                                                                                                                       Jul-04



                                                                                                                                                                                     Jan-05



                                                                                                                                                                                                      Jul-05



                                                                                                                                                                                                                  Jan-06



                                                                                                                                                                                                                              Jul-06



                                                                                                                                                                                                                                          Jan-07



                                                                                                                                                                                                                                                      Jul-07




Chart 2.4.2.5 - End Month Weighted Average Interest Rate,
Bank & Building Societies (source: Bank of England 2007)




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                                                                  26
Credit and Debt Management – 2008 Survey



2.5.      The Over-Indebtedness Debate                              Those with a rising property value have also had the option
                                                                    to re-mortgage and/or ‘equity release’ as a means of
                                                                    recovering in the short-term. Thus, even though changes in
Once a borrower reaches the position that they are unable
                                                                    arrears levels may be a useful proxy for potential over-
to meet their debt obligations and scheduled repayments,
                                                                    indebtedness, it could either seriously under-estimate or
i.e. the borrower defaults or falls into ‘arrears’; then they
                                                                    seriously   over-estimate    the   true   extent   of   over-
can be regarded as over-indebted. Most consumer lenders
                                                                    indebtedness. In the past, the path to default was easier to
define ‘default’ as three consecutive missed payments and
                                                                    track, individuals in arrears soon ran out of refinancing
‘arrears’ as one or more missed payments on revolving or
                                                                    options. In the recent climate, an individual with serious
fixed term credit accounts. Clearly many borrowers may
                                                                    debt problems can manage to keep up to date on credit
miss payments due to some temporary financial difficulty,
                                                                    accounts and show none of the obvious symptoms of
but are able to recover the situation and return accounts up
                                                                    financial distress until the terminal stage. Recent accounts
to date and therefore would not be defined as ‘over-
                                                                    of up to a million individuals covering mortgage payments
indebted’. On the other hand, some borrowers may be
                                                                    with credit card cheques is perhaps a compelling example
currently up to date but realise that is not long-term
                                                                    of this (Shelter, October 2007).
sustainable and therefore are at risk of being ‘over-
indebted’. Assessing the incidence and extent of over-
indebtedness amongst UK households is, therefore,
                                                                    In order to assess the household sector’s ability to meet
problematic.
                                                                    debt obligations its is important to analyse debt service
                                                                    ratios, i.e. the funds available to meet monthly interest
                                                                    payments and debt to income/wealth ratios.
Households that are ‘in arrears on a structural basis’
eventually default, the extent of which can be estimated by
the numbers of bankruptcies, IVA’s, and to some degree by
                                                                    The ratio of household debt to income has risen by 50%
the number and values of CCJs and debt write-offs and/or                       13
                                                                    since 2000 and stands at 160% in the first quarter of
debts being placed with Debt Collection Agencies and
                                                                    2007. The debt to income ratio has been rising steadily
Debt Buyers. Estimating the number of households ‘at risk’
                                                                    since 1998 with an acceleration in growth rate post 2000.
is far more difficult to determine in the current climate.
                                                                    The recent interest rate rises and the strong growth in debt
Those ‘at risk’ may be conflated with debtors in
                                                                    levels relative to earnings are likely to further increase the
‘temporary difficulties’ if we analyse the level of ‘arrears’.
                                                                    debt to income ratio.
However, the lending market now allows debtors ‘at risk’
to disguise any problems for much longer than in the past
by the ability to continually restructure debts by taking on
products from other lenders or rescheduling their debts
with existing lenders i.e. the balance transfer, ‘arrangement
to pay’ and consolidation loan environment.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                           27
Credit and Debt Management – 2008 Survey




                                                                        Chart 2.5.1 – Debt to Income Ratio (source: ONS
                                                                        and Bank of England 2007)


The ratio is now close to that in the US economy. A more
important concern, however, is how well the consumer can                                                          D e b t t o In c o m e R a t i o
                                                                         160%
service the debt out of current and future cash-flow. In order to
                                                                       e1 4 0 %
                                                                       m
                                                                       o
assess the financial fragility of households we need to have a         c1 2 0 %
                                                                       n
                                                                       I
                                                                       e
                                                                       l
view of the consumers complete balance sheet position which            b1 0 0 %
                                                                       a
                                                                       l
                                                                       a
                                                                       s
                                                                       o 80%
takes account of household assets. The latter is more difficult        p
                                                                       s
                                                                       i
                                                                       D 60%
                                                                       l
                                                                       a
                                                                       u 40%
to proxy.                                                              n
                                                                       n
                                                                       A
                                                                       f 20%
                                                                       o
                                                                       %
                                                                             0%
                                                                                  87   88       89   90     91     92       93   94    95       96   97   98       99   00    01       02   03     04       05       06   07

                                                                                                                                                               S o u rc e  O N S  a n d  B a n k  o f  E n g la n d


An indicator of financial health is the share of income
devoted to servicing debt (income gearing). Mortgage debt
                                                                        Chart 2.5.2 – Income Gearing (source: ONS and
service measures have been quite stable since the interest
                                                                        Datastream 2007)
rate hikes of the late 80’s and have fluctuated around 8-
10% in the period up until 2004 including unsecured debts
                                                                      8 ,0 0 0

the share of income has fluctuated around 20% until more              7 ,0 0 0


recent times.                                                         6 ,0 0 0


                                                                      5 ,0 0 0
                                                                    n
                                                                    o
                                                                    i
                                                                    l 4 ,0 0 0
                                                                    i
                                                                    B
                                                                    £3 ,0 0 0
The increase in mortgage debt levels coupled with recent              2 ,0 0 0


rises in interest rates has resulted in a sharp increase in the       1 ,0 0 0


                                                                            0
share of income devoted to servicing debt. Gross interest                         9
                                                                                  7
                                                                                  9
                                                                                  1
                                                                                       0
                                                                                       8
                                                                                       9
                                                                                       1
                                                                                            1
                                                                                            8
                                                                                            9
                                                                                            1
                                                                                                 2
                                                                                                 8
                                                                                                 9
                                                                                                 1
                                                                                                     3
                                                                                                     8
                                                                                                     9
                                                                                                     1
                                                                                                            4
                                                                                                            8
                                                                                                            9
                                                                                                            1
                                                                                                                 5
                                                                                                                 8
                                                                                                                 9
                                                                                                                 1
                                                                                                                        6
                                                                                                                        8
                                                                                                                        9
                                                                                                                        1
                                                                                                                             7
                                                                                                                             8
                                                                                                                             9
                                                                                                                             1
                                                                                                                                 8
                                                                                                                                 8
                                                                                                                                 9
                                                                                                                                 1
                                                                                                                                       9
                                                                                                                                       8
                                                                                                                                       9
                                                                                                                                       1
                                                                                                                                            0
                                                                                                                                            9
                                                                                                                                            9
                                                                                                                                            1
                                                                                                                                                 1
                                                                                                                                                 9
                                                                                                                                                 9
                                                                                                                                                 1
                                                                                                                                                     2
                                                                                                                                                     9
                                                                                                                                                     9
                                                                                                                                                     1
                                                                                                                                                          3
                                                                                                                                                          9
                                                                                                                                                          9
                                                                                                                                                          1
                                                                                                                                                               4
                                                                                                                                                               9
                                                                                                                                                               9
                                                                                                                                                               1
                                                                                                                                                                    5
                                                                                                                                                                    9
                                                                                                                                                                    9
                                                                                                                                                                    1
                                                                                                                                                                        6
                                                                                                                                                                        9
                                                                                                                                                                        9
                                                                                                                                                                        1
                                                                                                                                                                             7
                                                                                                                                                                             9
                                                                                                                                                                             9
                                                                                                                                                                             1
                                                                                                                                                                                   8
                                                                                                                                                                                   9
                                                                                                                                                                                   9
                                                                                                                                                                                   1
                                                                                                                                                                                        9
                                                                                                                                                                                        9
                                                                                                                                                                                        9
                                                                                                                                                                                        1
                                                                                                                                                                                             0
                                                                                                                                                                                             0
                                                                                                                                                                                             0
                                                                                                                                                                                             2
                                                                                                                                                                                                   1
                                                                                                                                                                                                   0
                                                                                                                                                                                                   0
                                                                                                                                                                                                   2
                                                                                                                                                                                                        2
                                                                                                                                                                                                        0
                                                                                                                                                                                                        0
                                                                                                                                                                                                        2
                                                                                                                                                                                                                 3
                                                                                                                                                                                                                 0
                                                                                                                                                                                                                 0
                                                                                                                                                                                                                 2
                                                                                                                                                                                                                      4
                                                                                                                                                                                                                      0
                                                                                                                                                                                                                      0
                                                                                                                                                                                                                      2
                                                                                                                                                                                                                          5
                                                                                                                                                                                                                          0
                                                                                                                                                                                                                          0
                                                                                                                                                                                                                          2
                                                                                                                                                                                                                               6
                                                                                                                                                                                                                               0
                                                                                                                                                                                                                               0
                                                                                                                                                                                                                               2

payments have increased by more than 2% as a share of                                                                                 W e a lth               Debt
                                                                                                                                                                    S o u rc e  O N S  a n d  B a n k  o f E n g la n d
disposable income since 2004. This trend increase is
expected to continue as the impact of larger mortgages and
higher rates feeds through despite the obvious tightening of            Chart 2.5.3 – Debt to Wealth Ratio (source: ONS and

credit policy by the lenders. Reported statistics on debt               Bank of England 2007)

servicing vary considerably and are, of course, sensitive to
the sample selected. Although the ‘average household’ is
spending around 12% of its disposable income on interest                   2 0%                                         In c o m e G e a rin g
                                                                        e
                                                                        m
payments, if we take only the ‘credit active’ population                o
                                                                        c
                                                                        n
                                                                        I 1 5%
                                                                        e
                                                                        l
                                                                        b
then, in 2007, households are spending around 30% of their              a
                                                                        s
                                                                        o
                                                                        p
                                                                        s
                                                                        i
                                                                        D
                                                                        f 1 0%
income servicing debt, up from around 20% 10 years                      o
   14                                                                   %
                                                                        a
                                                                        s
ago .                                                                   a
                                                                        s 5%
                                                                        t
                                                                        n
                                                                        e
                                                                        m
                                                                        y
                                                                        a
                                                                        p
                                                                        e
                                                                        R 0%
                                                                                  8 7 8 8 8 9 9 0 9 1 9 2 9 3 9 4 9 5 9 6 9 7 9 8 9 9 0 0 0 1 0 2 0 3 0 4 0 5 06 0 7

                                                                                                          Inte re s t o nl y           In te re s t a nd m o r ta ge r ep ay m e nts

                                                                                                                                                                             S o u rc e:   ON S  a nd  D atastre am




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                           28
Credit and Debt Management – 2008 Survey




Some commentators point to the growth in ‘wealth’                   mortgages in short-term arrears rose to 125,100 in June
relative to the growth in household debt. Wealth comprises          2007 which was slightly down on the previous year. The
household assets such as pensions, shares, savings and              Bank of England’s Financial Stability Report (2007,
property values. The chart shows that the growth in wealth          October) attempts to measure the number of households
has outpaced that of debt and the gap between wealth and            that are liable to default should economic conditions
debt has increased. Of course, there are problems with such         worsen. They report a model of household distress that is
analysis. Firstly, wealth is something of a ‘will o’ the wisp’      disaggregated by age and income. They conclude that
- property prices and share prices can ‘collapse’ and so            arrears will be concentrated in a small proportion of
with them much of the reported balance sheet wealth.                households with low income/high debt and that “the
Secondly, the distribution of debt and wealth across the            number of arrears spanning the majority of the income and
population are very different as is the gap between wealth          debt distribution is small” but with changes in interest rates
and debt across the rich-poor the spectrum. A recent study          and growth in indebtedness “there is a growing tail of
by the Bank of England (Quarterly Bulletin, 2007 Q1)                vulnerable households” and that the “outlook for the UK
reports that older households (55+) have experienced the            household sector appears to be more uncertain than for
greatest net gains in wealth whilst the middle-aged                 some time”. Moreover, the Bank of England Quarterly
households (35-54 years) have increased their indebtedness          review (2007 Q1) warn that “larger shocks than seen
most over the same period. They suggest that “the                   recently, particularly shocks impacting on interest rates,
distribution of debt has become more skewed with fewer              income or employment, could cause adverse interactions
households borrowing larger amounts” (p71).                         between debt, house prices and consumption” (p76).



Obviously the middle-age population have a longer
                                                                    2.5.2    Trends in Write-offs by Major Lenders

expected future income stream and using the flexibility in
the credit industry can take action to spread current               Whereas secured lending write-offs decreased from 2000
problems over an extended period and avoid short-term               to 2004, unsecured lending write-offs, both credit cards
financial distress. However, this is the same age group that        and other unsecured lending, have kept rising steadily since
have the largest outstanding credit card balances and other         2000 accelerating from 2003 up until summer 2007.
unsecured lending products.                                         Together with a lower level of credit card repayments and
                                                                    an increasing trend in amounts outstanding of unsecured
                                                                    lending, the steady increase in unsecured lending write-offs
2.5.1    Arrears
                                                                    may be the sign of a lowered credit quality level in the
                                                                    unsecured lending industry.     The ratio of write offs-to-
Arrears levels and trends in arrears are an important               amounts outstanding for credit cards is also increasing
indicator of debt problems and a gauge of the extent of the         steadily with a remarkable peak in the first quarter of 2002.
shift from temporary difficulties to more structural                The secured lending write-offs show a considerable
problems in debt servicing. Hard statistics on arrears across       increase in 2005 and 2006 with a peak similar to the end of
the range of financial products are difficult to obtain. The        1999. They have started to decline in 2007.
Council for Mortgage Lenders report that the number of




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                           29
Credit and Debt Management – 2008 Survey




                                                                              1000

                                                                               900

                                                                               800

Credit Card Lending…                                                           700

                                                                               600

Chart 2.5.4 – Credit Card Lending                                              500

                                                                               400
(source: Bank of England)                                                      300

                                                                               200

                                                                               100

                                                                                   0




                                                                                            Dec-99




                                                                                                                                              Dec-00




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                                                                                                                                                                                                                                                                                   Dec-03




                                                                                                                                                                                                                                                                                                                          Dec-04




                                                                                                                                                                                                                                                                                                                                                                  Dec-05




                                                                                                                                                                                                                                                                                                                                                                                                           Dec-06
                                                                                                                   Jun-00




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                                                                                                                                                                                                                                                                                                                                                                                                                               Jun-07
                                                                              1800

                                                                              1600

                                                                              1400

Other Unsecured Lending…                                                      1200

                                                                              1000

Chart 2.5.5 – Other Unsecured Lending                                          800

                                                                               600
(source: (source: Bank of England)
                                                                               400

                                                                               200

                                                                                   0         Dec-99




                                                                                                                                                   Dec-00




                                                                                                                                                                                                 Dec-01




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                                                                                                                                                                                                                                                                                                                                                                                                             Dec-06
                                                                                                                        Jun-00




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                                                                                                                                                                                                                                                                                                                                                                                        Jun-06




                                                                                                                                                                                                                                                                                                                                                                                                                                 Jun-07
                                                                              70


                                                                              60
Secured Lending…
                                                                              50


Chart 2.5.6 - SecuredLending                                                  40


(source: (source: Bank of England)                                            30


                                                                              20


                                                                              10


                                                                               0
                                                                                   Dec-99




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                                                                                                                                                                                                                                                                                                                                                                                                              Dec-06
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                                                                                                                                                                                                                                                                                                                                                                                         Jun-06




                                                                                                                                                                                                                                                                                                                                                                                                                                   Jun-07
The ratio of write-offs to credit card lending peaked in
January 2002 as a result of a considerable increase in
                                                                               0.018
arrears in 2001. Since 2003 the trend has been sharply                         0.016

                                                                               0.014
upwards until summer 2007.
                                                                               0.012

Ratio: (An Example)                                                                0.01

                                                                               0.008
Quarterly Amount of UK Resident Banks’ Sterling Write-offs of Credit Card
                                                                               0.006
Lending to Individuals / Quarterly mounts Outstanding of Total Sterling Net    0.004

Credit Card Lending Individuals                                                0.002

                                                                                            0
                                                                                                      Dec-99




                                                                                                                                                            Dec-00




                                                                                                                                                                                                          Dec-01




                                                                                                                                                                                                                                                     Dec-02




                                                                                                                                                                                                                                                                                              Dec-03




                                                                                                                                                                                                                                                                                                                                     Dec-04




                                                                                                                                                                                                                                                                                                                                                                             Dec-05




                                                                                                                                                                                                                                                                                                                                                                                                                      Dec-06
                                                                                                                                 Jun-00




                                                                                                                                                                                   Jun-01




                                                                                                                                                                                                                                Jun-02




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                                                                                                                                                                                                                                                                                                                 Jun-04




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                                                                                                                                                                                                                                                                                                                                                                                                  Jun-06




                                                                                                                                                                                                                                                                                                                                                                                                                                          Jun-07




Chart 2.5.7 – Ratio of Write offs to Credit Card
Lending (source: ???




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                                                                                                                                                                                                                                 30
Credit and Debt Management – 2008 Survey




                                     Chart 2.5.8 – Major UK Banks Annual Write Off Rates
                                                 (source: Bank of England 2007




2.6      Personal Insolvency:
         Bankruptcy and Voluntary
                                                                    The legislation changes allow individuals in serious
         Arrangements
                                                                    financial difficulty to be discharged from bankruptcy after
                                                                    a maximum of one year as opposed to 3 years under the old
The levels of personal insolvency as gauged by the number           rules. Although the legal changes make the bankruptcy
of bankruptcies and individual voluntary arrangements               option more attractive, the bankruptcy trend is more likely
show a quite spectacular increase since 2000. The                   symptomatic of a tremendous increase in the number of
beginning of this upward trend pre-dates the changes in             individuals facing severe financial difficulty. The level of
bankruptcy law introduced in April 2004, although there is          personal insolvency appears to have peaked at the end of
a clear acceleration in the levels of declared insolvencies         2006 and was at a level almost 3 times higher than the
post-2004. The Act appears to have encouraged individuals           previous peak in the early 90’s recession.
on the path to bankruptcy to declare early.


                                      Chart 2.5.9 – Personal Bankruptcies and Individual
                                          Voluntary Arrangements (source: DTI 2007)




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                         31
Credit and Debt Management – 2008 Survey



                                    Chart 2.5.10 – Personal Bankruptcy Ratio (Source ???)




What is particularly striking about the growth in                   It   is   clear   that   personal   bankruptcies,   household
bankruptcy is that the trend increase occurs against a              indebtedness, and consumer credit are highly interrelated.
background of generally good macro-economic and
monetary conditions, GDP growth, low interest rates, high
                                                                    Furthermore, it is suggested that the evolution of personal
levels of employment and strong asset prices. The 90s’
                                                                    bankruptcies and laws related to them have been
peak occurred against a backdrop of economic decline and
                                                                    influenced considerably by the consumer credit expansion.
nominal interest rates in the region of 13-14%.
                                                                    Although there are some conflicting arguments regarding
                                                                    why bankruptcies have increased steadily and reached to
Some commentators argue that the insolvency levels are              record levels, the main reasons are generally cited as the
still relatively low in relation to the number of individuals       increased credit availability, decreased credit quality in the
in debt and therefore are not indicative of a general               industry, decreased default costs (fall in “social stigma” or
increase in household financial stress. The personal                in “legal costs”), changes in regulations and laws, and
bankruptcy ratio, bankruptcy filings per 10000 adults               macroeconomic shocks.
(source: Insolvency Service and ONS), rose from 0.30 in
1970 to 3.86 in 2005 and is estimated to have reached 4 in
                                                                    The data used in our study are described briefly below:
2006.
                                                                    The personal bankruptcy ratio is calculated as the number
                                                                    of individual insolvencies divided by the adult population.
2.6.1. Bankruptcy Modelling – Key Drivers
                                                                    The insolvency data is gathered from the Insolvency
                                                                    Service as the number of individual insolvencies in
The CMRC has produced a model of personal bankruptcy                England and Wales on a seasonally unadjusted and
rates in an attempt to determine the key drivers of                 quarterly basis from 1960 to 2006. The quarterly
bankruptcy. The purpose is to model variations in personal          population data for the UK is collected from the Office for
bankruptcy in relation to other macro-economic and credit           National Statistics as the population aged over 16 (ONS
related statistics.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                           32
Credit and Debt Management – 2008 Survey




code: MGSL). The England and Wales quarterly adult                  Banks’ secured or unsecured lending is not available
population is then calculated from the population estimates         separately. Therefore, although it is more desired to use the
gathered from the General Register Office for Scotland and          unsecured lending write-off ratio, such an application is not
Northern Ireland Statistics and Research Agency.                    possible with the data available. Hence, the ratio calculated
                                                                    here is the UK Residents’ Banks’ write-off ratio in total
                                                                    including both secured and unsecured lending due to the
Debt-to-income ratio, an indicator of the household
                                                                    data limitation.
indebtedness level, is calculated as the total household
liabilities (ONS code: NNPP) divided by the real
households’ disposable income (ONS code: NRJR) with                 ILO Unemployment Rate for England (ONS code: YCZG)
the ONS data on a quarterly basis from 1987 to 2006.                is selected to represent Unemployment, a proxy of
Quarterly values of Real Households’ Disposable Income              economic discomfort and financial strain for households.
are multiplied by 4 to match the nature of the liability            Since the ILO rate is calculated for the economically active
values. Capital Gearing, a factor that shows the level of           resident population, it may also be more representative for
indebtedness relative to household wealth, is calculated as         the economic shocks for households.
the ratio of total household liabilities (ONS code: NNPP)
divided by total household financial assets (ONS code:
                                                                    Data for Interest Rates, which could be stated as the cost of
NNML).
                                                                    credit, is collected as Treasury Bill interest rates given that,
                                                                    as widely argued, economic conditions as well as the
Amounts Outstanding of Net Lending to Individuals, an               inflation may have an effect on Treasury Bill Interest
indicator of the trend in the consumer credit volume, is            Rates. Data for Quarterly average rate of discount of 3
reported both for each lender type and for each type of             mount Treasury Bills is gathered from Bank of England on
lending. The Bank of England data contains information              a quarterly basis from 1975 to 2006.
about UK Resident Banks’, Building Societies’, other
specialist lenders’, retailers’, and other lenders’ lending as
                                                                    Data for Household Savings, which would help to deal
well as secured and unsecured lending in total over time.
                                                                    with income shocks, is gathered from the ONS as the
However, the data do not inform about the proportion of
                                                                    Households’ Saving Ratio (ONS code: NRJS) on a
secured or unsecured lending for each type of lender.
                                                                    quarterly basis from 1963 to 2006. Self-employment is
                                                                    calculated with a ratio as the number of self-employed
Write-off Ratio, an indicator of the default behaviour over         divided by the adult population. Data for the number of
time, is calculated as the Amount of Write-offs of Lending          self-employed is gathered from the ONS (ONS code:
to Individuals divided by the Amounts Outstanding of Net            MGRQ) for the UK and the UK adult population is used to
Lending to Individuals using Bank of England data on a              calculate the ratio accordingly.
quarterly basis. The data includes only UK Resident
Banks’ write-off amounts for secured and unsecured
                                                                    Retail Prices Index (RPI), one of the main measures of
lending. However, amounts outstanding of UK Resident
                                                                    inflation, is used as an indicator of the changes in the cost




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                             33
Credit and Debt Management – 2008 Survey




of living that may have an effect on households. The RPI            long-term determinants of personal bankruptcies in the
data is collected from the ONS as the RPIX (ONS code:               sample period. The econometric model suggests that other
CHMK) which is the retail prices index excluding                    than the debt-to-income ratio, the growth rate of the write-
mortgage interest payments to minimise the impact of the            off ratio and consumer confidence have significant short-
interest rate changes.                                              run effects on personal bankruptcies. Although the study
                                                                    does not find unemployment or inflation significant in the
                                                                    equation, they still may have an impact on bankruptcies.
Consumer Confidence, a factor that may affect bankruptcy
                                                                    The reason of insignificance may be the relatively stable
decisions as public’s confidence in the economy, is
                                                                    nature and low levels of such factors in the sample period.
represented with Retail Sales Index (RSI) in terms of
                                                                    The results of this study need to be interpreted according to
volume with constant prices for predominantly non-food
                                                                    the sample period. The write-off ratio only has a short-run
stores (ONS code: EAGX). Consumer spending, which is
                                                                    impact on personal bankruptcies in the sample period. The
one of the main economic drivers of the whole economy, is
                                                                    ratio used in this research is a general ratio of all lending
generally cited to be affected by consumers’ confidence in
                                                                    types. However, unsecured lending write-off ratio may still
the economy. Another general view is that when consumer
                                                                    form a long term relationship with personal bankruptcies.
confidence falls, it is more likely to see a drop in spending
                                                                    The research is unable to explain a relatively sharper
on comfort or durable products than in spending on food.
                                                                    increase in personal bankruptcies between 2004 and 2006
                                                                    other than suggesting that the new bankruptcy law is
                                                                    largely responsible for this increase.
Income Gearing, an indicator of the affordability of debt, is
considered as both mortgage and total income gearing.
Total Income Gearing, which is related to the total cost of         2.7.     County Court Actions to
servicing household debt, is calculated as the ratio of                      Recover Debt
household interest payments (ONS code: QWMG) to real
households’ disposable income (ONS code: NRJR) on a
                                                                    Previous research by CMRC (Debt Survey 2004) indicated
quarterly basis. Mortgage Income Gearing is calculated as
                                                                    that the use of court action, by the major lenders and credit
mortgage average interest rate (ONS code: AJNL)
                                                                    card providers, to recover debt from consumers in default
multiplied by amounts outstanding of total secured net
                                                                    had generally been in decline. In recent interviews with
lending (Bank of England data) and divided by real
                                                                    lenders, however, it is clear that the use of various forms of
households’ disposable income (ONS code: NRJR).
                                                                    court action to secure and recover outstanding debt have
                                                                    been increasing again. Indeed the Registry Trust recently

The series are modelled using a dynamic time-series                 commented that, “lenders are increasingly using the court

methodology which attempts to identify and model those              route to deal with unsecured debts. A judgement opens the

factors that form a long term relationship with personal            way to further action such as a charging order “(RT Press

bankruptcy rates with those that affect bankruptcy rate in          Release, October 2007).

terms of short-run dynamics. The debt-to-income ratio and
the indebtedness level of households, emerge as the key




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                           34
Credit and Debt Management – 2008 Survey



                               Chart 2.5.11 – Consumer County Court Judgements 2002-2007
                                                      (Source: Registry Trust)




The number of CCJ’s against consumers has grown rapidly                  Households in financial difficulty will typically have a
since 2004 and reached a ten year high by the end of 2006                ‘pecking order’ of creditors and are likely to pay those whose
with 843,853 judgment orders. The growth has continued in                service   they    value    most,    those   who   have     most
2007 with almost 250,000 judgements in Q1 and therefore the              sanctions/threats and/or those with the most sophisticated and
total could reach 1 million judgements by the end of the year            proactive collections activities.
compared to just over half a million in 2004. Registry Trust
estimates that around 70% of judgements are ‘credit related’
the remaining 30% being for unpaid tax, utility bills and motor          There are a number of reasons put forward to explain why

tax. Interviews with major lenders found that county court               accounts become delinquent i.e. the borrower defaults on

action in order to gain a ‘charge on the assets’ of a debtor were        payments. Most have          always been cited as        factors

becoming common practice.                                                precipitating financial difficulty. For example, changes in
                                                                         work circumstances and unemployment or problems with self-
                                                                         employment; changes in family circumstances such as marital
2.8       Factors Affecting Indebtedness                                 break-up, separation and divorce or illness and bereavement;
                                                                         suspicious circumstances such as suspected fraud. Clearly
                                                                         some of the factors might be interrelated. For instance,
This section provides some background on trends in consumer
                                                                         unemployment may place strain on marriages and precipitate
indebtedness and the recent response of collections and
                                                                         indebtedness. More recently, factors such as over-commitment
recovery departments. A key point is that consumer
                                                                         and spending sprees have been cited as reasons for advanced
indebtedness has increased substantially in the last 5 years and
                                                                         arrears and indebtedness. The latter, in practice, may be
households typically have debts spread across multiple
                                                                         difficult to define. It may be treated as 'quasi-fraud' or
creditors. There are signs of an increasingly fragility in the
                                                                         'malicious spending' rather than financial mismanagement.
economy with a larger proportions of households on the
                                                                         Understanding the customer's psyche and the difference
interface between ‘struggling’ with payments and being in
                                                                         between those who are 'free and easy' with spending and those
more serious ‘financial difficulty’.
                                                                         who are slightly over-committed but 'in control' is important
                                                                         but not trivial. Understanding the reasons for over-committed
                                                                         customers is a particularly important for those working at the




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                  35
Credit and Debt Management – 2008 Survey




sharp end, such as collections agencies that have to develop             •     Borrowers are increasingly using debt management
collections strategies to deal with this type of customer. From                and IVAs as a route out of debt.
our interviews with lenders, we can draw the following
general conclusions regarding credit and indebtedness:
                                                                    A common finding from our study of large volume collection
                                                                    activities was that customers would often find themselves in
    •     Consumers have found it easier to get credit as           financial difficulty and arrears on consumer debt due to 'over-
          lenders competed for business; even when their            commitment' i.e. too many debt repayments in relation to
          credit worthiness has been highlighted as a problem;      current levels of income. Recent survey evidence suggests that
          More recently credit policies across both secured         over-commitment continues to be cited as the major reason for
          and unsecured lending has considerably tightened          payment difficulties. Increasingly, however, the borrower
          (in the last 2 years) making credit access more           treats the matter with less concern, less urgency and feels less
          difficult for customers with high levels of debt and      ‘stigma’    about   the   problem.    Because     a   consumer's
          ‘restructuring opportunities’ less likely;                indebtedness is a function of total consumer debt outstanding
                                                                    it will span all types of credit across many possible lenders.
    •     Consumers are likely have more debt and more
                                                                    The practice of spreading debts across a wide range of
          unsecured debt as the average outstanding balance
                                                                    products and lenders obviously makes it very difficult for an
          of the credit active household has increased;
                                                                    individual lender to assess the customer's 'ability to pay' and
    •     Consumers are more likely to have multiple debts          the likelihood that they will service the debt.
          spread across different lenders; the average value of
          outstanding unsecured debt of households that are in
          difficulties is estimated as between £20,000 to           Increasingly consumers in financial difficulties are applying

          £40,000 and spread across multiple creditors;             for finance without revealing their complete financial position.
                                                                    The lender is only likely to discover the true position when
    •     Personal finance (e.g. loans; consolidation loans)
                                                                    repayment difficulties become apparent. Thus information on
          now tend to have longer repayment periods
                                                                    over-committed customers, often only comes to light once the
          compared to a few years ago and higher interest
                                                                    debtor is in an advanced state of arrears and in the collections
          rates;
                                                                    system. The Credit Reference Agency, Experian, has recently
    •     Lenders are more willing to restructure debt over         launched a new product that attempts to assess the total level
          longer periods and ‘re-age’ current balances;             of indebtedness of individual borrowers (Indebtedness Index).
                                                                    The trend in consumer indebtedness has led to charges of
    •     There has been a significant increase in Home
                                                                    irresponsible lending on behalf of the lenders and has seen an
          Equity Finance as a means of consolidating
                                                                    escalation in the use of debt consolidation services and 'advice'
          debt;
                                                                    organisations. These trends have implications for the debt
    •     There has been a significant increase in lending and      collection industry. The large volume lenders that were
          products aimed at the sub-prime market, particularly      recently interviewed expressed some concern that indebted
          sub-prime and buy-to-let mortgages;                       customers are more likely to use fee-paying advisors and
                                                                    consolidation companies to manage their debts rather than
    •     Lenders are beginning to use litigation via the
                                                                    confront the situation themselves. Some general conclusions
          county court system to obtain ‘charges on assets’;
                                                                    were observed:




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                              36
Credit and Debt Management – 2008 Survey




                                                                    information via the CRAs. Recent work by the CRAs to build
                                                                    ‘indebtedness   indices’   which      profile   the   customers
     •    Indebted customers are more likely to pay fee
                                                                    debt/income position should be helpful for future lending
          paying advisors in order to avoid confronting the
                                                                    decisions but have not been available in the past. The sharing
          problem with individual lenders;
                                                                    of positive credit data is another welcome development for
     •    Indebted customers go earlier to advisors;                lenders and collection departments.

     •    They are likely to turn down or avoid free advice
          from their creditor/lender;
                                                                    Recent changes to the Consumer Credit Act and other
     •    There is a trend increase in the number of consumers      government interventions have attempted to improve the
          using   bankruptcy     and    Individual     Voluntary    information provided by lenders, particularly transparency on
          Arrangements (IVAs) in order to deal with creditors       quoted APR’s, bank and late payment charges and redemption
          (Trust Deeds in Scotland);                                penalties. The Consumer Credit Bill aimed to create more
                                                                    competition and protection for consumers. The growth in
     •    The major lenders are beginning to resist IVAs.
                                                                    payment protection products and other safety-nets should
                                                                    reduce the impact of ‘changes in circumstance’ on vulnerable

Over-commitment may stem from a number of causes, clearly           groups.

changes in levels of income e.g. due to unemployment or
divorce may leave a customer unable to meet commitments
that were arranged on the basis of higher levels of expected
income. It may, however, be a function of the mismanagement
of personal finances or rash spending sprees. These latter two
are the most likely reasons for over-commitment i.e. general
indebtedness where the consumer takes on too much debt in
relation to income and spending sprees where injudicious
spending begins to cause mounting problems in servicing
current debts.



The government and regulators have taken an interest in
promoting both ‘responsible lending’ and ‘responsible
borrowing’ in order to mitigate potential debt problems. The
lender-borrower relationship has often been blighted by
problems of incomplete and ‘asymmetric information’. The
lenders require a complete picture of the borrowers income
and asset position in order to be able to assess risk and
appraise credit worthiness. The information provided by
Credit Reference Agencies has provided a incomplete picture
of the potential debtors profile since only recently have some
of the major banks (HSBC, NatWest) agreed to share




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            37
Credit and Debt Management – 2008 Survey



2.9         Fraud

The Credit Industry Fraud Avoidance System (CIFAS) report
an escalation in fraudulent behaviour in the use of financial
products. Recent data released by CIFAS (October 2007)
suggests that fraud trends continue upwards. Application fraud
increased by 23% from 2006-7 with 57,321 detected cases
reported to CIFAS and identity fraud, although slightly down
had 57,302 reported cases.

                                          Chart 2.9.1 – Fraud Trends 1997- 2005 (Source: CIFAS 2007)


                    CIFAS Category                            1997      1998         1999      2000           2001       2002      2003     2004      2005

Category 1 - False Identity                               2,231       1,902       2,189       12,310      27,270       42,029    57,669    69,512     80,894
Category 2 - Victim of Impersonation                      17,847      16,810      18,075      22,539      26,266       32,737    43,094    50,455     56,200
Category 3 - Application Fraud Facility Granted           15,338      15,348      11,531      13,524      13,213       18,354    18,893    19,865     22,466
Category 4 - Application Fraud Facility Refused           54,284      60,710      66,006      86,077      123,606      146,431   152,070   162,911   153,290
Category 5 - Conversion*                                  1,180       1,238       775         751         800          662       832       875         1,140
Category 6 - First Party Fraud                            13,343      13,014      17,608      21,867      30,507       36,453    36,526    41,588     41,313
Category 7 - Aiding & Abetting**                          0           0           0           6           24           37        12        27         47
Category 8 - Insurance Claims Fraud**                     0           0           0           10          144          993       960       802        488
Total                                                     104,223     109,022     116,184     157,084     221,830      277,696   310,056   346,035    355,838

% Change over previous year                               -           4.60%       7.15%       35.20%      40.46%       25.18%    11.65%    11.60%      2.80%

% Change since 1997                                       -           4.60%       12.08%      51.53%      112.84%      166.44%   197.49%   232.01%   241.41%
*Sale of assets subject to a credit agreement where the lender retained title to the asset.

**Category introduced in the year 2000




                                         Chart 2.9.2 – Fraud Trends 1997- 2005 (Source: CIFAS 2007)

                                                                                                   January           January
                                                                                                                                   %
                                                    CIFAS Case Type                                to Sept           to Sept
                                                                                                                                 Change
                                                                                                    2006              2007

                                 Identity fraud                                                       58,050         57,302      -1.29%

                                 Application Fraud                                                 46,468            57,321      23.36%

                                 Facility Takeover Fraud                                               3,625         4,844       33.63%

                                 Asset Conversion                                                       285           352        23.51%

                                 Misuse of Facility                                                16,774            16,841      0.40%

                                 False Insurance Claim                                                  281           306        8.90%

                                 Identity Fraud cases include cases of false identity, identity theft, account takeover and
                                 other impersonation situations.

                                 Application Fraud/False Insurance Claim relate to applications or claims which include
                                 lies or false supporting documentation where the name has not been identified as
                                 false.

                                 Facility Takeover Fraud occurs where a person (the 'Facility Hijacker') unlawfully
                                 obtains access to details of an existing account holder or policy holder or an account or
                                 policy of a genuine customer or policy holder (the 'victim of takeover') and fraudulently
                                 operates the account or policy for his benefit or the benefit of another authorised
                                 person.

                                 Asset Conversion relates to the sale of assets subject to a credit agreement where the
                                 lender retained ownership of the asset, for example a car or a lorry.

                                 Misuse of Facility is where an account, policy or other facility is obtained for fraudulent
                                 purposes or the fraudulent misuse of a facility.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                             38
Credit and Debt Management – 2008 Survey




3.           Commercial Lending and                                 3.1      Business Growth and
             Trade Credit                                                    Insolvency in the UK

All organisations that are involved in any form of lending
                                                                    The common definition of default, 90+ days late, applies
to the commercial sector, corporate and small businesses,
                                                                    equally to the commercial and consumer sectors. Basel II
are a potential source of business for the commercial debt
                                                                    deliberations defined default as 90 days late and such a
collection,     debt   purchase   and   outsourced     credit
                                                                    definition is commonly used by the credit insurers as a
management services industry. This lending includes all
                                                                    trigger for    claims.   Default     and   ‘arrears’ can   be
manner of bank products from overdraft to loans, factoring
                                                                    distinguished. The Finance and Leasing Association (FLA)
and asset-based finance and commercial mortgages all of
                                                                    regards a debt to be in arrears if it is more than two
which may be subject to default/payment arrears. Indeed
                                                                    payment instalments overdue and/or over 31 days overdue
since 1999, the net indebtedness of the corporate sector,
                                                                    - approx 3% of outstanding balances in direct and sales
measured by gearing ratios, has shown a marked increase                                                        15
                                                                    finance were in 'arrears' in their analysis . Euler Hermes
and remains at an historically high level. Moreover, all
                                                                    estimated that businesses that use collection agents contact
business and organisations involved in business to business
                                                                    their debtor an average of six times before passing on the
trade (supplying trade credit) on a deferred payment basis                             16
                                                                    debt to the agency . Thus, commercial debt arising from
(on invoice) in both product and services markets may
                                                                    trade credit can be considerably older than 90 days prior to
decide to make use of collection agents if debts fall into
                                                                    being placed with a debt collector. Clearly the 'younger' the
arrears. Increasingly, the government sector, as a collector
                                                                    debt is when it is placed with a collection agent, then the
of taxes or a contractor with the private sector, is becoming
                                                                    better chance of recovery. The market for commercial debt
a source of debt collection and recovery business. The
                                                                    sale is, consequently, very small.
potential size of the commercial debt collection market is,
and will be, influenced by the total amount of corporate
lending activity and the propensity for borrowers to go into        As in consumer credit the latter is affected by underlying
'arrears'.    The implementation of the Late Payment of             economic conditions, the quality of lending and risk-return
Commercial Debts (Interest) Act has increased the                   decisions and in-house credit management practice, i.e.
propensity for businesses, of all size, to pass on trade debt       how well the debt is worked prior to being out-placed. The
to commercial debt collectors. At the time of writing our           Late payment of Commercial Debts (Interest) Act has had
analysis forecasts an increase in corporate insolvencies            an impact of the extent of outplacement to the DCA sector.
during 2008-09 and particular pressure on the SME sector            The fact that DCAs can impose an interest charge and
that that is most affected by the recent restrictions in bank       recover some collection costs has made out-placing debt
lending to business. The result is to try and substitute bank       more cost effective for the commercial sector and
credit for trade credit and take extended trade credit where        particularly SMEs. Increasingly DCAs are offering to
possible (resulting in late payment). Corporate payment             collect overdue debts ‘for free’ i.e. the DCA keep the
delays and bad debts are likely to increase along with              interest charge (8% + base rate) rather than charge
insolvencies.                                                       commission.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            39
Credit and Debt Management – 2008 Survey




Clearly the volumes of commercial debt out-placed will be                                                             The stock of small businesses is estimated at 3.8 million.
a function of the number of businesses experiencing                                                                   SMEs account for 52% of aggregate business turnover and
financial difficulties and delaying payments to suppliers.                                                            56% of private sector employment, according to the SBS.
The pattern of corporate bankruptcies and liquidations will
be indicative of the degree of fragility and corporate
financial distress.



                                       Chart 3.1.1 – Register Size in Great Britain (1992-2006)
                                                                    (Source: Companies House)


                                                                                 Number of Registered Companies


                             2500000



                             2000000



                             1500000



                             1000000



                              500000



                                   0
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There has been a trend increase in the number of active                                                               Barclay’s bank estimated that the number of business start-
companies registered with Companies House. The stock of                                                               ups has been growing at approximately 20% pa since 2002;
active businesses approached 2.3 million in 2006.                                                                     and in 2003 the number of new start-ups was 465,000.
According to Companies House the number of new                                                                        Business closures, however, are also high. It is estimated
incorporations has been growing rapidly year on year, e.g.                                                            that over 50% of new starts go out of business within 3
43% 2003-6.                                                                                                           years. Of course, not all of these leave unpaid debts behind.

                                                                                                                      The company birth rate, new registrations and a proportion
                                                                                                                      of the stock of active companies showed strong growth
In total, unincorporated businesses and SMEs account for a
                                                                                                                      from 2000 to 2004 with a levelling off up to 2006 (Q2) at
significant proportion of the business stock. This is
                                                                                                                      around 2%.
estimated to have grown by more than 1.4 million since
1980.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                       40
Credit and Debt Management – 2008 Survey



                                                            Chart 3.1.2 – Company Birth Rate (2001-2006)
                                                                                 Source: Companies House

                                                                                         COM PANY BIRTH RATE

                            0.035


                             0.03


                            0.025


                             0.02


                            0.015


                             0.01


                            0.005


                               0
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The number of company insolvencies (compulsory and                                                                Although the trend fluctuated around 3,500 insolvencies
creditors’ voluntary liquidations) in the England and Wales                                                       per quarter between 1995 and 2007, the figures have been
was 3,194 in the last quarter of 2006, nearly half of the                                                         much lower than the levels of the early 1990s’ recession.
figure that was observed in the third quarter of 1992 with a                                                      The seasonally adjusted figures provided by the Insolvency
record number of 6,509.                                                                                           Service show 3,032 liquidations in the second quarter of
                                                                                                                  2007, representing a 4.2% decrease on one year ago.



                                                    Chart 3.1.3 – Company Insolvencies (1975-2006)
                                                                             (Source: Companies House)




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                   41
Credit and Debt Management – 2008 Survey




Corporate failure may be the necessary by product of the            Company failure investigations can be highly useful for
competitive process. One might argue that markets                   banks, investors, and also trade credit specialists. On the
basically keep efficient firms inside but throw out the             one hand, lenders need to know who to give credit safely
inefficient ones, as the natural process in aggregate               and profitably or creditors who to trade with or investors
economic activity, in order to secure future growth and the         who to invest in. On the other hand, they also want to
efficient use of resources. However, company failures               know how companies they have a business relationship
result in immediate social costs for families after possible        would react to aggregate economic fluctuations. For
job losses or more seriously affect a whole region or a city        instance, the Basel Capital Accord has provided the
if the company is large enough to drive that area’s                 impetus to lenders to research and develop adequate
economy. Indeed individual corporate failures have a                default/failure prediction models for all of the business
knock on effect via bad debts that puts pressure on the             sectors of their lending portfolios. Once implemented these
cash-flow of otherwise healthy companies and impacts on             risk management systems have to be ‘stress-tested’ under
their ability to generate new future projects or investments,       different economic scenarios which track the ‘prior
and indeed, may push them into bankruptcy.                          probabilities’ of failure.



                                                                    Research by the Bank of England shows a clear
                                                                    relationship between insolvencies and the write-off rate of
                                                                    the banks.



                               Chart 3.1.4 – The Relationship between Insolvencies and the
                                    Write-off Rates of Banks (Source: Bank of England)




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                        42
Credit and Debt Management – 2008 Survey



3.2       Forecasting Corporate                                            •      All Others (Office for National Statistics),the
          Insolvencies                                                            ONS code of the data set is also provided where
                                                                                  applicable);

In order to gain insights into the economic drivers of                     •      County Court Judgement Information .
business failures, we compile a macro-economic data-base
using aggregate UK data between 1995 and 2007. It is
worth noting that this data is from a period of relatively          Corporate insolvencies are represented with the corporate
stable economic conditions A sample, which is exclusive             insolvency ratio that involves both compulsory liquidations
of a recession, may offer results that can reveal what              and creditors’ voluntary liquidations. Members’ voluntary
aggregate factors are likely to affect company failures             liquidations are not included because such liquidations do
under a relatively healthy economic environment. Such               not necessarily represent insolvency. The corporate
results can be considered with an aim of understanding the          insolvency ratio is calculated by dividing the number of
factors that keep the number of operating companies at a            compulsory and creditors’ voluntary liquidations (ONS
maximum. Lower levels of company failures are likely to             code: AIHQ) by the number of active registered companies
lessen not only reverse social costs in the society (e.g. job       in that period. The liquidation data and registered
losses) but also administrative costs of bankruptcies, which        companies data are gathered from the Office for National
could be used more productively in the whole economy                Statistics and the Companies House respectively.
instead of officially eliminating ineffective companies.


                                                                    It is widely argued that corporate insolvency rates may be
Having employed advanced econometric methods, it is                 related to the “business cycle”. Besides, it is also stated
found that whereas company birth rate, income gearing,              that       business   cycles   may   largely   affect   company
and money stock form a long term relationship with                  profitability and, hence, failure rates (e.g. Turner et al,
corporate insolvency levels, lending to corporate sector,           1992).   Therefore, the growth in GDP index at market
                                                                                                      1
aggregate profitability, trade credit defaults (county court        prices with chained volume indices (ONS code: YBEZ) is
actions) and business confidence have significant short-run         used to control such a relationship. Furthermore, it is also
effects on corporate insolvencies.                                  aimed to control the level of “business investments”, which
                                                                    is proxied by “Gross Fixed Capital Formation: Business
                                                                    Investment” in chained volume measures (ONS code:
Data sources are generally from publicly available sources          NPEL).
and are as follows:

      •   The Number of Active Registered Companies
          (Companies House);

      •   Business Confidence Indicator (OECD);


                                                                    1
                                                                      Chained volume measures are used by ONS to
                                                                    represent “constant prices” where the base year is
                                                                    updated regularly.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                             43
Credit and Debt Management – 2008 Survey




Despite some opposing arguments and differing empirical             Building Societies Lending to Non-financial corporations
findings regarding other factors, there is a consensus that         (deflated by GDP deflator) (ONS code: VQSG).
profitability    is    vastly     important   for     companies.
“Profitability” is controlled with four different variables.
                                                                    “Over-indebtedness” and high capital gearing are cited as
The first one is a straightforward profits variable: Real
                                                                    possible causes of high levels of corporate failures. It is
Gross      Operating    Surplus    of   Private     Non-financial
                                                                    argued that tax advantage of debt finance should be
Companies (deflated by GDP deflator) (ONS code:
                                                                    managed carefully not to increase the probability of failure.
LRWL). The second one is Gross Rate of Return of Private
                                                                    Indebtedness is controlled with a proxy of Debt-to-GDP
Non-financial Companies (ONS code: LRWV). The
                                                                    ratio. Debt is calculated by subtracting liquid assets of
remaining two variables considered here are generally cited
                                                                    Private Non-financial Companies from their total liabilities
as the drivers of profitability. They are: Real Unit Wage
                                                                    at current prices (ONS code: NLBB-(NKJZ+NKXQ)) and
Costs (deflated by GDP deflator) (ONS code: LNNK) and
                                                                    divided by GDP at current prices to obtain the Debt-to-
Real Input Prices (materials and fuel purchased) (ONS
                                                                    GDP ratio.
code: RNNK) (deflated by output prices (manufactured
outputs) (ONS code: PLLU) deflator). “Productivity” is
also controlled with proxies of output per filled job (ONS
                                                                    Income Gearing is used to represent the effects of interest
code: LNNN) and output per worker (ONS code: A4YM)
                                                                    rates, indebtedness, and how debt is managed in the same
indices.
                                                                    measure. It is calculated by dividing Interest paid by
                                                                    Private Non-financial Companies at current prices (ONS
                                                                    code: ROCG) by their Gross Operating Surplus at current
Interest rates are commonly mentioned as drivers of
                                                                    prices (ONS code: CAER).
company fragility and failures. It is claimed that real
interest rates can be highly influential for company health.
On the other hand, it is also put forward that inflation
                                                                    Tax payments relative to profits are also controlled by
and/or nominal interest rates can be the main cause of
                                                                    calculating the ratio of current tax payments of Private
company insolvencies depending on the circumstances. It
                                                                    Non-financial Companies (ONS code: RPLA) to their
is aimed to control both types of interest rates, as well as
                                                                    Gross Operating Surplus at current prices (ONS code:
inflation, in this study. Nominal interest rates are proxied
                                                                    CAER).
by London Clearing Banks’ Base Rate (ONS code: AMIH)
and real interest rates are calculated by using GDP deflator.
Inflation is calculated by using GDP (expenditure) deflator         Exchange rates are also cited as a possible determinant of
at market prices (ONS code: YBGB).                                  company failure. Sterling Effective Exchange Rate Index
                                                                    (ONS code: BK67) is used to control such an effect.

The availability of money and/or credit is regarded as an
important factor for the aggregate economic activity. It is         Labour conditions are cited as being related to closures and
controlled by Real Money Stock (M4) (deflated by GDP                controlled by a proxy of employment rate (%, age 16-
deflator) (ONS code: AUYN) and Real Banks’ and                      59/64) in this study (ONS code: MGSU).




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                          44
Credit and Debt Management – 2008 Survey




It is also suggested that property prices may influence               Table 3.2 – Variables used to Forecast Insolvencies
insolvency rates since properties are mainly used for                                           (Source: CMRC)

collateral. Besides, the changes in such prices may also
affect the liquidation value of a company. Hence, property       VARIABLE                          DESCRIPTION
                                                                 1-Insolvency Rate                 No.of Insolvencies/
prices are also controlled in the model with a proxy of real                                       No.of registered Companies

house price index (deflated by GDP deflator) (ONS code:          2-Company Birth Rate              Growth rate of the number of registered
                                                                                                   companies
WMPQ).                                                           3-Growth in Short Term Loans
                                                                 4-Growth in Short Term Bank
                                                                 Loans
                                                                 5-Capital Gearing                 Total Debt/Total Assets
Share values are also controlled since they may show a
                                                                 6-Income Gearing                  Interest Payments/
company’s worth and affect the liquidation value of a                                              Operating Profit
                                                                 7-Growth in Operating Profit
company. The proxy used is Price Index of FTSE industry
                                                                 8-Inflation                       Calculated from
sector, non-financials (ONS code: HSER).                                                           GDP Deflator
                                                                 9-GDP Growth                      Quarterly
                                                                 10-Exchange Rate Index            Sterling Effective Exchange Rate index
                                                                 11-Nominal Interest Rate          London Clearing Banks’ Base Rate
It is widely suggested that new companies are more likely        12-Real Interest Rate             Deflated by GDP deflator
                                                                 13-Real House Price Index         Deflated by GDP deflator
to fail than the old mature ones. Such an effect is
                                                                 14-Employment Rate                Between age 16-59/64
controlled by company birth rate, which is represented by        15-Business Confidence            Manufacturing

the growth in active registered companies (Source:               Indicator
                                                                 16-Real Money Stock (M4)          Deflated by GDP deflator
Companies House).                                                17-Real CCJ Value (total)         Deflated by GDP deflator
                                                                 18-CCJ Count                      Number of CCJs
                                                                                                   in a quarter
                                                                 19-Real CCJ Value/CCJ Count       Ratio
Business confidence is also controlled as it may affect both
borrowers’ and creditors’ decisions. The data is gathered
from    OECD      as    Business    Confidence    Indicator:         The results of the analysis were as expected. That is, in the
Manufacturing for the UK.                                            long term insolvency rate increases when income gearing
                                                                     or real CCJ values increase, and when the employment rate
                                                                     or real money stock decrease.
The factors affecting the business failure rate in the long-
term and in terms of short-term dynamics were modelled
using the final data selection tabled opposite.                      The Growth in Real Short Term Loans and Business
                                                                     Confidence are the short-run dynamics of the insolvency
                                                                     rate. That is, whereas short term increases in the growth in
                                                                     real short term loans are likely to create short term
                                                                     increases in the insolvency rate, short term increases in
                                                                     business confidence are likely to create short term
                                                                     decreases in the insolvency rate.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                     45
Credit and Debt Management – 2008 Survey




The relatively high levels of indebtedness in the corporate              There was some slow down in this form of lending towards
sector coupled with recent interest rate increases and a                 the end of 2000 and early 2001 but the total lending has
decline in business confidence suggest that corporate                    increased 23% in the last 5 years.
insolvencies are set to increase in the next 2 years.
                                                                         Lending to non-financial companies rose by £13.3 billion
                                                                         in the last year to 2005(Q4) with real estate taking a large

3.3. Commercial Lending                                                  share of this total.



Since 1996, the total lending to the non-financial sector, in            Statistics provided by the Bank of England (January 2006)
the form of loans by the banks and building societies, has               show a sharp increase in lending growth since 2004(Q2)
increased by over 75%. The figures include all lending to                compared to deposits from non-financial corporations (see
PLC's, limited companies and partnerships.                               charts below).



                            Table 3.3.1 – Bank and Building Society Lending to Industrial and
                              Commercial Companies 1996-2006 (Source: Bank of England)



                                              1996       1997     1998       1999      2000       2005

                Outstanding Lending
                at year end (£m)             160,744    178,928   189,260 201,797 228,686       281,606

                 % change                       -         11.3%     5.8%      6.6%      13.3%    23.1%




                            Chart 3.3.1 – Contributions to Annual Growth Rate from Non Financial
                                             Corporations (Source: Bank of England)




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                              46
Credit and Debt Management – 2008 Survey




Asset finance in the form of HP and Leasing remains an              Chart 3.3.2 – New Leasing and HP Business Finance
important source of funding and particularly for SME’s.                    by Client Size and Business Investment

Data from the Finance and Leasing Association shows that                             (Source: FLA and ONS)

total new finance to fund capital investment totalled over
£2.3 billion by June 2005 and that growth in the financing
of investment goods outperformed motor vehicle leasing.



There has been some growth in HP and Leasing to the
SME sector, predominantly to firms in the £1-5 million
turnover.



Recent theories of corporate finance have emphasised the
importance attached to internally generated finance and
managerial preferences for internal over external sources of
                                                                    Recent surveys (e.g. Bank of England Surveys of 'Finance
finance in certain situations, particularly when managers or
                                                                    for Smaller Firms') have suggested that 'asset-based'
owner-managers are better informed about the firm's future
                                                                    finance accounts for an increasing proportion of external
prospects than can be 'costlessly' conveyed to external
                                                                    finance for the smaller company sector. Leasing and hire
lenders (i.e. the problem of 'asymmetric information'). The
                                                                    purchase, factoring trade debt, invoice discounting and
'pecking order hypothesis' (POH) of financial structure, for
                                                                    pledging trade debtors as collateral for bank finance are all
instance, suggests that firms will finance projects by first
                                                                    growing forms of asset-based finance.
using internal resources, then debt finance and, as a final
resort, equity. This theory has been empirically verified for
large firms. For smaller and growing firms, the POH may             The Bank of England study ‘Finance for Small Firms –
be particularly relevant when informational asymmetries             Eleventh Report’ suggests that external bank finance for
are likely to be more acute and potential debt providers            SMEs is important but not dominant. Leasing and HP has
may seek premium interest rates and high levels of                  grown in importance. Operating leases and hire purchase
collateral on loans.                                                are common forms of asset-based finance utilised by the
                                                                    smaller company sector - an important means of spreading
                                                                    the purchase costs of an asset over the asset's lifespan.
The POH theory predicts that smaller firms are likely to
                                                                    Research has estimated that hire purchase and leasing
rely to a greater extent on trade credit and short-term bank
                                                                    account for over 30% of all external finance utilised by
finance to support their operations and have a preference
                                                                    small firms. Factoring and invoice discounting has grown
for 'asset-based' finance over external debt and equity.
                                                                    quite considerably over recent years, albeit from a small
                                                                    base as discussed below.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                          47
Credit and Debt Management – 2008 Survey




The chart below shows the proportions of overdraft relative
to fixed term lending in the SME sector.


                              Chart 3.3.3 – Small Business Borrowing and Deposits at Year End (£ Billions)
                                                   (Source: BBA and Bank of England)




The Bank of England and BAA in their analysis of lending             Consequently, data prior to 2002 (Q4) is calculated on a
and deposits to and from the SME sector recently tightened           slightly different basis to more recent figures. Nonetheless
up their definition of a small firm.                                 the data shown below reveals that the structure of bank
                                                                     lending to SMEs has shifted markedly away from overdraft
                                                                     to more fixed term lending.


                                   Chart 3.3.4 – Changes in Sources of External Finance for SME’s
                                           (Source: ESRC Centre of Business Research)




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                          48
Credit and Debt Management – 2008 Survey



                                                                                                          2
The ESRC Centre for Business Research produce surveys                A recent study by the Bank of England shows a sharp,
which illustrate the decline in the proportion of finance            and to some extent inexplicable rise in the level of capital
accounted for by traditional bank borrowing and the                  gearing in the UK (large) corporate sector. Capital gearing
growth of the use of leasing and factoring.                          remains at a historically high level which, some
                                                                     commentators believe, is a symptom of a fragile economy.
                                                                     The measures of capital gearing are indebtedness to market
Thus in recent years, fixed term loans have replaced
                                                                     value and indebtedness to capital stock replacement costs
overdrafts as the main source of bank lending for small
                                                                     ratios.
businesses. There appears to have been a shift away from
an over-reliance on overdraft and short- term finance to a
more    structured     approach     in   addressing   capital        The chart below shows the trend increase in these ratios,
requirements. This should have an impact on the late                 particularly since the late 1980s.
payment of commercial debt that is often precipitated by
firms   juggling     short-term   finance   when   they   are
undercapitalised.

                                     Chart 3.3.5 – Aggregate Capital Gearing of UK companies
                                                (Source: ONS and Bank calculations)




                                                                     2
                                                                      The determinants of UK Corporate Capital Structure
                                                                     (2005)




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                          49
Credit and Debt Management – 2008 Survey




                                                                     Chart 3.3.6 –Capital Gearing/Total Debt/Total Assets
                                                                                                                       (Source: Creditscorer)


                                                                                                                       Capital Gearing(Total Debt/Total Assets)

                                                                   0.16

                                                                   0.14

                                                                   0.12

More recent data derived from an analysis of UK Company             0.1

accounts suggests that the ratio of total debts to total assets    0.08

                                                                   0.06
has risen quite sharply since 2004.
                                                                   0.04

                                                                   0.02

                                                                      0




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                                                                              Chart 3.3.7 –Income Gearing/Operating Profit
                                                                                                                       (Source: Creditscorer)

                                                                                                     Income Gearing(Interest Payments/Operating Profit)

When we also analyse rations reflecting the ability of firms       0.45

                                                                    0.4
to cover their debt interest repayments, we observe a
                                                                   0.35
similar rise since 2004. This suggests that there are a large       0.3

number of companies that are not generating sufficient             0.25

                                                                    0.2
profit to cover their interest payments. The considerable
                                                                   0.15
growth in private equity backed leveraged buyouts has               0.1

increased the role of debt in capital structures. It is            0.05

                                                                     0
estimated that value of investments LBOs in 2007 was
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                                                                                                                                                                                                                      20053

                                                                                                                                                                                                                              20054

                                                                                                                                                                                                                                       20061

                                                                                                                                                                                                                                               20062
around £22 bn.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                                                   50
Credit and Debt Management – 2008 Survey



3.4      Trade Credit                                                                                      These two components represent a substantial market for
                                                                                                           debt collection services. Indeed, trade debtors are one of
                                                                                                           the main assets on most corporate balance sheets,
Trade credit involves supplying goods and services on a
                                                                                                           representing up to 30-35% of total assets, on average, for
deferred payment basis that is, giving the customer time to
                                                                                                           all companies.
pay. The vast bulk of inter-firm sales are made on credit
terms. Trade credit is a particularly important source of
funding for smaller companies; the stocks and flows of
                                                                                                           The      chart     compiled        from      a   sample   of   100,000
trade credit are typically twice the size of those for bank
                                                                                                           manufacturing companies over 2 decades illustrates the
credit. In the UK corporate sector it is estimated that more
                                                                                                           relative importance of trade debtors as an asset on the
than 80% of daily business-to-business transactions are on
                                                                                                           balance sheet. The share of total assets, on average, is in
credit terms. This form of financing, trade credit, is the
                                                                                                           the region of 30-35% of total assets over the time period.
most important and largest form of short-term financing for
                                                                                                           This contrasts with stocks (inventories) which over time
the corporate sector. The amount of credit extended by a
                                                                                                           have fallen as a proportion of total and current assets as
business to its customers (and not yet recovered) appears as
                                                                                                           firms have become more efficient in the management of
a current asset ('trade debtors') on the balance sheet and is
                                                                                                           inventories.
therefore a component of net working capital. The amount
of credit received by a business from its suppliers (and not
yet paid back) appears as a current liability (trade creditors)
on the balance sheet.


                                           Chart 3.3.8 – The Importance of Trade Debtors to the Balance Sheet
                                                                                 (Source: Creditscorer)



                                                                          All UK Manufacturing 1977-2004
                                                                                 N=100,000 approx.

                                      70

                                      60

                                      50
                         Percentage




                                      40

                                      30

                                      20

                                      10

                                       0
                                         77


                                                 79


                                                         81


                                                                 83


                                                                            85


                                                                                    87


                                                                                            89


                                                                                                      91


                                                                                                               93


                                                                                                                       95


                                                                                                                               97


                                                                                                                                       99


                                                                                                                                               01


                                                                                                                                                       03
                                      19


                                              19


                                                      19


                                                              19


                                                                         19


                                                                                 19


                                                                                         19


                                                                                                   19


                                                                                                            19


                                                                                                                    19


                                                                                                                            19


                                                                                                                                    19


                                                                                                                                            20


                                                                                                                                                    20




                                                                                                 Time Period

                                                                      Trade Debtors/Total Assets              Trade Debtors/Current Assets
                                                                      Stocks/Total Assets                     Stocks/Current Assets




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                           51
Credit and Debt Management – 2008 Survey




An important aspect of trade credit, however, is the two-
way   nature   of   the   transaction.   Many     companies,         Chart 3.3.9 – DSO and Creditor Days Trends (1982-2004)
                                                                                              (Source: Creditscorer)
particularly those at intermediate points in the value chain,
both use trade credit as customers and provide it as
                                                                                                All UK Manufacturing 1982-2004
suppliers. The debtor (DSO) and creditor days figures                        90

(DPO) were calculated over the same time period as above.                    80

                                                                             70

                                                                             60




                                                                Percentage
                                                                             50

                                                                             40
The DSO figures which can be seen in the chart to the right
                                                                             30
are in the region of 60-70 days for manufacturing firms and                  20

                                                                             10
DPO are in the region of 50-60 days. These aggregates,
                                                                             0

however, disguise some wide variations when analysed by




                                                                                82

                                                                                83

                                                                                84

                                                                                85

                                                                                86

                                                                                87

                                                                                88
                                                                                89

                                                                                90

                                                                                91

                                                                                92

                                                                                93

                                                                                94

                                                                                95
                                                                                96

                                                                                97

                                                                                98

                                                                                99

                                                                                00

                                                                                01

                                                                                02
                                                                                03

                                                                                04
                                                                             19

                                                                             19

                                                                             19

                                                                             19

                                                                             19
                                                                             19

                                                                             19

                                                                             19

                                                                             19

                                                                             19

                                                                             19
                                                                             19

                                                                             19

                                                                             19

                                                                             19

                                                                             19

                                                                             19

                                                                             19
                                                                             20

                                                                             20

                                                                             20

                                                                             20

                                                                             20
                                                                                                              Time Period
sector and company size. Moreover, for individual firms
                                                                                                        Debtor Days    Creditor Days
the net trade credit position is of more importance.

                                                                                    Chart 3.3.10 – Net Trade Credit Trends

Managing the net trade credit position is critical. The                                       (Source: Creditscorer)

CMRC Quarterly survey of businesses tracks the net trade
credit position of respondents. The average net trade credit
position of companies can be seen to the right throughout
the life of the survey. A positive value indicates that firms
are extending more credit than is being received whereas
negative figures suggest the company is receiving more
credit than it is extending. Essentially, the Net Credit Days
figure is the difference between Debtor Days (DSO) and
Creditor Days. There was a significant rise in the Net
Credit Days figure during 2005. A survey in the UK (FPB,
1994) estimated that there was £10 billion (ECU 14.8 bn)
net late trade credit owed to small businesses.



Trade credit can involve a 'one-off' sale on invoice to a                     Companies engaged in exporting their goods or services
customer to be paid say, in thirty days from receipt of the                   across national boundaries may supply them on a deferred
goods. In the case of repeat purchasers however, the                          payment basis (i.e. trade credit) but make extra provisions
supplier may open and manage a customers 'credit                              to finance export trade and/or take additional steps to
account', whereby the buyer may order goods up to an                          'secure' future payments (i.e. 'export-credit').
agreed limit (the credit limit) and pay funds into the
account according to agreed payment terms.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                    52
Credit and Debt Management – 2008 Survey




For small firms, supplying trade credit can be an important         ownership of goods prior to payment (e.g. retention of title
strategic or competitive tool that plays a role in capturing        to the goods or other types of security); and (if applicable)
new business, in building supplier-customer relationships,          interest or penalties for late payment. The terms of
in signalling product quality, 'reputation' and financial           payment on business-to-business sales can take many
health and in price competition and price discrimination.           forms and a wide variety of possible payment terms can be
                                                                    offered. Cash on or before delivery (COD, CBD) obviously
                                                                    does not involve trade credit. Progress or 'stage payment'
Yet, for many firms supplying and financing trade credit,
                                                                    terms usually involve an up-front deposit or down payment
and managing trade debt, can cause cash-flow/financing
                                                                    with the outstanding invoice value being spread in
difficulties. Trade credit contracts are by their nature
                                                                    payments over a set period or at specific points in the
incomplete and often established between supplier and
                                                                    fulfilment of a supply contract. The majority of trade credit
buyers with asymmetric bargaining positions. Indeed,
                                                                    sales however, are offered on a net period or a net period
enforcing credit terms can be a problem, particularly for
                                                                    with cash discount for early settlement.
smaller firms. The late payment of commercial debt has
often been cited as a factor that precipitates financial
distress and/or constrains growth amongst smaller firms.            Net terms involve the setting of a period after which
Small firms can be particularly vulnerable to bad debts,            payment should be made in full. This is usually defined
because they tend to have a smaller customer base than              either as a number of days after the invoice date or a
their larger counterparts.                                          number of days after the end of the month in which the
                                                                    invoice is issued (e.g. 30 days EOM, meaning thirty days
                                                                    from the next month end). The use of EOM terms
Trade credit as a form of short-term financing is not
                                                                    obviously has a substantial impact on the actual credit
costless. The cost of trade credit however, as compared to
                                                                    period; if sales are evenly spread through the month 30
other forms of financing (i.e. bank credit, factoring, etc) are
                                                                    days EOM will lead to an average credit period of
quite difficult to ascertain. The duration and implicit costs
                                                                    approximately 45 days. With two-part terms the supplier
of trade credit loans vary across firms and industries.
                                                                    specifies a net period, as with net terms, but also specifies a
Moreover, as we will show later, customers often violate
                                                                    shorter period (the discount period) during which payment
the stated terms in practice. This obviously creates a debt
                                                                    will attract a discount. Terms of 2/10 Net 30, for example,
collection problem.
                                                                    mean a buyer can obtain a 2% discount by paying in 10
                                                                    days or less, otherwise payment of the undiscounted price
                                                                    is required in 30 days. Although the percentage discount
                                                                    offered might often seem small, it is equivalent to a high
3.4.1. Credit Terms and Credit
                                                                    annual rate of interest being charged for the additional
       Management Practice
                                                                    extension of credit to net terms. Variations on this concept
                                                                    also exist, for example, the payment of a rebate to
Credit terms refer to the written or stated policies given to
                                                                    customers who pay in full by the discount date. This latter
a customer with regard to: the timing of payments;
                                                                    variation protects the seller from the buyer taking unearned
discounts for early settlements; the methods of payment;
                                                                    discounts opportunistically.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            53
Credit and Debt Management – 2008 Survey




Predominantly, the payment period specified, in the UK, is          the factors determining the usage of trade credit (demand-
30 days (net 30 or 30 EOM) but can vary from less than 7            side) and the implications for the credit management
days (near cash) to over 120 days. Typically, credit periods        process.
offered on export contracts are slightly longer than those
for domestic sales, but this varies according to the
                                                                    Trade Credit Extension and Credit Terms: The Supply-Side
destination country, the industry sector, the characteristics
                                                                    Motivation
of the buyer and the nature of the product/service involved.



                                                                    This section provides a brief overview of the main motives
Credit terms and payment behaviour varies within the EU
                                                                    that (non-financial) firms have for extending credit. In
Member     States.   In   general,   Northern/Scandinavian
                                                                    particular, we examine the motivations for extending credit
countries trade on shorter credit periods and pay promptly,
                                                                    from a 'strategic' or 'competitive' perspective.
whilst some Southern European countries have long
periods and long delays. Intrum Justitia’s Business Survey
suggests that Portugal, Spain and Italy have the longest
                                                                    Firms add value by creating and sustaining competitive
payment periods and Finland, Denmark, Sweden, Austria
                                                                    advantages. The seminal work by Michael Porter suggested
and Germany have the shortest. The European Commission
                                                                    that competitive advantages emanate from strategies of
have estimated, based on the FPB estimates, that the total
                                                                    either cost-leadership or differentiation that may or may
amount of net (late) trade credit owing to EU businesses
                                                                    not be focused on a well-defined market segment. Others
could be in the region of ECU 90 billion at any point in
                                                                    develop more complex models which suggest that
time. The sectors which are frequently cited as being 'bad
                                                                    competitive advantages are established through innovating
payers' are construction, transport, retail and wholesale,
                                                                    products and processes (including information systems);
primary industries and the public sector.
                                                                    building and reinforcing relationships with customers and
                                                                    suppliers (external and internal to the firm); establishing
                                                                    and maintaining a reputation; and by having         'strategic
3.4.2. Motives for the Supply of and
       Demand for Trade Credit                                      assets,' i.e. market dominance or position. One could argue
                                                                    that the extension of trade credit is an increasingly
                                                                    important element of corporate strategy and a potential
It is clear, however, from CMRC survey evidence that the
                                                                    source of competitive advantage. Offering and managing
motives individual firms have for extending trade credit to
                                                                    credit can be a key element in developing a strategy which
customers (supply-side) are complex and manifold.
                                                                    can both create and sustain competitive advantage. In the
                                                                    context of the Porter model it can clearly play a subtle or

The market for debt collection services is to some extent a         overt role in price competition and can be an engine for

function of the supply of and demand for trade credit and           driving differentiation strategies.

the factors that affect the level and flows of trade credit in
the corporate sector. This section provides a brief review of
the motivations for extending trade credit (supply-side) and




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            54
Credit and Debt Management – 2008 Survey




Of course, firms will vary in the extent to which they use               Table 3.4.2.1 – Motivations for Trade Credit
credit pro-actively in this way. Some organisations credit                           Extension (Source: CMRC)

policy is closely aligned to the sales and marketing
function, whereas in some it is seen as a subsidiary
                                                                             Strategy                               Impact
function to the finance department. In still, others it is seen
forming a vitally important loop between the two. For                                      Credit acts as an implicit guarantee of

                                                                     Market Signalling     product       quality.    Available         credit   terms
instance, suppliers may use trade credit as a means of
                                                                                           provide a ‘quality signal’ to potential buyers.
                                                                     and Differentiation
competing in markets and generating sales and customer                                     Offering credit may be a key factor that
                                                                                           differentiates           one        supplier         among
loyalty. Trade credit as a competitive tool is many faceted
                                                                                           competing suppliers.
and can be used to respond to customers' sensitivities to
total effective price (goods plus finance); their needs or
                                                                                           Trade     credit    can        be    used      to    ‘tie-in’
demand for short-term finance; their focus on product                                      customers and encourage repeat purchase
                                                                     Customer Loyalty
quality and after-sales service; and their requirements for                                i.e. ‘building relationships’. Extending credit
                                                                     & Information         generates potentially useful information on
continuity and reliability in the timing and quality of                                    customers.

supplies. The table summarises the way in which trade
credit can provide an important component of business
                                                                                           Offering       credit     terms       provides        more
strategy. None of which, of course, are mutually exclusive                                 opportunities for varying effective price to
                                                                     Price
                                                                                           buyers with different elasticities of demand
and some of which will depend on the extent of the firm's            Discrimination &      or different credit risk. Credit terms can be
market power or 'strategic assets'. The nature and way in            Price Competition     an important element of price competition
                                                                                           and     the    ‘marketing-mix’         in     competitive
which credit can be used as a tool for gaining competitive
                                                                                           markets.
advantages and reducing demand uncertainties will depend
on the competitive structure of the markets facing the
                                                                                           Offering a package of both product and
supplier and the customer, their relative bargaining                                       finance that is cheaper than a buyer
                                                                                           negotiating with two parties (supplier &
strengths and the conditions affecting the supply of                 Cost Leadership       financier) may generate profitable sales. The
alternative sources of corporate finance.                                                  supplier may generate profit from both
                                                                                           activities - profit margin on the product;
                                                                                           (premium) interest on the finance.


Trade credit extension could be viewed as an important
                                                                                           Using and extending trade credit can be
means of managing 'relationships' with customers, e.g.
                                                                                           used to reduce the uncertainties in trading
generating    repeat   purchase     behaviour,    establishing       Managing
                                                                                           relationships and minimise ‘transactions
                                                                     Uncertainties         costs’. It can therefore help the firm develop
reputation and building stable and long-term relationships
                                                                                           an environment conducive to innovation.
with customers (i.e. good-will and a future income stream,
and of generating market or customer information). As
discussed above, potential buyers of a product may require
an 'inspection period' in order to ascertain product quality.
In the same way sellers may wish to differentiate their
offering to the market by extending credit as a signal or
'pledge' of product quality.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                               55
Credit and Debt Management – 2008 Survey




Manipulation of standard credit terms through informal              firms will add a premium onto product price in order to
deals is one way in which the extension of trade credit can         cover the costs of extending credit or to discriminate
be   used    for   marketing    purposes   and    for   price       between different classes of risk in the customer base.
discrimination between customers (e.g. to compensate for            Others may offer credit at a loss to illiquid buyers but
different risks). The presence of such deals to any                 offset this against a surplus from cash buyers. There may
significant extent in a market means that the actual price of       be other situations where the firm will wish to trade-off the
trade credit in a particular circumstance can be difficult or       short-term profitability of individual customers with the
impossible for a third party to determine (or for a potential       increased volume of sales or market share and, of course,
customer to determine prior to negotiation). The CMRC               the potential for generating repeat purchase behaviour and
found, for example, that over 30% of firms said they were           market or customer information.
likely to vary credit terms to attract new large customers or
promote slow moving products and over 20% were likely
                                                                    Trade credit extension may be used to smooth the pattern
to do so to retain existing customers. Such deals may even
                                                                    of customer demand over the business cycle or seasonally.
include effectively allowing a customer to pay late or
                                                                    For instance, trade creditors may relax credit terms in order
allowing a customer to obtain discount without paying
                                                                    to stimulate demand in lean periods and recover the costs
early. The willingness of companies to vary terms suggests
                                                                    of this policy in more buoyant times. Thus, although trade
that a standard assumption that credit terms are standard in
                                                                    credit is short-term finance for the recipient, as far as the
an industry and perhaps over time must now be
                                                                    supplier is concerned it may be used as part of a long-term
reconsidered in such an environment. Evidence suggesting
                                                                    strategy of managing the customer-base. Consequently, the
that firms are using trade credit terms more pro-actively
                                                                    supplier may be prepared to extend trade credit at a short-
and flexibly has implications for the debt collection
                                                                    term loss (or cross-subsidised by cash payers) for the
industry, which, in the past, has had a poor image in terms
                                                                    benefits of a long-term relationship and future income
of managing 'customer relationships'.
                                                                    stream. Whereas the seller may regard the bundling of
                                                                    products and finance from a marketing/relationship point
Extending credit to customers who themselves face highly            of view, the buyer may value the financing element.
competitive product markets can be a useful means of
winning business. Such firms are likely to attach a greater
                                                                    Finally, in the context of financial markets suppliers may
weight to the availability of credit when choosing amongst
                                                                    have cost-savings vis-à-vis institutional lenders both in
competing suppliers. Indeed these are likely to be the firms
                                                                    assessing credit worthiness initially, and in monitoring it
that have difficulty raising institutional credit and/or are
                                                                    on-going basis. Some of these cost savings arise from
credit rationed by the banking sector. This, however, is
                                                                    industry knowledge and others from the contact of the
clearly not without risk since credit rationed firms are also
                                                                    selling process and potentially from the trade credit
more likely to default or pay late.
                                                                    transaction itself. A supplier may also get more collateral
                                                                    value, in the event of default, from goods sold on credit
The supplier may well be able to offer products with trade          than would a third party (e.g. a bank). Offering products
credit and pass on the cost of credit to the buyer. Some            and finance (trade credit) can thus be part of a strategy of




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                          56
Credit and Debt Management – 2008 Survey




cost leadership. In such cases, the cost of obtaining both                 •    To specify performance targets and monitoring
merchandise and credit from a single firm can be lower                          activities for credit staff.
than purchasing them through separate transactions. The
provider may be able to generate profit from both the sale
of the product and from the provision of finance.                   Most large companies will have a documented credit
                                                                    policy, but many medium-sized and smaller companies
                                                                    lamentably neglect this aspect of their business. A CMRC
3.4.3     Credit Management: The Impact on                          survey in 1995 revealed that only 35% of manufacturing
          Corporate Performance
                                                                    companies and less than 20% of small companies had a
                                                                    written credit policy. Over 30% of firms extending credit
Companies extending and managing trade credit should
                                                                    did not agree credit terms in writing prior to the sale. More
establish a credit policy which provides the framework for
                                                                    recent      research    by    CMRC,        suggests   that     credit
making consistent and well-informed credit decisions
                                                                    management practice, SME financing and banking
which are compatible with the company's strategic
                                                                    relationships and perceptions of the late payment problem
objectives and the goals of the credit function. The credit
                                                                    have all improved significantly in the period 1995-2000.
policy is a document that specifies the course of action for
granting credit and for recurring credit activities.
Obviously, the credit policy has to be understood by and
                                                                    The credit policy of a company should be developed in
communicated to all relevant parties, particularly credit
                                                                    accord with the strategic, marketing, financial and
staff, sales staff and customers.
                                                                    organisational context of the business and be designed to
                                                                    contribute to the achievement of corporate objectives. The
                                                                    corporate strategy can include trade credit management,
Credit policies need to be reviewed and monitored on a
                                                                    not just in terms of its contribution to collection and cash
regular basis. A carefully documented credit policy is a
                                                                    flow, but as a means of generating sales and profits, and of
fundamental requirement of sound credit management
                                                                    investing in customers by building relationships.
practice, and should serve at least the following purpose:



                                                                    The management of trade credit can help build stable and
     •    To define the objectives of credit extension in the
                                                                    long       term   relationships    with     customers,       generate
          context of corporate strategy and organisation
                                                                    information about the customer and their requirements and
          structure;
                                                                    facilitate different customer strategies in terms of credit
     •    To define the authority and responsibilities for          granting, credit terms and customer service. The objective
          credit granting, establishing and varying terms           is to generate growing, but profitable sales. Managing
          and the timing of collection actions;                     collections lowers cash-flow risks and helps to ensure that

     •    To provide documented procedures in relation to           cash is available for investment opportunities. The

          the above that can be communicated to all staff;          objective is to collect in accordance with credit terms,
                                                                    minimise collection costs and reduce the need for finance
     •    To specify training policy for credit staff;
                                                                    whilst responding quickly to customer queries and/or




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                  57
Credit and Debt Management – 2008 Survey




disputes. Managing the total investment in debtors and              company is a better risk from the perspective of current
‘money at risk’ has a direct impact on profitability and the        and potential suppliers since they will be protected against
ability of firms to raise external funds. Measuring,                the ‘knock-on’ effects of bad debt.
monitoring and minimising credit risk is an important
activity for credit management. Minimising bad debt in the
                                                                    In previous research by CMRC, it was possible to
context of the risk-return decision has a direct impact on
                                                                    demonstrate that relatively simple credit management
profitability.
                                                                    practice could have significant effects and certainly give
                                                                    the firm an edge over its competitors. For instance, in the
The decision of the extent to which the firm uses the               sample as a whole only 20% of companies had a written
services of external agents such as credit reference agents,        credit policy and over 50% did not agree credit terms in
credit insurance, factoring, invoice discounting and debt           writing prior to a sale. Few used credit reference
collection/recovery services is a strategic issue and will          information or credit insurance - a substantial number were
have a bearing on overall performance. The use of credit            extending credit to bad risks. However, those companies
insurance can impact on credit management practice and,             that were devoting more time to ‘front-end’ credit
in turn, on corporate performance in a number of ways.              management      (i.e.   checking    credit-   worthiness    of
Firstly, credit insurance protects cash-flow against                customers; negotiating and agreeing terms in writing and
protracted default and protects profits from the risk of bad        monitoring credit limits) had: a greater proportion of
debt. Credit insurance, however, imposes a discipline on            accounts paid on time, lower levels of bad debts, lower
the credit management activities of the firm. Thus, sales on        average debtor days (controlling for credit periods), and
credit have to be agreed formally between the two parties           perceived less of a late payment problem.
along with payment dates.


                                                                    Of course, firms will vary in the extent to which they use
                                                                    credit pro-actively in this way. Some organisation’s credit
The credit grantor has to monitor payment times in order to
                                                                    policy is closely aligned to the sales and marketing
inform the insurer of any overdue and comply with the
                                                                    function, whereas, in some it is seen as a subsidiary
terms of the policy. In effect this improves the collection
                                                                    function to the finance department. In still others, it is seen
time on all trade debt and impacts on cash-flow as well as
                                                                    a forming a vitally important loop between the two. For
allowing the firm to analyse individual customer payment
                                                                    instance, suppliers may use trade credit as a means of
histories. The credit insurer will credit vet all the firm’s
                                                                    competing in markets and generating sales and customer
customers, provide the firm with advice on credit limits
                                                                    loyalty. Trade credit as a competitive tool is multi-faceted
and provide early warnings of customers in financial
                                                                    and can be used to respond to customers’ sensitivities to
difficulty. This information may be useful for marketing
                                                                    total effective price (goods plus finance); their needs or
decisions and customer relationship management as well as
                                                                    demand for short-term finance; their focus on product
with credit decisions. Having trade debtors insured may
                                                                    quality and after-sales service; and their requirements for
facilitate the raising of finance from the banking sector and
                                                                    continuity and reliability in the timing and quality of
foster better banking relationships. In turn, a credit insured
                                                                    supplies. The nature and way in which credit can be used




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            58
Credit and Debt Management – 2008 Survey




as a tool for gaining competitive advantages and reducing                          3.4.4 The Use of Trade Credit and
                                                                                         Payment Behaviour: The Demand
demand uncertainties will depend on the competitive
                                                                                         Side Motivation
structure of the markets facing the supplier and the
customer, their relative bargaining strengths and the
conditions affecting the supply of alternative sources of                          Understanding how customers, 'buyers', might behave in

corporate finance.                                                                 respect on their usage of trade credit (their demand for
                                                                                   trade credit), their payment behaviours and the likelihood
                                                                                   of protracted default and/or insolvency is an important
The strategy map below summarises the routes by which                              aspect of the credit manager's role and may, in turn, affect
good credit management practice can impact on a                                    their decision to insure the risks of trade debt. This section
companies overall performance, i.e. profitability, growth,                         focuses on the factors affecting the demand for trade credit.
shareholder value.


                      Chart 3.4.4.1 – The Use of Trade Credit and Payment Behaviour – A Strategy Map
                                                               (Source: CMRC)


                                                             CORPORATE STRATEGY


                                                  FINANCIAL STRATEGY          MARKETING STRATEGY
                                                                                                                                RISK-RETURN
                                                             CREDIT STRATEGY

                                                                                                                                COST-BENEFIT
 ORGANISATION         IN-HOUSE ACTIVITIES                      CREDIT MANAGEMENT                    OUT-SOURCED ACTIVITIES
                - CUSTOMER KNOWLEDGE
                - CREDIT GRANTING/POLICY/CRM                                                         - CREDIT REFERENCE DATA/RISK SCORES
                - SALES ADMINISTRATION                    Cost Effective Credit Management           - DEBT RECOVERY/LITIGATION
                - COLLECTIONS                                                                        - CREDIT INSURANCE
                - FINANCING/ RISK PROVISIONS                                                         - FACTORING/INVOICE DISCOUNTING

                        RISK MANAGEMENT                           CREDIT CONTROL                         CREDIT GRANTING

                   - CREDIT INFORMATION                  - SALES/CREDIT COORDINATION                - CUSTOMER PRODUCT DEMAND
 Customer                                                                                           - CUSTOMER CREDIT DEMAND
                   - RISK MEASUREMENT                    - MONITOR CREDIT LIMITS
 Perspective                                                                                        -TAILORED PRODUCT/CREDIT PACKAGE
                   - DEFAULT PROBABILTIY                 - INVOICE EFFICIENCY/PAYMENT OPTIONS
                   - COLLATERAL/GUARANTEES               - DISPUTE RESOLUTION                       - MAXIMISE CUSTOMER PROFITABILITY
                   - ‘MONEY AT RISK’/ FINANCING          - PRO-ACTIVE COLLECTION/CRM                - SERVICE QUALITY/FLEXIBLE TERMS
                   - RISK TRANSFER (BUYER)               - MINIMISE OVERDUES/CREDIT NOTES           - GENERATE NEW/REPEAT BUSINESS
                   - RISK TRANSFER (INSURER)             - MAXIMISE CUSTOMER SATISFACTION           - PRODUCT LIFE-CYCLE MANAGEMENT
                                                                                                    - CUSTOMER LIFE-CYCLE MANAGEMENT
  OPERATIONAL
                                                                 INFORMATION GENERATION                                           SHORT-LONG
                                                             CUSTOMER AND MARKET KNOWLEDGE
                                                                                                                                     TERM

               Customer Portfolio Management                     Collection Strategy                   Customer Relationship Management

                                                                 Collection Periods/Costs                         -New customers
                     Minimise Delinquency
                                                                     Net Trade Credit                           -Customer Retention
                   Minimise Bad Debt Losses
                                                                                                               - Customer Profitability
 Financial                 MAXIMISE INVESTMENT
 Perspective                                                       OPTIMISE                                       GROW REVENUE
                          IN CUSTOMERS/ MINIMISE
                              ‘MONEY AT RISK’                   CASH CONVERSION                              MAXIMISE CUSTOMER VALUE




                                                                  CREATE
                                                             SHAREHOLDER VALUE                                                    OBJECTIVE




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                            59
Credit and Debt Management – 2008 Survey




It was suggested above that a buyer may wish to purchase            is viewed by the customer base, or the potential impact on
on trade credit in order to protect against forms of seller         public perceptions of the lender.
non-compliance e.g. delivering goods of poor quality or
not fully complying with the terms of sale. Moreover a
                                                                    If credit rationing exists in a market (e.g. amongst small
firm may have no real preference for trade credit over other
                                                                    growing businesses) then trade credit can be an attractive
forms of finance but accept trade credit as but one element
                                                                    way of obtaining finance even if the costs are high due to
of the supplier's total 'marketing bundle' (of goods + credit
                                                                    foregone discounts or late payment penalties.
+ after-sales service etc.). The most likely motivation for
using trade credit is however, to satisfy a financing demand
(financing theory) and/or to minimise transactions costs
                                                                    This motivation for trade credit demand would imply that
(transactions cost theory).
                                                                    firms who are higher credit risks would have a higher
                                                                    demand for trade credit, including that at premium cost,
                                                                    and would be more likely to display behaviours such as
As we have discussed above trade credit, to the recipient, is
                                                                    late payment, which are effectively breaches of the terms
primarily a form of short-term financing. If we consider
                                                                    of sale. Suppliers may be willing to finance such customers
trade credit as one of several options for financing
                                                                    because the firms have more in common than the financial
purchases, then the attractions of trade credit will depend
                                                                    transaction; the supplier benefits in the longer term by
on the relative costs and availability of other options. If
                                                                    helping a customer in temporary difficulty to stay in
credit market imperfections cause some buyers to have
                                                                    business and therefore making future sales. The supplier is
unsatisfied demand for finance, i.e. to experience credit
                                                                    also in a potentially better position to ascertain the
rationing, then they will be willing to use trade credit even
                                                                    probability of default, than an institutional lender if the
at a premium cost. Academic studies of trade credit
                                                                    relationship is long term or the selling process facilitates
demand provide some support for this notion. If, on the
                                                                    the collection of credit information. In the event of default
other hand, firms are cash rich then trade credit must be
                                                                    the supplier may be able to obtain greater value from the
compared with the opportunity cost of other uses of the
                                                                    goods if they are repossessed than would a third party. The
money. Possibilities for credit rationing arise where lenders
                                                                    supplier's credit management department may also be in a
are not able to set an appropriate rate for each loan
                                                                    better position to monitor customers on an ongoing basis.
applicant based on the riskiness of the loan. This situation
                                                                    Moreover, suppliers can also use two part terms to obtain
may arise because of imperfect information; where a lender
                                                                    ongoing information on credit worthiness; buyers who fail
is unwilling, due perhaps to economic viability, or unable
                                                                    to take early payment discount may be signalling financial
to obtain sufficient information on the borrowers
                                                                    difficulty. Finally, the differences between the market
creditworthiness or the risk-return profile of the project for
                                                                    borrowing and market lending rates of interest provide a
which the loan is being raised. If a lender is asymmetrically
                                                                    financial incentive for suppliers to engage in arbitrage,
informed compared to the borrower, they are exposed to
                                                                    using surplus funds to finance customer purchases, rather
the problems of adverse selection and moral hazard.
                                                                    than earning interest on the market.
Alternatively, the ability of the lender to set an appropriate
rate may be restrained by usuary laws, the way such action




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                          60
Credit and Debt Management – 2008 Survey




Even if a firm is not subject to credit rationing, trade credit     and/or for small amounts, consequently firms have a
may be an economic option compared to other finance                 demand for precautionary cash balances. Trade credit
because suppliers are in a position to save on information          reduces the need for this, particularly where there is
costs in assessing a buyer's creditworthiness and in                uncertainty in the trade exchange. For example, supplier
collection and monitoring costs, particularly with regular          relationships are important; a firm facing variable and
customers. The relative price of trade credit may therefore         uncertain delivery schedules with no trade credit available
be favourable. We might then expect that firms who have             has to take the risk of a delivery arriving when it does not
long-term relationships with suppliers might use more               have available cash (and therefore incurs implicit or
trade credit, and might obtain more favourable terms.               explicit penalties). This risk level will, of course, influence
                                                                    the size of the firms precautionary cash balance. Trade
                                                                    credit gives a buyer notice of when cash is needed for
The lack of the fixed costs associated with arranging a loan
                                                                    payments and thus allows them to keep reduced
or line of credit and the administrative costs to the
                                                                    precautionary balances and to plan movements from liquid
borrower may also make trade credit more attractive.
                                                                    assets to cash in the most cost effective manner; this is
Another factor which may make trade credit a more
                                                                    therefore a motive for buyers to use trade credit and we
attractive option financially is the motivation of the
                                                                    might expect that uncertain delivery schedules would be
supplier in extending it; although making a profit from the
                                                                    associated with more use of trade credit.
credit side of the transaction is a potential motivation, it is
not necessarily the major determining factor - the suppliers
main business is usually the goods being sold. Alternatives         The above argument in fact gives rise to two motives; the
to the profit motive for credit extension are unlikely for          buyer can plan the management of cash versus liquid assets
financial institutions, where the credit transaction is             more effectively optimising returns on assets (the cash
primary business. The CMRC surveys support this notion,             management motive), but the buyer will also potentially
suppliers indicated that they offered credit as a necessary         reduce the number of transactions on their current bank
part of marketing their products and did not think of trade         account (because one cheque may be able to pay many
credit as a potential substitute for bank credit when credit        invoices) thereby reducing banking costs (as most banks
terms are requested by a customer.                                  charge businesses on a per transaction basis); we refer to
                                                                    this as the transaction volume motive. The ability to group
                                                                    invoices for payment at predicted dates in the future may
Transactions costs theory emphasises trade credit's
                                                                    also make it easier for firms to organise payment by credit
intermediary    role   in   removing    a   requirement    for
                                                                    transfer, which would again reduce bank charges as such
simultaneous action by both parties in a trade transaction,
                                                                    transactions usually have a lower fee compared with, for
(i.e. simultaneous exchange of money for goods and
                                                                    example, cheques.
services). Trade credit can be seen as a way of reducing the
transaction costs involved in trade exchange. A main issue
is the cost of making money available. To do this, firms            The businesses purchasing and delivery schedule would
have to convert liquid assets into cash; there are costs to         affect the benefit they could potentially gain from the
doing this that may be greater if conversion is frequent            transaction volume motive. If a firm requires frequent




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            61
Credit and Debt Management – 2008 Survey




deliveries, particularly from a large number of suppliers           accounts being reported as overdue by our panel of
then they have the most potential for gain. Obviously a             respondents.
business' purchasing and delivery schedule may in turn be
influenced by the availability or otherwise of credit terms;
if a firm has a transaction charge on each individual
purchase they might seek to have fewer, larger purchases            In terms of customer accounts, the proportion of customers
(if their business allows), the trade off being the additional      paying at or near the due date is slightly lower. 46% of our
costs of holding extra stock. We might therefore expect a           survey panel state that customers at an account level pay
positive relationship between use of trade credit and               on time. This equates to 54% of all customer accounts
frequency of orders as those who require frequent orders            currently being paid late.
have most motivation to use credit.



3.5      Late Payment and Bad Debt
                                                                                      3
                                                                    In the CMRC survey , when asked about late payment,
                                                                    89% of firms responding to the survey admited that they
The relative importance of trade creditors and debtors as an
                                                                    have sometimes faced late payment from customers.
asset and liability has increased in recent years, as shown
earlier. Trade debt, however, is a risky asset as a
component of the seller’s balance sheet. Trade debtors may          Upon further analysis, we find that one-third of firms in the   All
generate a future cash flow but need to be financed while           sample receive more than 80% of payments at the due date,
waiting for this cash to be paid. The financing costs of late       while only one-third of firms receive less than 60% and
payment, additional and unanticipated collection costs              11% receive less than 20% of accounts at the due date.
and/or bad debts all impact adversely on the profitability of       These findings are similar, if we consider the accounts as
credit sales and working capital requirement. Thus,                 percentage of customers as opposed to sales invoices.
management decisions regarding credit such as assessing
credit risk, extending credit and setting limits, and
                                                                        Chart 3.6.1 – % of Accounts Paying beyond the
managing/monitoring the credit cycle, are of central
                                                                                    Due Date (Source: CMRC)
importance.
                                                                                          (S        C    C)


3.6      Late Payment Trends


However, late payment as a phenomenon is enduring. The
CMRC Quarterly Review monitors payment behaviour
across a sample of 2000 enterprises. As can be seen to the
right, sales accounts which pay at or near the due date are
currently reported at 54%. This leaves 46% of all sales             3
                                                                     Credit Strategy and Corporate Performance, CMRC
                                                                    2005




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                          62
Credit and Debt Management – 2008 Survey




                                                                                                Chart 3.6.2 – % of Companies Paying on Time
                                                                                                                               (Source: CMRC)


                                                                                                            PERCENTAGE OF INVOICES PAID ON TIME - SECTOR ANALYSIS



                                                                                                Wholesale distribution

                                                                                           Transport/ Communication

                                                                                                     Retail distribution
Smaller firms tend to have highest percentage of accounts
                                                                                                         Manufacturing
paid on time and the figure decrease in opposite direction                                           Hotels/ Recreation

                                                                                                          Construction
with firm size.
                                                                                       Business and financial services

                                                                                        Agriculture, hunting & forestry

                                                                                                             All sectors

                                                                                                                             0%              20%          40%         60%           80%             100%
                                                                                                                                                                                           Percentage of
                                                                                          Accounts as % of sales             Accounts as % of customers                                     responses




                                                                                            Chart 3.6.3 – % of Invoices Paid on Time – Sector
                                                                                                                      Analysis (Source: CMRC)

                                                                                                                 PERCENTAGE OF INVOICES PAID ON TIME -
                                                                                                           SUB-SECTOR ANALYSIS FOR THE MANUFACTURING SECTOR


                                                                                              Transport equipment
                                                                     Electrical & optical equipment
                                                                                           Machinery & equipment
                                                                                                     Metal products
                                                                                             Non-metalic products
Firms in agriculture, hunting and forestry and hotels and            Chemical, plastic & petroleum
                                                                                       Paper, publishing & printing
recreations tend to have higher percentage of accounts paid
                                                                                              Textile & uphoistery
on time, while firms in construction and business and                                     Food, beverage & tobaco
                                                                                                     Manufacturing
financial services have lower percentage of invoices paid
                                                                                                                        0%             20%           40%            60%             80%            100%

on due date.                                                                                                                                                                              Percentage of
                                                                                                                                                                                           responses
                                                                                        Accounts as % of sales            Accounts as % of customers




                                                                                               Chart 3.6.4 – % of Invoices Paid on Time – Sub
                                                                                                   Sector Analysis for the Manufacturing Sector
                                                                                                                               (Source: CMRC)

                                                                                                                  MEAN PERCENTAGE OF PAYING ON TIME -
                                                                                                                          FIRM SIZE ANALYSIS

                                                                                            100%
                                                                 Percentage of firms




                                                                                            80%

In the manufacturing sub sector, textiles and upholstery
                                                                                            60%

and transport equipment have the higher-than-average
                                                                                            40%

percentage of invoices paid on time, while machinery
                                                                                            20%

equipment, metal products and paper, publishing and
                                                                                             0%
                                                                                                        Under 10                  10 to 49                50-249             Over 250
printing sector tend to be paid late.
                                                                                                                                   Employee size bands

                                                                                                                 Accounts as % of sales                Accounts as % of customers




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                          63
Credit and Debt Management – 2008 Survey




                                                                                                                    Chart 3.6.5 – Average Debtor Days
                                                                                                                                       AVERAGE DEBTOR DAYS
                                                                                                                                             Percentage of responses




                                                                                           #
Debtor days and payment beyond the due date show the                                               100%




                                                                  Percentage of firms
                                                                                                       80%
picture of the extent to which payments are made after or
                                                                                                       60%

before the due date. The following figures analyse these
                                                                                                       40%


indicators to reveal more about the payment behaviour of                                               20%



firms in the sample. 87% of firms in the sample cite a                                                 0%
                                                                                                                   0 to 29 days        30 to 59 days                   60 to 89 days        90+ days

debtor day figure of 30-89 and the average value of the                                                                                   Average debtor days


whole sample is 45 days.

                                                                                                              Chart 3.6.6 – Payment Beyond Due Date
                                                                                                                                              Percentage of responses
                                                                                                                                    PAYMENT BEYOND THE DUE DATE




                                                                                                       100%




                                                                           Percentage of firms
                                                                                                       80%


                                                                                                       60%


                                                                                                       40%
Around two-third of firms receive payment from 0 to 30
                                                                                                       20%

days beyond the due date                                                                                 Chart 3.6.7 – Payment Beyond the Due Date
                                                                                                        0%
                                                                                                                    0 to 14 days         15 to 29 days                  30 to 59 days        60+ days

                                                                                                                                       Payment beyond the due date




                                                                                                              Chart 3.6.7 – Debtor Days - Size Analysis

                                                                                                          AVERAGE DEBTOR DAYS AND AVERAGE PAYMENT BEYOND
                                                                                                         THE DUE DATE - FIRM SIZE ANALYSIS (NO. OF EMPLOYEES)

                                                                                                  60
                                                                   Number of days




                                                                                                  50

                                                                                                  40

Average debtor days figure is highest in medium firms (50-                                        30

                                                                                                  20
249 employees). Large firms (over 250 employees) have
                                                                                                  10
lowest debtor days as well as lowest number of days of
                                                                                                   0

payment beyond the due date                                                                                    Under 10                  10 to 49                          50-249                 Over 250

                                                                                                 Average debtor days       Average payment beyond the due date                          Employees size bands




Firms with a turnover from £10-19.9 million have the                                                   Chart 3.6.8 – Debtor Days - Turnover Analysis
highest payment beyond the due date figure, but at the
                                                                                                             AVERAGE DEBTOR DAYS AND AVERAGE PAYMENT BEYOND
                                                                                                                     THE DUE DATE - TURNOVER ANALYSIS
same time, have the highest debtor days. Firms with a
                                                                                                  60
turnover from over £50 million have lower payment
                                                                     Number of days




                                                                                                  50

beyond the due date, and firms with turnover from £20-                                            40


49.9 million have the lowest debtor days.                                                         30

                                                                                                  20

                                                                                                  10

                                                                                                   0
                                                                                                              <1            1-2.4       2.5-4.9           5-9.9             10-19.9     20-49.9         >50 £ Millions

                                                                                                 Average debtor days        Average payment beyond the due date                            Turnover size bands




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                          64
Credit and Debt Management – 2008 Survey




The average debtor days figure is high within firms in                                                     Chart 3.6.9 –Debtor Days – Sector Analysis
transport and communication, followed by retail                                                         AVERAGE DEBTOR DAYS AND AVERAGE PAYMENT BEYOND THE DUE
                                                                                                                        DATE - SECTOR ANALYSIS

distribution and some sub-manufacturing sector as paper,                                                Wholesale distribution

                                                                                                   Transport/ Communication
publishing and printing, metal product, textile and
                                                                                                            Retail distribution

upholstery. To the contrary, ‘debtor days’ indicator is low                                                     Manufacturing

                                                                                                            Hotels/ Recreation
within firms in agriculture, hunting and forestry, business                                                      Construction

and financial services, hotels with recreation and food,                                Business and financial services

                                                                                                Agriculture, hunting & forestry
beverage and tobacco sector.                                                                                         All sectors

                                                                                                                                   0            10        20        30       40       50       60         70        80

                                                                                                           Debtor days      Payment beyond the due date                                             Number of days



                                                                                                   Chart 3.6.10 – Debtor Days – Sub Sector Analysis
                                                                                                       AVERAGE DEBTOR DAYS AND AVERAGE PAYMENT BEYOND THE DUE
                                                                                                              DATE - SUB MANUFACTURING SECTOR ANALYSIS

                                                                                                      Transport equipment
The average payment beyond the due date figure is high in                Electrical & optical equipment

                                                                                                   Machinery & equipment
transport,    communication,      wholesale     distribution,                                               Metal products

chemical, plastic and petroleum sector, and is low in                                                Non-metalic products

                                                                         Chemical, plastic & petroleum

agriculture, hunting and forestry, retail distribution, non-                             Paper, publishing & printing

                                                                                                      Textile & upholstery
metal products, electrical and optical equipment sectors.                                        Food, beverage & tobacco

                                                                                                             Manufacturing

                                                                                                                               0           10        20        30          40       50        60        70      80

                                                                                                       Debtor days    Payment beyond the due date                                                  Number of days



                                                                                                Chart 3.6.11 –Interest Charged on Overdue Accounts
71% of responses indicate that their credit terms allow
                                                                                                              RATE OF INTEREST CHARGED ON OVERDUE ACCOUNTS

them to charge interest on overdue accounts. There is
                                                                                                   100%

evidence for the positive correlation between the incidence
                                                                  Percentage of firms




                                                                                                    80%

of firms having such a credit policy and firm size, implying
                                                                                                    60%

that large firms are more likely to have conditions of sale
                                                                                                    40%
that allow them to charge interest on overdue accounts.
                                                                                                    20%
58% of firms use the interest rate from 2% to 5%. 31%
                                                                                                     0%
charge a 6% to 10% interest rate on overdue accounts.                                                                0-1%                   2% to 5%                 6% to 10%                10% +




                                                                                                    Chart 3.6.12 – % Firms Affected by Late Payment
Interestingly, 12% of firms in the sample are willing to
                                                                                                                 IS LATE PAYMENT A SERIOUS PROBLEM FOR YOUR
execute this condition when it is needed (i.e. actually                                                                           BUSINESS?

                                                                                                    50%
charge interest on overdue accounts). However, 76% of
                                                                          Percentage of firms




                                                                                                    40%
firms never or rarely to do so.
                                                                                                    30%
Around one third of firms in the sample see late payment a
                                                                                                    20%
serious or very serious problem for their businesses.
                                                                                                    10%


                                                                                                      0%
                                                                                                                Not at all                                                                     Very important
                                                                                                               important
                                                                                                                                       Domestic customers                Overseas customers




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                      65
Credit and Debt Management – 2008 Survey




                                                                                                    Chart 3.6.13– Receivables Beyond 30/90 Days
                                                                                                                       RECEIVABLES BEYOND 30/ 90 DAYS


                                                                                            100%

22% of firms seriously rate the threat of bad debt from




                                                                 Percentage of firms
                                                                                             80%

domestic customers on their operation. Firms in the sample
                                                                                             60%

obtain an average receivables volume of £1.62 million
                                                                                             40%

beyond 30 days and £0.35 million beyond 90 days.
                                                                                             20%



                                                                                              0%
                                                                                                         0 to 100k          100k to 500k    500k to 1m       1m to 5m            5m+

                                                                                                                                           Receivables                          30 days    90 days



                                                                                           Chart 3.6.14 – Accounts Beyond 30/90 Days - Sector
                                                                                                              AVERAGE RECEIVABLES BEYOND 30/ 90 DAYS -
                                                                                                                          SECTOR ANALYSIS

                                                                                                Wholesale distribution

                                                                                                      Retail distribution

                                                                                                          Manufacturing

The business and financial services and transport                                                     Hotels/ Recreation

                                                                                                           Construction
equipment sector have the higher than average volume of
                                                                                       Business and financial services
receivables beyond 30 days, while retail/wholesale                                      Agriculture, hunting & forestry

distribution, hotels, recreation, and construction.                                                           All sectors

                                                                                                                            0.0      0.5    1.0     1.5      2.0     2.5       3.0     3.5        4.0
                                                                                                                                                                                                  £m
                                                                                          30 days            90 days                                       Receivables




                                                                                                     Chart 3.6.15 – Accounts Beyond 30/90 Days
                                                                                                               AVERAGE RECEIVABLES BEYOND 30/ 90 DAYS -
                                                                                                                 SUB MANUFACTURING SECTOR ANALYSIS

                                                                                                    Transport equipment

                                                                                        Electrical & optical equipment

                                                                                              Machinery & equipment

                                                                                                         Metal products

                                                                                                Non-metalic products

Most of sub-sectors in the manufacturing industry average                               Chemical, plastic & petroleum

                                                                                                    Textile & upholstery
below 30 days.      Over 90% of firms have receivables
                                                                                            Food, beverage & tobacco

beyond 90 days while this figure for receivables beyond 30                                                Manufacturing

                                                                                                                            0.0      0.5     1.0     1.5      2.0        2.5    3.0       3.5        4.0
days is 65%.                                                                                                                                                                                         £m
                                                                                          30 days            90 days                                       Receivables




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                          66
Credit and Debt Management – 2008 Survey




Bad debt as percentage of turnover for the last year of                 We find that larger firms tend to have higher level of bad
trading is recorded at 0.47% on average for the whole                   debt written off. The following table presents the profile of
sample. This level of bad debts represents £4,700 lost for              firms with a high level of bad debts. However, some levels
every £1 million of turnover. There are clear variations in             of bad debt are inevitable, but good credit management
the amounts written off as bad debts in the sample.                     practice involves growing profitable sales and minimising
                                                                        bad debts.



                                 Table 3.6.1 – Profile of firms suffering from Bad Debt


                   Profile of firms with high level of bad debts
                   - Large firms
                   - Products are standardized and similar to those of other competitors
                   - Operate in highly concentrated industries
                   - Have higher frequency of daily order from customers
                   - Use credit terms rather than price to promote sales


                   Firms with high level of bad debts appear to
                   - Focus more on the importance of credit management to corporate
                     performance, especially on profit before tax
                   - More likely to cope with corporate fraud by a documented fraud
                     response plan
                   - Resort more to debt collection agents for receivables/ debt collection
                   - More likely to use Alternative Dispute Resolution



Large businesses, the NHS and central government are
claimed by more than 40% of firms in the sample as slow
payers. These are followed by local government (37%);
individuals (37%), small businesses (34%) and European             Chart 3.6.16– Types of Customer who are Slow Payers
commission (26%). Medium businesses appear to be the
                                                                                      WHICH TYPES OF CUSTOMERS ARE SLOW PAYERS?
most prompt payers, with only 24% of respondents
indicating them as slow.                                                                            NHS

                                                                                   European Commission

                                                                                       Local government

                                                                                      Central government

Nearly half of firms (45%) conduct a formal analysis of the                                   Individuals

                                                                 Large businesses (200 to 499 employees)
reasons for late payment. Of these, 96% of record an aged
                                                                 Medium businesses (50 to 99 employees)
debt profile; 53% categorize customers into different risk      Small businesses (less than 50 employees)

classe;, and 21% mark these customers on aged debt                                                          0%       20%   40%   60%       80%       100%

                                                                     Never                                  Always               Percentage of responses
reports.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                               67
Credit and Debt Management – 2008 Survey




3.7.     Impact of the Late Payment
         Legislation


In the UK and EU, the crux of the recent debate on the late            The policy prescription favoured by the FPB was the

payment of commercial debt, and its impact on small firms,             statutory imposition of interest on late payment by debtors.

revolved around whether legislation, or simply improved                It was argued that such a provision would simultaneously

credit management practice, was required to alleviate the              bind all firms into paying promptly, create a level playing

problems. Various lobbying groups put forward cases for                field in payment behaviour and ease the cash flow

and against the right to statutory interest and other policy           problems of small firms, who will be compensated for any

interventions.   Others stressed the need for a greater                overdue payments (HMSO, 1998). The 'causes' of late

awareness of, and training in, 'best practice' credit                  payment behaviour are complex and summarised in the

management. For example, the Institute of Directors (IOD,              diagram. Dominant customers are often able to leverage

1993) argued that the majority of overdue debtors can be               cash-flow and profits if they have a good bargaining

reduced by improved credit management. However, the                    position vis-à-vis their suppliers or very competitive supply

Forum for Private Business (FPB), a representative of                  chains.

small UK businesses, was amongst the most vociferous
advocates of government intervention to mitigate the
effects of late payment on the smaller firm sector.


                                            Chart 3.6.17– Assertions about Late Payment



                                              Assertions About Late Payment

                                imperfect competition                     inefficiencies
                                dominant customers                       poor credit and
                                 exploit competitive                         financial
                                  supplier markets                         management;
                                                                         product/service
                                              macro/financial environment     quality

                                                         financial difficulty

                                  undercapitalised firms
                                                                          financial distress
                                     credit rationing/
                                  inappropriate finance                     and insolvency




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                             68
Credit and Debt Management – 2008 Survey




Late payment is often a function of poor credit                      Arguments against the statutory imposition of interest for
management practices of the supplier or poor quality and             late payment were formulated in terms of 'contractual
after-sales service. Firms in financial difficulty often             freedom'; in that trade credit is often used as a competitive
stretch their creditors in order to alleviate cash-flow              tool and as a means of building trading relationships.
problems. These may be firms on the path to failure or               Suppliers may wish to retain the flexibility to vary
small and growing firms that have difficulty raising                 (informally) credit terms for specific customers, and
institutional finance. The different and complex causes of           customers may value the freedom to negotiate payment
late payment behaviour suggests that policy measures                 periods with their suppliers as financial circumstances
aimed at tackling late payment would have to attack the              dictate. A further powerful argument against legislative
problem in a number of ways and led to a vigorous debate.            intervention contended that the imposition of statutory
                                                                     interest might in fact, dwindle a key source of short-term
                                                                     finance for the small firm sector. Small firms have been
A range of possible measures might have an impact.
                                                                     shown to value trade credit as a source of finance for its
Measures to tackle dominant bargaining positions of
                                                                     flexibility and freedom from formal restrictions. It is also
customers; education and training in credit and financial
                                                                     posited that trade credit is used widely by small firms who
management and improvements in the flow of finance to
                                                                     are unable to obtain sufficient finance from other sources,
SMEs would all help as would macro-economic policies
                                                                     such as financial institutions.
that avoid boom and bust and consequent high levels of
business failure and financial distress.


                                           Chart 3.6.18– Possible Policy Measures


                                                Possible Policy Measures ?
                             Asymmetric Bargaining Power
                                competition policy – MMC, Office of Fair Trading
                                codes of practice and improved information

                             Management Practice/inefficiency
                                education and awareness - credit and financial management
                                SME support services    - out-placed and out-sourced
                                progress               - information and technological advances
                             Financial Markets/Banking Relationships
                                functioning of financial markets - financing SME’s
                                                                 - growth and export finance
                                banking relationships & efficiency
                                                                 - informed decisions
                                                                 - specialist products
                                macro-economic management - smoothing the cycle
                                                                   - rescue culture




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                           69
Credit and Debt Management – 2008 Survey




CMRC in an empirical study of the demand for trade credit           that have been proposed or implemented include voluntary
by small UK firms, found strong evidence of a financing             codes of practice; a British standard for payments; the
demand for trade credit. They surmised that small firms,            establishment of the 'Better Payment Practice Group'; the
which pay trade credit liabilities late, appear to do so when       compulsory disclosure of payment policies in company
they reach their limit on short-term bank finance. These            accounts and the streamlining of legal procedures for the
'credit rationed' firms were typically growing and export           recovery of debt. In response to the above debate, and
oriented. In consequence, if the imposition of statutory            following a period of consultation, the current government
interest significantly reduces the trade credit offered to          introduced legislation (the Late Payment of Commercial
smaller firms, this may lead to severe liquidity problems           Debts (Interest) Act 1998) entitling firms to claim a
and increased failure rates unless alternative finance is           statutory right to interest on late payment of trade debts, to
readily available.                                                  be phased in over four years.



A number of other solutions to the problem of late payment          The first stage, introduced in November 1998, allows only
have been put forward. For example, it has been argued              the smallest companies to claim interest from larger
that credit management is a neglected function in many              companies and the public sector in recognition of their
organisations with a focus on collection rather than the            vulnerability to dominant customers. Small firms had a
front-end activities of negotiating, risk screening, using          statutory right to interest from each other two years later,
credit information and establishing clear credit policies.          and large firms will be able to claim interest from 2002.
The CMRC identified poor credit management practices as
one of the underlying causes of late payment. In addition to
                                                                    In 1998, the Credit Management Research Centre was
poor credit management practices, causes were considered
                                                                    commissioned by the Department of Trade and Industry to
to include over reliance on trade credit and short term
                                                                    monitor the proposed introduction of the Late Payment of
finance and consequently an increased sensitivity to late
                                                                    Commercial Debts (Interest) Act.
payments. The Bank of England report on finance for
small firms (BOE, 1996) observed a similar occurrence of
ad hoc credit management that was viewed as being
                                                                    Referred   to   as   the   Government’s      Late   Payment
inefficient.   They concluded that this was due to the
                                                                    Observatory by Barbara Roche (Hansard 1997), the CMRC
inherent lack of administrative resources in the small firm
                                                                    was able to construct a panel of 1100 Credit Professionals.
sector.
                                                                    It was agreed that the Observatory would also identify best
                                                                    practice in credit management so that small businesses can
                                                                    benchmark their own performance. The CMRC then
It is argued that policies that emphasise the provision of
                                                                    developed a quarterly trend database to assess the impact
financial and credit management training for smaller
                                                                    of measures introduced to combat late payment and
businesses would have a beneficial impact. This may also
                                                                    provide an indication of changes in credit management
raise awareness of the services and potential benefits of
                                                                    culture in the UK. 82% of businesses were aware of the
credit insurance and factoring and the returns to
                                                                    Late Payment Legislation in 2002.
investments in information technology. Other measures




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                             70
Credit and Debt Management – 2008 Survey




The number of firms using the legislation has consistently          21% of firms see it is advantageous and around 10% show
been low with figures showing it to be 5% of those eligible         a negative feedback: ‘the legislation/ Directive will
(CMRC Quarterly Review, 1999, 2000, 2001, 2002).                    generate detrimental impacts on the UK payment culture in
CMRC have argued for some time that actual use of the               the long term’. We find that those firms that have high
Legislation is not necessarily a measure of the overall             expectations about the effectiveness of the Legislation are
effectiveness. Relations between the payment behaviour              those that view bad debt and late payment as a serious
and patterns of payment are far more complex and this               problem for their businesses. They tend to conduct formal
report attempts to examine firms’ attitudes to the statutory        analysis of the reasons for late payment and are more likely
right to charge interest on late payments and highlights            to apply the third phase of the legislation in charging
other key indicators of late payment to provide a                   interest on late payments.
comprehensive review of large and small firms in terms of
late payment in 2002. A large number of firms in the
                                                                    However, for the whole sample, firms show some
sample (79%) are aware of the UK first phase (November
                                                                    hesitation when being asked whether they would use the
1998) and second phase (November 2000) of the late
                                                                    third phase of the legislation to charge interest on late
payment legislation. But only 38% of firms actually make
                                                                    payment. 57% of sample firms confirm that they would not
their customers aware of their rights under the late payment
                                                                    do it for any customer. 35% of firms do so to some
legislation when negotiating terms and conditions for
                                                                    customers and only 3% apply for all customers. Not many
granting trade credit. 36% of these firms admit that being
                                                                    firms quote a specific reason for this, but a great part of the
charged interest makes them pay a debt more quickly than
                                                                    obtained responses (20%) rely on the fact that the
otherwise would have been the case.
                                                                    relationship with customers will be damaged if they do so.


It seems that firms in the sample have not placed high
                                                                    Nonetheless, if the situation worsens, 78% of sample firms
expectations on the effect of the Legislation on the UK
                                                                    are willing to pursue late payments through the courts and
payment culture. 69% of sample firms have a neutral
                                                                    97% of them are willing to consider claiming interest for
opinion about this.
                                                                    late payment. As expected, firms that specify their rights
                                                                    under the late payment legislation when negotiating terms
                                                                    and condition of credit grants are more likely to pursue late
                                                                    payments through the court.




                       Table 3.6.2– % of Companies Pursuing Late Payments through the Courts

                       Do you pursue           Sub-group of      Sub-group of
                       late payment               firms that     firms that do
                                                                                        Significant
                       through the              specify their     not specify
                       courts (1)                    rights       their rights
                                                      0.87            0.73                 0.011*
                       * Significant at 5% level,
                       (1): ‘0’ for ‘no’ and ‘1’ for ‘yes’




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            71
Credit and Debt Management – 2008 Survey




62% of firms are not willing to receive more information                   Statistical evidence shows that firms that are not aware of
about the legislation. This is reasonable as most of these                 the   late   payment    legislation   are   requesting   more
firms are aware of the UK first and second phase of the late               information about how to implement it.
payment legislation.


                                 Table 3.6.3– Awareness of the Late Payment Legislation

                          The need for         Sub-group of        Sub-group of
                            further              firms are         firms that are
                                                                                        Significant
                       information of the      aware of the         not aware of
                         legislation (1)        legislation        the legislation
                                                    0.31                 0.67             0.000**
                       ** Significant at 1% level, Value for (1): ‘0’ for ‘no’ and ‘1’ for ‘yes’


3.8.     Use of Third Parties in Credit
         Management


Once a firm has decided to offer trade credit, an important                There is a scale of strategies from full integration of the
decision relates to the way in which the firm chooses to                   credit function within the organisation (i.e. vertical
organise its credit management process.                                    integration) through to externally run credit management
                                                                           (i.e. contracted out to agents).




                                 Chart 3 6 19 Awareness of the Late Payment Legislation

                                                           CUSTOMERS


                                                               SUPPLIERS


                                                    CREDIT MANAGEMENT


                                              AGENTS                       IN HOUSE


                        Services provided by Agents                  Credit Management Functions

                              Credit References                           Credit Risk Assessment
                                Debt Collection                          Credit Granting Decision
                               Credit Insurance                        Sales Ledger Administration
                             Invoice Discounting                        Collection of Monies Owing
                                  Factoring                           Financing Accounts Receivable
                                                                            Bearing Credit Risk




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                  72
Credit and Debt Management – 2008 Survey




Thus, organisations may choose to manage the entire credit          Developments in information technology facilitate the
administration process 'in-house'. In contrast, however,            development of credit management and credit insurance
some or all of these activities can be 'out-sourced' to             packages targeted to specific corporate sectors (e.g. small
specialised institutions that perform the various credit            and growing firms). The rapid growth in the number of
administration functions. There are, of course, various             debt collection and related services on the internet offering
institutions or agents that will provide services for credit        'on-line' collections will clearly have an impact on the
management: factoring companies who will take over a                structure and economics of the commercial debt collection
company's sales ledger and collect outstanding balances on          industry.
behalf of the company (finance, collection and, in some
cases, risk-bearing); credit insurers who will insure trade
                                                                    Information      and    communication    technologies   have
credit against bad debt risks (credit risk assessment and
                                                                    improved the interface between the service provider and
risk bearing); credit reference agencies who provide
                                                                    the customer via 'on-line' links and have considerably
information about companies or individuals with which
                                                                    speeded up response times for, say, chasing debtors. The
people may wish to trade and, by providing credit ratings
                                                                    move is now to a greater degree of 'customer focus' and
or credit scores, advise on the risks of dealing with certain
                                                                    market segmentation within the credit services industry.
customers (credit risk assessment); and debt recovery
agents who will recover monies owed, directly or via the
legal system (collection and recovery).
                                                                    Moreover, technological developments are changing the
                                                                    economics of the costs and benefits of 'in-house' versus
                                                                    'out-sourcing' decisions at the level of the firm. Whereas
The services provided by these organisations have, in the
                                                                    scale economies and economies of information may have
past, overlapped to some extent but nonetheless remained
                                                                    made contracting out elements of the credit management
quite distinct. However, this situation is changing quite
                                                                    function more cost-effective in the past, developments in
rapidly. Almost all organisations in credit services have at
                                                                    information provision and the lower costs of data
their 'core' a large I-T investment in the collation and
                                                                    warehousing and analysis may have shifted the balance in
management of corporate databases and 'data warehouses'
                                                                    favour of in-house credit management for some larger
that support their various credit service activities.
                                                                    organisations.    For    the   smaller   and   medium-sized
Consequently, as information technology progresses, the
                                                                    organisations, on the other hand, that now find themselves
boundaries    between    companies     engaged    in   credit
                                                                    trading at greater geographical distance, utilising the
insurance, credit reference provision, factoring and debt
                                                                    services of large-scale and global credit service providers
management and collection activities are becoming
                                                                    may prove an attractive and cost-effective solution.
increasingly blurred as each can develop new products
which cut across these various inter-related services. For
instance credit insurers can feasibly offer credit reference
information, market intelligence, debt collection services
and general credit management advice. Credit insurers can
also work with banks and other finance providers to offer
finance packages collateralised by insured trade debt.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            73
Credit and Debt Management – 2008 Survey




Developments in electronic trading and payment systems
                                                                                                                                                 3.8.1 Factoring and Invoice Discounting
may impact upon the demand for credit insurance and other
credit services. Corporate credit cards, debit cards and
payment cards (a corporate charge card which logs                                                                                                Factoring is an important source of finance for businesses
purchase order and VAT information about transactions)                                                                                           with growing sales but low asset bases. The global market
can be considered as substitutes for certain of these                                                                                            for domestic factoring is nearly £800 billion with Europe
services should they become widespread in the future,                                                                                            accounting for around 70% of the total global market.
                                                                                                                                                                                             17
although they may not be options for all firms (those with                                                                                       Cross border factoring generates £68 billion .The UK
high value goods for example). All these systems offer the                                                                                       has a well established market for factoring services. By
seller guaranteed money within a few days. Effectively                                                                                           July 2006, total advances by FDA members to business
from an administrative point of view all transactions are                                                                                        was around £4.5 billion. Growth in the demand for has
like cash (or perhaps cheque) sales; there is no need to                                                                                         been relatively low during the last 3 years in contrast to the
support a sales ledger and there is no need to assess and                                                                                        value of Invoice Discounting which has exhibited strong
take on credit risk. The possibility that a significant amount                                                                                   growth since 2000 and stands at around £ 30 billion in
of trade credit risk may shift to the financial services                                                                                         2005.
provider (e.g. purchase card provider) has obvious
implications for the out-placed collection industry since it
implies collection activity moving in-house to the large
volume lenders.

                                          Chart 3.6.20 – Domestic Factoring Trends (Source: FDA)

                                                                                                   Domestic Factoring £M

                         5000
                         4500
                         4000
                         3500
                         3000
                         2500                                                                                                                                                 Domestic Fcatoring
                         2000
                         1500
                         1000
                          500
                            0
                             5


                                          6


                                                        7


                                                                     8


                                                                                  9


                                                                                               0


                                                                                                                1


                                                                                                                           2


                                                                                                                                        3


                                                                                                                                                     4


                                                                                                                                                                  5
                           -9


                                        -9


                                                      -9


                                                                   -9


                                                                                -9


                                                                                             -0


                                                                                                              -0


                                                                                                                         -0


                                                                                                                                      -0


                                                                                                                                                   -0


                                                                                                                                                                -0
                         ar


                                      ar


                                                    ar


                                                                 ar


                                                                              ar


                                                                                           ar


                                                                                                            ar


                                                                                                                       ar


                                                                                                                                    ar


                                                                                                                                                 ar


                                                                                                                                                              ar
                        M


                                  M


                                               M


                                                                 M


                                                                              M


                                                                                           M


                                                                                                           M


                                                                                                                     M


                                                                                                                                 M


                                                                                                                                            M


                                                                                                                                                              M




                            Chart 3.6.21 – Domestic Invoice Discounting Trends (Source: FDA)

                                                                                                        Domestic Invoice Discounting


                        35000

                        30000

                        25000

                        20000
                                                                                                                                                                      Domestic Invoice Discounting
                        15000

                        10000

                         5000

                             0
                                 Mar-95

                                           Mar-96


                                                        Mar-97


                                                                     Mar-98

                                                                                  Mar-99


                                                                                               Mar-00


                                                                                                            Mar-01


                                                                                                                     Mar-02

                                                                                                                               Mar-03


                                                                                                                                        Mar-04


                                                                                                                                                     Mar-05




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                        74
Credit and Debt Management – 2008 Survey



                                                               Chart 3.6.22 – Export Factoring and Invoice Discounting (Source: FDA)

                                                                   1200


                                                                   1000


Export factoring and export invoice discounting advances            800


were in the region of £250m and 1.1billion respectively.            600
                                                                                                                                            Export Factoring
                                                                                                                                            Export Invoice Discounting

Again invoice discounting advances show the strongest               400

growth.                                                             200


                                                                     0
                                                                          1   3   5 7   9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41




                                                               Chart 3.6.23 – Firms using Invoice Finance (Source: Bank of England)




                   4
The Bank of England point out, however, that for firms
with a turnover of less than £1million factoring provided
just less than £1billion in finance compared to the £9
billion that bank overdrafts provide as a source of finance.




                                                                   Chart 3.6.24 - Growth in Demand for Factoring (Source: FDA)

The data to the right demonstrates that most of the growth
in the demand for factoring came from firms with
turnovers in the region of £1-10million. Table shows the
average amounts advanced by size of firm. The amounts
involved are considerably larger than the average overdraft
(approx. £10k).




4
 Bank of England 11th Report on Financing of Small
Firms




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                        75
Credit and Debt Management – 2008 Survey



3.8.2. Credit Insurance and Related                                  Chart 3.6.25 – Credit Insurance Growth (Source: ICISA)
       Services
                                                                    0.06%
                                                                    0.05%
Credit insurance is traditionally used by companies to              0.04%
                                                                    0.03%
protect their business against bad debts, payment delays
                                                                    0.02%
and protracted default which can seriously                erode     0.01%

profitability and liquidity. The size of the trade credit           0.00%




                                                                                   1990


                                                                                                 1992


                                                                                                           1994


                                                                                                                   1996


                                                                                                                               1998


                                                                                                                                         2000


                                                                                                                                                    2002


                                                                                                                                                                      2004
insurance market, measured by global premiums, is in the
region of £3.75 billion. The market is dominated by                                               USA                     Germany               France
                                                                                                  Italy                   Austria               Switzerland
increasing global trade and the development of new
markets in China, Asia and Eastern Europe has stimulated
the growth of credit insurance particularly in the latter               Clearly the growth in internet and information technology

regions. Growth in the US has been slow and Western                     has helped reduced the cost base of credit insurers as they

Europe has experienced only moderate growth in recent                   increasingly integrate their information systems with those

years but still accounts for almost 75% of the total global             of their clients. Increased connectivity has to some extent

market. Penetration rates in the major European markets                 facilitated the growth in direct selling as apposed to

and the US have generally increased over the past 15 years              broking or, at least, extended the broker-base by enabling

although France and Italy have experienced a downturn in                smaller players to enter the market. Alliances with banks

the share of GDP in the new millennium. The penetration                 and factoring companies has help to extend the reach of

rate in the US is very small but rising.                                credit insurance.




The market structure for credit insurance provision can be
characterized     as    oligopolistic,     concentrated     yet   Chart 3.6.26 – World Market for Credit Insurance (Source: ICISA)

competitive. Recent years have witnessed consolidation via
                                                                                   World Market 2004 ICISA members (credit insurance)
                                                                                             Total Market appr. EUR 4,56 bn
merger activity. The 4 largest players, Atradius, Euler
                                                                                          AIG             Others
Hermes, Coface and Credito y Caucion have a combined                                      2,4%            11,5%
                                                                            QBE                                                 Credito y Caucion
                                                                            1,7%                                                      8,6%
                                                                                                                                                           Atradius
market share of over 80%. Credit Insurance is an industry                                                                                                   21,1%
                                                                   Mapfre
where there are considerable economies of scale and scope,         2,5%


particularly in information, I-T and networks brought about
by the necessity of having a global coverage. Credit                                                                                                              CESCE
                                                                                                                                                                   2,4%

insurance is a very cyclical business in terms of premium                   Euler Hermes                                                   Coface
                                                                               34,4%                                                       17,8%
generation, claims and profit/loss. Claims/losses vary with
the business cycle and         particularly    the aggregate
insolvency rate of businesses in the economy.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                             76
Credit and Debt Management – 2008 Survey



                                                                       Chart 3.6.27 – Use of Credit Insurance by SME’s (Source: ICISA)
The penetration of credit insurance in the SME market has,
over the past decade, been poor but is seen as the market
                                                                              35
segment that has the most to benefit form credit insurance                    30
products and the most potential for growing premiums and                      25
cross selling other credit management services in the                         20
future. In particular credit insurers have increasingly                       15
marketed bundled services that attempt to offer a ‘credit                     10
management solution’ rather than just insurance cover and                      5
                                                                               0
have necessarily diversified into receivables management,
credit and market information services, collection services                        Small enterprises (<10 Mn. €)
along with risk coverage.                                                          Medium-sized entities (between 10 and 150 Mn. €)
                                                                                   Large companies (>150 Mn. € turnover)

                                      5
A recent survey undertaken by the CMRC suggested that                              The main reasons cited were that credit insurance was
the penetration of credit insurance amongst SMEs was less                          perceived to be too expensive (68% of firms). The second
than 2% compared to around 30% in the largest company                              highest reason was that firms believed that credit insurers
sector. Given that SMEs are the predominant form of                                provided inappropriate cover (51.2%). 39% do not use it
business across Europe and the globe then the potential                            because   they   believe   that    it   requires   too   much
market for credit insurance and credit management services                         administration and reporting. 21% thought credit insurance
is huge. In a recent survey of UK businesses undertaken by                         had a poor image and 25% used other credit services. The
       6
CMRC firms were asked why they do not use credit                                   results of this part of the survey are summarized in the
insurance.                                                                         chart below.



                               Table 3.6.4 – Reasons for not using Credit Insurance (Source: CMRC)

                                                                                                                     Very
                                                                 Not at all
                                                                                                                     much
                                                           1           2       3        4                             5
                       Poor insurance image               20.9       11.6    46.5      7.0                           14.0
                       Too expensive                      0.0         2.0    30.0     22.0                           46.0
                       Inappropriate cover                7.0         7.0    34.9     23.3                           27.9
                       Involve too much admin/
                                                          7.3        19.5    34.1     12.2        26.8
                       reporting
                       Use other credit services          25.0       10.7    39.3     14.3        10.7
                              Table : Why do you NOT use credit insurance – percentage of responses


5
    Nicholas Wilson and Don Leahy (1998): “Credit insurance in
the UK and Europe”, The Stationery Office.



6
    Corporate Strategy and Growth, CMRC, January 2005




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                          77
Credit and Debt Management – 2008 Survey




Credit insurance can be made more attractive to the SME             The obvious benefits of using credit insurance are that it
market through increased automation to both reduce the              transfers credit risk to insurers; it protects the insured
cost base of the service and reduce the administration and          company’s balance sheet and reduces uncertainties in
reporting burden by developing better software interfaces           earnings; it provides a variety of related services:
with the client and simplifying the reporting/claims                continuous monitoring of the creditworthiness of the
process.                                                            insured’s customers, maintaining account receivables,
                                                                    suggesting payment and delivery conditions and supporting
                                                                    debt collection; it can improve access to financing in that
Further ground could be made in this market by extending
                                                                    firms with credit insurance can get better credit terms from
the range of services offered and marketing the ‘product’
                                                                    banks since the debtors book is collaterised. Finally, it can
by emphasizing the impact that good credit management
                                                                    help to generate sales and repeat business through agreed
practice can have on the overall business performance, i.e.
                                                                    credit limits.
that the credit insurer is offering a credit management
                                                                    In the survey cited above, when credit insured businesses
solution that has a wider impact than merely protecting
                                                                    were asked why they use credit insurance, 85.9% of firms
cash-flow. Such re-branding could involve developing the
                                                                    in the sample respond that the do so for peace of mind. The
range of services offered, improving and modifying
                                                                    second highest reason is to protect cash flow (74%). Only
existing services and/or changing the ‘image’ of existing
                                                                    16% and 21.8% of firms use credit insurance to raise
services via marketing activities.
                                                                    finance and to enter new markets.




                      Table 3.6.5 – Reasons why companies use Credit Insurance (Source: CMRC)


                                                                                                      Very
                                                    Not at all
                                                                                                      much
                                                        1         2          3           4              5
           Previous bad debt experience                12.3      16.8       23.5       22.9           24.6
           To grow the business                        17.1      17.6       24.1       27.6           13.5
           To protect cash flow                        4.4       6.1        15.5       40.9           33.1
           Helps raise finance                         29.6      32.0       22.5        8.3            7.7
           Help enter new markets                      25.9      30.0       22.4       15.9            5.9
           To improve knowledge of
                                                       13.1      16.6       26.9        28.6          14.9
           customers
           Peace of mind                                3.1      0.6        10.4       35.6           50.3




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                          78
Credit and Debt Management – 2008 Survey




A recent CMRC survey showed that those companies with                                   The chart below outlines the traditional view of the
credit insurance were more likely to indicate that they                                 benefits of credit insurance as a means of helping to protect
received preferential credit terms from their own suppliers                             and manage cash-flow and customer risk. The technology
thus improving the overall cash and working capital cycle.                              and information used in managing a credit insurance policy
Credit insured firms are more likely to gain the confidence                             however confers other benefits. A secured trade debtor
of the supply chain because their own cash-in position is                               book can be useful in obtaining other sources of finance
more certain and therefore they are less likely to pay                                  from the banking sector and may help to reduce the firms
suppliers late.                                                                         cost of capital and access to finance. Credit insurance can
                                                                                        indirectly help to improve supplier relationships. A credit
                                                                                        insured business is probably in a better position to pay its
Moreover, 43% of businesses suggested that credit
                                                                                        own suppliers promptly and therefore may get preferential
insurance is useful for generating customer knowledge.
                                                                                        credit terms form suppliers and enjoy a more stable
The users of credit insurance showed that they have to
                                                                                        supplier base. Credit insurance can facilitate improved
spend less time resolving disputes and chasing late payers,
                                                                                        customer relationship management by generating more
they have better control over cash flow and understanding
                                                                                        customer ‘knowledge’, having the systems in place to
of the customer portfolio and they are more likely to have
                                                                                        better manage and resolve invoice disputes and confers
software packages that improve the management of the
                                                                                        advantages form being able to offer customers both credit
customer and sales ledger. It is clear, therefore, that credit
                                                                                        and products/services. Finally, the information base of
insurance has a wider impact on the overall customer
                                                                                        credit insurers can be utilized to identify new market and
relationship management and the overall performance of
                                                                                        customer opportunities and facilitates speedy decision-
the business. Emphasis on these wider impacts may attract
                                                                                        making in respect of new requests of credit accounts and
new customers for all markets and particularly SMEs.
                                                                                        limits.



                            Table 3.6.28 – Traditional Benefits of Credit Insurance (Source: CMRC)




                                                                      Cash-flow and Debt
                                          Traditional area of focus      management               Traditional area of focus




                                                                                                            Customer
                                      Banking Relationship,
                                                                         - intelligence                   Relationship
                                         Cost of Capital
                                                                         - technology
                                                                                                          Management
                                         and Financing




                                                                           Supplier
                                                                         Relationship
                                                                         Management




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                              79
Credit and Debt Management – 2008 Survey



4.        Large Volume Debt                                         processes, procedures and technologies that help to
          Management – Actual Case                                  minimise the level of ‘un-collectable’ and ‘bad debt’ from
          Studies                                                   the domestic (household) market.


4.1.      Introduction and Objectives
                                                                    Organisations providing financial services have a different
                                                                    context and regulatory environment than organisations
In this section, we report a synthesis of interviews with
                                                                    providing gas, electricity, water and telecoms. Financial
organisations involved in large volume debt management.
                                                                    services are in effect competing for debt and customers but
The aim is to provide a framework from which an
                                                                    have to maximise collections performance and minimise
organisation can begin to assess whether they are
                                                                    bad debt losses within a relatively short time horizon on
employing good practice in relation to the collection of due
                                                                    individual accounts. Water suppliers have limited sanctions
and overdue debt in terms of: (1) taking enough action to
                                                                    against late and non-payers in that they cannot disconnect
prevent debt from occurring; (2) pursuing debts quickly by
                                                                    supply and have no choice over their customers. Gas and
using appropriate methods to obtain payment cost
                                                                    Electricity suppliers have some choice over their customers
effectively; and, (3) investing in debt management systems
                                                                    and can take action to secure payments from riskier
and more sophisticated recovery activity in order to collect
                                                                    customers    (pre-payment     meters,    deposits,   credit
cost effectively within the ‘regulatory constraints’.
                                                                    references). They have, of course, the sanction of
                                                                    disconnection   to   non-payers.   Gas    and   Electricity

We examine trends and developments in debt management,              companies, however, have to compete for customers and

debt collection and recovery and look at the processes and          the industry has been subject to considerable restructuring

practices of large volume lenders in the consumer credit            (mergers, acquisitions, outsourcing customer service and

industry and utlilties. The study looks at current practices        collections). We draw upon evidence of ‘good practice’ in

in collections and recovery amongst large volume lenders            this sector from a series of structured interviews and a

and looks at the forces recent driving change in the credit         forum that has been devoted to benchmarking credit and

and collections departments. The report highlights new              collections performance and credit/debt management

approaches to collections and customer-base management              practices. We are able to identify the good performers in

including new technologies and innovations and attempts             then UK utilities from the Utilities Benchmarking Forum

to assess the performance impact of these new investments.          data-base and analyse the specific factors that appear to

We review recent trends in the collections strategies and           impact on debt levels in this sector. From this we are able

the    general   approaches     taken    towards    customer        to draw up a check-list of perceived ‘good practice’ in the

indebtedness, collection and recovery. The analysis                 sector.

examines the path through which debts are processed, the
timing of various collection/recovery actions (i.e. the ‘debt
                                                                    The section is organised as follows. First we provide a
path’) and the effectiveness of actions at each stage. The
                                                                    generic overview of the credit account life-cycle. We then
focus of this part of the study is to identify ‘best practice’
                                                                    examine current good/best practice in debtor management
in collection and recovery departments and ascertain the
                                                                    and collections as synthesised from the various case




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                        80
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studies. We then provide a summary of the findings from             4.2.2. Account Life-Cycles
the surveys undertaken since our first study in 1998 in
order to trace major trends. We then report on the case             Although the operational processes and strategies will
studies and updates.                                                differ between lenders there are some basic, common
                                                                    elements. Credit accounts will generally go through a
                                                                    series of stages, illustrated below. The consumer credit
4.2.      Background to the Credit
                                                                    sector is characterised by lenders that typically deal with
          Account Life-cycle
                                                                    large volumes of accounts and consequently manage
                                                                    millions of relatively low value transactions on a day-to-
4.2.1. Customer Life-Cycle
                                                                    day basis.


This section provides some background to the typical
processes and stages in the management of a credit                  The stages in the process of account management equally

account. In financial services lenders are typically starting       apply to the trade credit, business to business context. In

to move towards a ‘customer-level’ view of individuals not          the latter case the lender will typically have a much smaller

only across different products but over the possible life-          customer-base and higher average invoice/order value. An

time of the customer. Although this section focuses on the          examination of the credit account life-cycle provides a

management of individual accounts it is worth noting that           useful background from which we can examine the main

financial services may take a life time view of the                 trends and forces driving change in debt collection as

profitability of a customer and manage individual accounts          gleaned from the series of interviews undertaken over the

with cross-selling opportunities in mind and long term              past 10 years.

profitability as an objective.



    Chart 4.2.1 – Customer Life-Time Management                        Chart 4.2.2 – The Customer Account Life-Cycle



                                                                       New Prospects               Application
                                                                                                   Processing

                                                                                                                        Set Up
                                                                             Marketing/
                                                                                                                       Account
                                                                             Recruitment
                                                                                                       Account
                                                                                                        In Use
                                                                        Collections
                                                                       and Recovery
                                                                                                Authorisations and
                                                                                                Account Management




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                          81
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The usual way of classifying consumer credit products is as         It is important for lenders to ascertain a profile of the
either 'revolving credit' or 'fixed term credit'. Revolving         potential borrowers past behaviour (e.g. payment pattern
credit allows the customer to make purchases up to an               on previous loans), current behaviour (e.g. how is the loan
agreed credit limit, regular (monthly) payments by the              applicant handling their credit cards or current account)
customer release available credit and allow further                 and total credit commitments. The latter is particularly
purchases to be made. There has, of course, been a recent           important, as borrowers will now typically spread their
proliferation of segmented Credit Card products and many            outstanding credit across multiple products and multiple
variations under the revolving account heading. The other           lenders. Most credit grantors in the UK contribute to closed
main type of credit account, fixed term credit, involves the        user groups, such as CAIS or Insight, which provide
customer paying for a single purchase or paying off a loan          information on the accounts the applicant has currently, or
by instalments.                                                     has had, with other credit grantors, i.e. total credit
                                                                    exposure. Credit reports can be obtained from Credit
                                                                    Reference Agencies, which provide details of, for example,
The number of instalments and the payment regime are
                                                                    the Electoral Roll at the applicant's address (to check
usually fixed at the start of the credit agreement. Recent
                                                                    residency), county court judgements against the applicant,
trends have seen a general increase in the repayment terms
                                                                    or recent credit searches done by other credit grantors. The
of personal loans (from 3 years a few years ago to 5-10
                                                                    CRA data-bases have recently been considerably enhanced
years now). Of course customers that have experienced
                                                                    by the major lenders HSBC and Natwest agreeing to share
payment difficulties on credit card or loan products may
                                                                    account level information and the development of
have put in place an ‘arrangement to pay’, i.e. a fixed
                                                                    indebtedness indices that evaluate an individuals debts in
monthly payment plan aimed at recovering debt over a
                                                                    relation to disposable income. Some lenders will now score
longer time period.
                                                                    applicants according to risk and their forecasted ability to
                                                                    service outstanding debts.

The application process for a new financial product is an
important means of establishing the customer's credit
worthiness and risk profile. Information is generally                                Credit Application
gathered via account/product application forms which can
vary from simple coupons in magazines asking for only                                                   Internal
                                                                                                                                  CRA
                                                                                                                                 Bureau
                                                                                                          Files                   Data

name address and telephone number, (as in the case of
                                                                             Application
                                                                               Credit




                                                                                                                   Other Data               Decision
                                                                                           Data Input
some mail order catalogues), to forms covering several                                                             Gathering                 Engine



pages and requesting detailed financial information such as
                                                                                                                   ACCEPT           REFER         DECLINE
                                                                                                                                                  DECLINE

salary and balances outstanding on current credit
                                                                                                            Proofs              Manual Review
agreements. Of course there are often informational
asymmetries between lender and borrower at this stage.                                                                                                      17



The lender may not have a complete picture of the
borrowers assets, liabilities and future prospects.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                         82
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The Basel II initiative has drawn attention to lender risk
                                                                    distributed across accounts and products. Application
assessment systems but more work can be done in this
area. Risk assessment at the point that the customer                scores may allocate new accounts into certain life-style
applies for credit has, historically, utilised credit scores
                                                                    clusters or segments which are then used in account
that rely on information regarding the applicants past
performance on credit accounts. New scoring systems,                management and or for cross-selling. In mobile phone life-
that are more forward looking, and factor in a more
                                                                    time value, risk and fraud are key dimensions that are often
complete picture of the customers’ indebtedness in
relation to current and potential income flows along                assessed at the account set up stage since recovering the
with features reflecting the impact of interest rate
changes and the economic cycle will undoubtedly lead                initial investment in the customer (handset and network);
to a reclassification of portfolio risks”.
                                                                    managing fraud in a fast moving market and managing
                                                                    payment risk are key to a profitable relationship. In the
Thus an integral part of the process is application scoring,        utilities, assessing risk in order to match the appropriate
based on the consumer's characteristics, and automated              payment method and plan; securing deposits where
(accept/reject) or manual (review) decision processing. For         necessary        and   clustering   customers   according   to
instance, the credit granting decision process may involve a        consumption patterns and life-style indicators can be
mixture of credit scoring, applying the company's policy            valuable in managing collections and overall customer
rules, and human judgement. There may also be checks                profitability.
against the company's in-house information; for example
checks for duplicate applications, checks for fraud and
checks on the applicant's performance on other credit               Account management involves a variety of activities that

accounts held with that company.                                    take place either on a regular basis or in response to
                                                                    specific circumstances or behaviour. One objective is to
                                                                    keep the customer in account management and prevent
Usually a decision process will have three outcomes;                progression into delinquency and recoveries. Some lenders
accept, reject and refer (referred applications could be            put effort into identifying payment risk pre-delinquency by
those with scores around the borderline, for example, or the        monitoring transactions and potential over-commitment.
company may have policy rules to refer certain types of
application).   Referred   applications   will   usually   be
processed by more senior staff, with queues of applications         The figure overleaf taken from Wilson and Summers (1998

to be reviewed being maintained by the system.                      p45) summarises the regular activities that a typical
                                                                    account management system would support.


The Application Processing system may also make
decisions in areas such as the setting of credit limits.
Consumers that have several credit accounts with the same
credit grantor, (several store cards can be run by one
finance company for example), may be set a credit limit on
their new account based on their exposure on existing
accounts. Alternatively, the lender might set an overall
credit limit for the customer. This total limit may be




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                             83
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                            Table 4.2.1 – Account Management Functions (Source: CMRC)


                                           A ccount M anagem ent Functio ns



                              Regular                                        A s Required

                            Transactions                                  A uthorisations
                            Paym ents                                     Credit lim it changes
                            Calculate interest                            A ddress changes
                            Statem ents                                   S ettlem ent
                            Account renew als                             Correspondence
                            M erchant support                             Lost cards
                            D iary/Account history                        M issed paym ents
                            Insurance                                     O ver lim it processes
                            Behavioural scoring
                            Strategy m anagem ent
                            Fraud detection




The key activity is processing payments and allocating the          Unmatched payments are normally posted to a suspense
funds to the appropriate accounts. A variety of payment             account and both automatic and manual efforts will be
methods/options are usually offered (cash, cheque,                  made to match them to an account, perhaps using the name
standing order, direct debit, switch, bank transfer etc)            on the cheque or an expected payment value to search for
although individual lenders may encourage particular types          potential matching accounts. The payments in suspense can
of payment method.                                                  be interrogated if a customer queries an un-posted
                                                                    payment.


Direct debits are usually processed within the BACS
system. BACS distribute payment requests to the banks               In addition to payments, for revolving credit accounts there
concerned. Direct debits can be used to make variable               will also be transactions representing purchases made with
payments, for example paying either a full amount                   the account and potentially credit notes if, for example,
outstanding or a minimum payment on an option account,              goods are returned. Many transactions are now recorded
such as a credit card. Direct debit is regarded as an               electronically although paper vouchers are still in use,
attractive payment method for fixed term loans and is               particularly in smaller outlets taking credit cards. Details of
increasingly encouraged for revolving credit as a risk              transactions may come to the lender direct or through
management device. The latter was not the case a few                intermediaries, as is the case with credit cards. Some
years ago since most credit card profit/income comes from           transactions may also be generated automatically, for
interest on the balance outstanding.                                example, the annual fee on a credit card or insurance
                                                                    charges for things like payment protection.


Account management systems have to be able to cope with
payments that cannot be matched to accounts. These can
arise from, for example, incorrectly stated account numbers
on a standing order or when a cheque and payment slip
become separated.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            84
Credit and Debt Management – 2008 Survey




                                       Chart 4.2.3 – Scoring in Account Management



                     Debt Prevention                 Collections Environment           Recovery/ Sale




                      Account Management                Early Delinquency               Recoveries




                    ‐Application scores           ‐ ‘Self‐Cure’ Score   ‐ Recovery Score
                    ‐ Limit Scores                ‐ Roll Rate Score     ‐ Litigation Score 
                    ‐ Affordability scores        ‐ Behaviour Score     ‐ Debt Price
                    ‐ Revenue/Risk Score          ‐ Collection Score




Scoring models are increasingly used at all stages of the                   Account Management system may either manage the
account life-cycle. Increasingly profitability or debt                      collections process itself or pass the account's details to a
servicing ability may be ascertained at the point of                        separate collections system. If the lender uses behavioural
application. Scores to detect early signs of problems and                   scoring then systems need to be in place to regularly
the likely debt path from ‘self-cure’ to arrears may aid the                update the behavioural scores. These may be part of the
collection process by either taking no action in the case of                account management software or may be provided by a
‘self-cure’ individuals or fast tracking cases through the                  link to a separate system.
collection sequences. Litigation scores may be used to
assess the likely success of legal action and scores may
                                                                            Alongside behavioural scoring there may also be strategy
help in pricing debt for sale.
                                                                            management processing; for each account a strategy may
                                                                            be assigned for anticipated circumstances, such as a request
These scores under the generic heading of behavioural                       for an increased credit limit or missing a payment, based
scoring are used at various stages of the accounts life. The                on the behavioural score and/or other factors.
production of behavioural scores (see later for an overview
of Behavioural Scoring) which provide an indication of
                                                                            Increasingly, account management systems will keep a
the way an account is being conducted and the level of risk
                                                                            record of the history of each account, showing all the
it   represents,   may   be produced         by   the Account
                                                                            transactions applied to it, and a diary of contact with the
Management system itself or by a separate system
                                                                            account holder on any actions in progress, such as
interfacing with it. If an account goes into arrears the
                                                                            following up queries about statements. These will be of use
                                                                            to the customer services department when contact is made
                                                                            with the account holder, as well as, the historic information




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                  85
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being potentially a useful input to behavioural scorecard           call centre to respond promptly to customer requests for an
development. Information collected from contact with a              increased limit if the request is within the shadow limit
customer in arrears may be used to modify collections               bounds. Responses to over limit situations include a
strategies that are being determined automatically. An              message on the statement, a letter or a phone call. The
obvious case is where an otherwise prompt paying                    account management system might have a strategy
customer has got into arrears because of a unexpected               allocated to the customer to deal with this eventuality.
event such as loss of income, accident or illness.


                                                                    Customers may also contact the lender with other requests
Account management systems have to be able to deal with             and enquiries, for example a change of address, a statement
authorisations. On revolving credit accounts there can be a         query, a lost card or a request to pay off a fixed term loan
requirement for sales over a certain value to be authorised         early. Customers who wish to pay off a loan early can
before they go ahead. This can be done by a phone call or           request a statement from the company of the amount
automatically when the card is swiped through an EFTPOS             required to pay off the loan by a certain date. This will
terminal. Checks done at authorisation stage might include          require new interest payment calculations and there may
calculating whether the transaction will take the account           also be early settlement penalties and administration fees to
over its credit limit and an assessment of the likelihood of        calculate.
fraud on a large transaction. As indicated earlier plastic
card fraud is a major and escalating problem. Fraud is one
                                                                    The account management systems generate different levels
area where non-statistical models such as expert systems
                                                                    of management information that is used to produce reports
and neural networks are most often used rather than
                                                                    to support operational and strategic decisions. This might
statistical models. These techniques can cope with the
                                                                    include volumes of business, volumes of payments and
rapidly changing nature of fraud, and identify new patterns
                                                                    aged debt reports, split by variables such as product and
of fraudulent behaviour. The identification of a potential
                                                                    source of business. Having real time information on
fraud can result in customer services contacting the
                                                                    delinquency levels is seen as important for modifying
account holder and checking on the transaction.
                                                                    collection and recovery stratgeies and/or realigning risk
                                                                    and behavioural scores.
Account management software will need to check credit
limits as transactions are posted. When an account goes
over the limit a decision is needed on the action to be
taken, and some evaluation made of whether the problem is
likely to be a result of fraud. This might be based on the
amount by which the limit is exceeded and the customer's
previous behaviour. Usually, systems maintain a shadow
credit limit (an amount of credit above the known limit that
the company would be happy to give the customer based
on their perception of risk). The shadow limit allows the




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            86
Credit and Debt Management – 2008 Survey



                                            Chart 4.2.4 – Applications to Collections



                                  A p p lic a tio n
                                  P ro c e s s in g S ys te m




                                           Account                        B e h a vio u ra l
                                           M anagem ent                   S c o rin g / S tra te g y
                                           S ys te m                      S ys te m


                                                                 C o lle c tio n s
                                                                 M anagem ent
                                                                 S ys te m




When an account shows signs of going into arrears, the                      Clearly a strategy needs to be adopted that minimises
lender needs to ascertain what the appropriate action might                 contact/collection costs but effectively remedies arrears.
be to remedy the situation. Arrears may be a sign of                        There may be several collections strategies, perhaps based
financial difficulty and a deteriorating profile or simply                  on collection scoring, involving phone calls, reminder
represent a situation where a person regularly pays their                   letters or passing the accounts to an external debt collection
monthly bill a few days late, perhaps coinciding with when                  company.
they receive wages/salaries. Collections systems primarily
provide a diary function, so that a record is kept of contacts
                                                                            The lender needs to identify the best route to take for a
with the accountholder and actions taken, and a queuing
                                                                            particular account as promptly as possible. At this stage, a
system that enables the processing of accounts to be
                                                                            decision may be made to pass the debt to an internal or
controlled. Accounts entering collections will be allocated
                                                                            external collection agent. Collection agents will often use a
to a particular queue initiating a particular action, such as
                                                                            collection score to determine the most cost effective
telephone contact with the customer or the sending of a
                                                                            actions to recover the debt.
letter.

                                     Chart 4.2.5 – Debt Management and Collection Trends



                                             Debt Management & Collection Trends


                                              telephone contact (power diallers)
                                                       more personal telephone / letter contact


                                          debt collection agencies                           litigation
                                          (internal and/or external)



                                       phone         letter      doorstep




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                   87
Credit and Debt Management – 2008 Survey




The timing of further actions is usually driven by a review               They write, "as a simple example Company A, who run an
date that can be set by the collector or by the computer                  in-house store-card system, would attempt to transfer
system after an automatic action such as the sending of a                 customers onto direct debit for payment of the card
standard reminder letter. Accounts within a queue can be                  wherever possible. This simplifies and speeds collection.
prioritised by criteria such as value of debt, time in arrears,           The objective here is to clear account balances in order to
or some combination of criteria.                                          facilitate further spending in the store. Company B, a
                                                                          credit card provider, operate a very similar collection
                                                                          system but have made a policy decision not to encourage
Wilson and Summers (1998) identified differing collection
                                                                          direct debit as this would reduce the profitability of the
strategies for different types of financial services.
                                                                          customer base. The objective here is to allow profitable
                                                                          debt to build but at the same time minimise the risk of
                                                                          default and costly collection activities".




                                   Chart 4.2.6 – Scoring to Determine Collection Strategies




                                                    Receive Bad Debt


                                                 Scoring/Decision Tree
                                                    (classifies debt)


                                                           Strategy
                                                          Allocation
                         No Action
                         Write-off
                                                                               Door step collection
                             Letter & telephone              Litigation




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                              88
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In the later stages of arrears accounts may be passed to            order to estimate the returns in relation to actions.
debt collection agencies, sold or go to litigation. The             Collection departments will be interested in analysing ‘cure
collections system now usually provide for monitoring/              rates’, that is the proportion of accounts that are currently
review of accounts passed to an external agent or litigation.       overdue that are fully or partially returned to order.
Some systems include litigation functions but separate
litigation packages are also available. In the case of debt
                                                                    4.3.     Elements of ‘Best Practice in
sale, information has to be provided so that the buyer can
                                                                             Collections’ and Implications
undertake due diligence.


                                                                    This section is based on an analysis of a series of case
The large volume lenders have relatively sophisticated              studies of the collection systems and structures of some
management information systems that facilitate the                  organisation that have large volumes of consumer debt to
tracking of customer risk and the progression of delinquent         manage, collect and recover which we refer to as ‘large-
debt. Such information is essential for making provisions           volume lenders’. The lenders cover: (a) Financial Services:
for bad debt write-off. Clearly the actual amounts                  Credit Card, Current Accounts, Personal Loans, Charge
outstanding will be converted fully into cash because a             Cards, Insurance Products, mortgage lenders; (b) Utilities:
proportion of borrowers will default on some or all                 Gas, Water and Electricity; (c) Telecommunications:
repayments. Management         information    systems have          Mobile and Fixed Line (d) Home Shopping: major Mail
improved substantially in recent years and allow various            Order Companies. Interviews have been conducted within
profiles and ‘drill downs’ of the current portfolios.               a selection of organisation in the categories above at
                                                                    various intervals since the initial survey in 1998. This
                                                                    report summarises the interview responses from the
Lenders attempt to model debt progression from current to
                                                                    original survey in 1998 (see 'Debt Collection in the UK and
delinquent in order to determine provisions and set targets
                                                                    Europe', by Wilson and Summers 1998 for more detail).
for collections and recovery operations. Common methods
                                                                    and the updates provided in 2001, 2003 and 2007. Thus,
for projecting bad debt levels are ‘roll-rate’ models and
                                                                    major trends in the collection systems and strategies can be
variants, such as Markov Chains. The former tracks the age
                                                                    gauged with a particular emphasis on the back-end of the
of debt and predicts the proportion of debt say in the 1- 30
                                                                    collection and recovery cycle and the usage of 'out-placed'
days overdue category that will progress into the next
                                                                    collection agents by large volume consumer lenders and
category of arrears 30-60 days overdue. By analysing
                                                                    the more recent trend to use debt sales as an alternative to
recent history the proportion that will roll forward can be
                                                                    placing for collection on commission. The trends in 'in-
estimated. In practice roll rates will often be calculated on
                                                                    house' collections systems and procedures have obvious
a daily basis, i.e. how much of the 1 day overdue rolls onto
                                                                    implications for the 'external' debt collection industry.
2 days overdue.



The Collection departments may look at the profile of
delinquency at each collection cycle or collection action in




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                             89
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This purpose of this section is to draw some general                                                                                       Clearly any investment 'in-house' in new debt management
conclusions     from     tracking                       developments                         within                                        philosophies and technologies should affect internal
organisations engaged in high volume consumer lending                                                                                      collections performance and efficiency and will have an
and debt management. The focus was an examination of                                                                                       impact on the type, age, quality and volume of debt that is
recent trends and strategies in collections. Interviews                                                                                    made available to external debt collectors and debt buyers.
allowed us to gain insights into the 'state of the art' in                                                                                 An attempt was made to focus on organisations held as
information provision, risk analysis and decision support                                                                                  examples of 'best practice' within the industry, or
and debt progression software, with a view to identifying                                                                                  organisations that had recently re-organised their credit-
common and 'best' practice whilst focusing on the forces                                                                                   debt management activities and/or invested in new
driving change in the credit and collections departments of                                                                                information-technology and collection systems. A synthesis
these organisations. The analysis provides a benchmark for                                                                                 of the main trends affecting high volume collection
organisations interested in appraising their current practice.                                                                             concludes the section.




                                                                     Chart 4.3.1 – New Debt Management Approaches



                          Product Level View

                           New Prospects                            Application
                                                                                                                                       Customer Level View
                                                                    Processing


                                                                                    Set Up
                                          Marketing                                Account


                                                                         Account
                                                                          In Use
                           Collections
                           and Recovery
                                                                                                                                                                                                   CRA’s
                                                              Account Management
                                 DCA’s ?
                                 Sale ?




                                    Credit Card                                                         Bank Loan                                          Current Account

                           New Prospects              Application                               New Prospects            Application                     New Prospects           Application
                                                      Processing                                                         Processing                                              Processing


                                                                          Set Up                                                            Set Up                                                  Set Up
                                     Marketing                           Account                          Marketing                        Account                Marketing                        Account


                                                           Account                                                            Account                                                 Account
                                                            In Use                                                             In Use                                                  In Use
                           Collections                                                          Collections                                               Collections
                           and Recovery                                                         and Recovery                                              and Recovery

                                                  Account Management                                                  Account Management                                      Account Management
                               DCA’s ?                                                              DCA’s ?                                                  DCA’s ?
                               Sale ?                                                                Sale ?                                                  Sale ?




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                          90
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4.3.1. Credit Information and Scoring                                             The compilation and management of 'data warehouses'
       Technologies
                                                                                  including credit reference data, lifestyle and geo-
                                                                                  demographic data, and 'closed user group' data has been
Profiling and understanding the ‘customer’ is at the heart                        facilitated by sophistication in computer technology and
of best practice account management debt prevention and                           software. Thus there has been a move towards profiling the
collections/recovery.   Organisations in financial services                       'customer' across all credit products, rather than a 'product
have and continue to invest in data-base systems that                             focus' and gaining a view of total indebtedness.
facilitate the generation of a view of the customer                               Organisations        have    been    re-organising    data   and
(customer-level) rather than behaviour in respect of a                            information systems to be able to 'manage the customer not
specific product (account-level).                                                 the debt'. Decisions are informed by scoring systems and
                                                                                  propensity modelling, but there has been considerable
                                                                                  resources devoted to the capturing of ‘up to date’ and
This has involved matching all internal product use with
                                                                                  ‘event’ data from telephone and letter contact with the
particular customers (e.g. bank account, credit card,
                                                                                  customer. For instance, a customer may currently have a
mortgage) and gaining an insight into the customers
                                                                                  good risk score but telephone contact reveals that the
behaviour and level of indebtedness with the credit
                                                                                  household has recently lost income through job changes.
accounts of other lenders via the credit reference agencies.
                                                                                  The profile of the customer can then be changed
The latter has been aided by major lenders, such as HSBC
                                                                                  accordingly         by   combining    both    the    quantitative
and Natwest sharing their data and the development of
                                                                                  information from scoring systems with ‘qualitative’
‘indebtedness’ indices by the CRAs (e.g. Experian,
                                                                                  information from customer contact. Profiling customers
Callcredit). Prior to these initiatives, the lender had a very
                                                                                  will usually involve 'segmenting' the customer base into
partial view of an individual’s debt commitments and
                                                                                  groupings with similar characteristics and behaviours
ability to service debt (creditworthiness).
                                                                                  and/or in relation to appropriate collection activity.



                                 Chart 4.3.2 – Motives for Credit Scoring in Consumer Credit



                                                                 Credit Scoring
                                                                           coping with high volumes with low 
                                                                         value in a competitive environment


                                                                           pricing risk – segmentation



                                                                          managing and understanding 
                                                                         customers (relationships) and
                                                                         maximising profits


                                                                  Propensity              ‘If’             ‘when’
                                                                  (probability)
                                                                  Modelling                     timing
                           15




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                            91
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Organisations use statistical models and 'scorecards' to             More recently, emphasis has been placed on modelling the
support credit decisions at all stages of the credit lifecycle       ‘timing’ of behaviours to determine the optimal ‘timing’ of
from credit applications to account management via                   actions. Scoring models are essential for the accurate
'behavioural scoring'. The term ‘credit scoring’ was coined          ‘pricing’ of debts and debt portfolios should a debt sale
in relation to application scoring used for reject/accept            opportunity arise.
decisions in high volume low value credit granting
environments. The technique has evolved to model many
                                                                     Best practice systems incorporate many of the elements
‘propensities’ as well as risk. For instance, there is an
                                                                     charted below. Data combinations that are able to profile
increased use of models to predict/understand customer
                                                                     account or service usage; the customer life-style;
'churn'; payment behaviour; collection scores; life-time
                                                                     indebtedness and income. Data is updated at every
value and profitability etc. Different techniques are often
                                                                     opportunity. This information feeds into propensity models
combined, e.g. statistical methods for scorecard building;
                                                                     that help to segment customer behaviours and determine
neural networks for account monitoring (behaviour, fraud
                                                                     strategies to be employed in responding to customer
etc); expert systems for implementing 'policy rules'.
                                                                     behaviours. This facilitates the efficient deployment of
Organisations are placing more emphasis on monitoring
                                                                     resources and skills in managing customers. MIS systems,
scorecard    performance      after   implementation      and
                                                                     strategy testing and benchmarking aids continuous
monitoring different strategies towards customer segments.
                                                                     improvement and adaptation to change.



                                      Chart 4.3.3 – Modelling for Collections Strategies




                                                                                     Informed
                     DATA                          PROPENSITY                      Processes and
               Customer Level                       MODELS                           Strategies
               Account Level                                                    ‐ Customer segmentation
                   Customer                                                     ‐ Tailored Collection
                   Behaviour                                                      and Recovery Processes

                                                                                ‐Focussed resources 
                   Contact                                                       and skills
                   Updates
                                                                                ‐ Champion‐ Challenger
                                                                                  testing
                   Credit 
                   Reference                                                    ‐ Cost‐benefit Analysis
                   Data
                                                                                ‐ Sophisticated MIS




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                         92
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Collections or behavioural scores are one variant on                  improvement; (4) Undertake ‘what if’ scenarios for future
propensity scores that may be used to accept/reject an                strategy implementation; (5) Report detailed management
application for finance. Risk scores rank the customer in             information on collections activities and returns and
terms of the probability that they might become delinquent.           provision for bad debt.
Collection scores are compiled based on risk and recent
behaviour. They are designed to determine the probability
                                                                      In order to build and utilise behavioural scores as a means
of collection and/or the percentage of debt that should be
                                                                      of making more effective and automated decisions the user
collected. Collection and recovery scores help the collector
                                                                      has to have a sophisticated customer data base and a high
prioritise actions and the debt path for each delinquent
                                                                      frequency of behavioural information. Typically, the user
customer. Thus, the score provides empirically an
                                                                      will have a high number of accounts, high volumes of
assessment of ‘collectibility’ and therefore determine an
                                                                      usage and historic performance, comprehensive and robust
appropriate      collection   strategy.   As    outlined    above
                                                                      periodic dates, a highly automated and integrated account
delinquent accounts flow through a collections life-cycle or
                                                                      processing system and automated delivery mechanisms.
debt path and require different techniques to solve the
                                                                      Samples of data can then be downloaded and analysed in
problem. The overdue payment will initially be dealt with
                                                                      relation to a particular outcome.
in the ‘account management’ system and then flow through
                                                 st nd
to ‘collections’, internal and external ‘DCAs’, 1 , 2 and
           rd
perhaps 3 placements with DCAs and then through to
                                                                      The principle is as follows and summarised in the diagram
write-off, ‘debt surveillance’ or ‘debt sale’. The collection
                                                                      overleaf. An outcome (i.e. 3 payments down) may be used
score can be utilised the path and the timing of actions.
                                                                      to build the behavioural score. Data is taken at the
Such score can also be utilised to help determine a ‘price’
                                                                      observation point for a sample of good/bad accounts.
for debt sale.
                                                                      Account characteristics and behaviour in the previous 12
                                                                      months is analysed and related to the particular good/bad
                                                                      outcome and behavioural scoring model is built and used to
The need for monitoring activities versus returns and
                                                                      classify the probability that current good accounts will
decision software tools has grown with the use of scoring
                                                                      become bad at the outcome point.
models. Champion-Challenger (see below) is commonly
used to test different strategies on different customer                      Chart 4.3.4– Behaviour Scoring: Principles
segments (based on scores). The collection process/strategy
                                                                                        Behaviour Scoring: Principles
is therefore adaptive and varied at regular intervals. Thus,
the key features of such a system are: (1) Segmentation -
the collection department must be able to identify customer
                                                                                                       Observation     Outcome
                                                                                                         Point          Point
sub-groups with similar characteristics/behaviour; (2)
                                                                                          Behaviour
Score calculation and implementation - the system must be
able to warehouse customer data from various sources,                                         Window

                                                                              24 months ago            12 months ago    Today
calculate and update scores and incorporate them into the
decision process; (3) Adopt a champion-challenger
environment        for   continual    testing    and       strategy




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                              93
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                                                                                             Chart 4.3.5 – Behaviour Scoring


                                                                  Behaviour Scoring: historic performance characteristics

                                                                  - How the account has been operating historically, e.g.

                                                                                - Number of times over the limit in last 3 months
                                                                                - Average balance over the last 6 months
                                                                                - Average payments/Average balance over the last 6 months
The chart to the right provides information on the types of                     - Average outstanding balance over the last 3 months/ average
                                                                                  outstanding balance last 6 months
variables that might be collected in the ‘behaviour
                                                                  - Decision point details
window’
                                                                                - Current balance
                                                                                - Current balance/limit %
                                                                                - Age of account
                                                                                - Current facilities




                                                                                 Chart 4.3.6 – Example Behaviour Score Card

                                                                                                Example Behaviour Score Card

                                                                                                                                                                           value
                                                                  Balance / limit%                             0 - 30      31 - 80 81- 100 101+
                                                                                                                                                                          points score
                                                                                                                +50         0, -30 -100

                                                                Ave payment / Balance%                         0-5         6 - 20          21 - 50 51 - 100
A statistical process is employed to derive points or               (last 6 months)                            -60          0, +20         +35

weights for each behaviour variable. These are summated        Cash advances/total debits % 0 - 5                           6 - 50         51 - 80 81 +
                                                                     (last 3 months)
                                                                                            -10                             -30, -20 -150
for each account to derive an overall behavioural score. An
                                                                 Age of account (months)                       0-6          7 - 12         13 - 24 25 +
example is provided in the Chart opposite.                                                                      -10              0          +10            +30
                                                                 Worst arrears stage                                0-1                2            3+
                                                                  (last 6 months)                                   0             -35        -120




                                                               Chart 4.3.7 – Behavioural Scoring and the Account Life-cycle

                                                                                             Behavioural Scoring and the Account Life-cycle


                                                                      Application            Early Behaviour               Behaviour/Delinquency                 Recovery

                                                                    Pre-acceptance             1st bill- 6 months          6th months- final bill            Final Bill          Write-off
The behavioural scores might be used to make decisions
about an account at the various stages in the life cycle.         Customer provided
                                                                  data to assess future
                                                                  risks and credit limits,
                                                                  billing and payment                                                                       Liklihood of this
Additional data and behaviour can be added to create              plans and security         Application risk score                                         account leaving an   Strategy as
                                                                                             and early behaviour                                            unpaid balance,      determined by
                                                                                             such as early transactions                                     arrangement vs       recovery score;
‘collection scores’ and ‘recovery scores’ as highlighted in                                  and payment                                                    action               Litigation ?
                                                                                                                                                                                 DCA?
                                                                                                                          Analyse actual customer                                Sale?
the Chart opposite.                                                                                                       behaviour such as payments,
                                                                                                                          overdues, balances .. To
                                                                                                                                                                                 Write-off ?

                                                                                                                          assess risk and set collection
                                                                                                                          or treatment priorities




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                94
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4.3.2. Customer contact and Customer                                Customers in early stage delinquency are contacted
       Retention and Collection
                                                                    immediately and repeatedly in order to resolve any
                                                                    problems    quickly.   Again,     restructuring   debts   and
In Financial Services, one of the impacts of Basel II rules         implementing a program to recover outstanding balances is
and the default definition (90 days) has been to focus the          the priority. Collection staff must be multi-skilled to deal
attention of lenders on the time path of debts. An emphasis         with multiple products on multiple systems. Recalcitrant
is now placed on detecting indebtedness problems and                customers will be passed on to a 'collections' environment
potential payment difficulties at an early stage and if             when the early stage collection has not been successful, i.e.
possible to solicit some payments that enable the debt to be        broken promises, arrangements not kept up.
reclassified. This may involve the use of scoring or
behaviour triggers to alert account management to relevant
changes. Customers may be contacted for counselling or              Customers are segmented by risk and outstanding balances

‘money management’ and pre-emptive action to relieve                and much champion-challenger testing in relation to

financial pressure via the restructuring of finances or debt        strategies and the timing of actions is undertaken. Scores

being re-aged. Emphasis is on customer retention and                focus on ranking customers by ‘propensity to pay’. The

rehabilitation in order to prevent future delinquencies.            cycle from arrears to recovery action and write-off has

Customer     retention   emphasises    early   contact    with      become much shorter but accounts and debts are worked

individuals and their education regarding payment habits            much harder or more aggressively in the early stages.

and indebtedness and referrals for 'debt counselling' in            Delinquent accounts are passed into the ‘external

some circumstances. Supported by 'on-line' and timely               environment’ via debt sale or to a DCA much sooner where

information on the individual's account history and                 the emphasis is on recovering arrears through repayment

payment scores.                                                     plans.




Call centre staff have increased flexibility and discretion in      The Champion-Challenger environment is commonplace in

the approach to indebted customers with an emphasis on              collections. Champion/challenger systems can be used to

resolving the problem and negotiating solutions to the              develop strategies over time. The basic approach is

problem, e.g. restructuring payments. It is recognised that         illustrated in the chart below. In collections, a particular

financial difficulties can be transitory (due to changing life-     collection sequence will be in operation for certain types of

styles and income streams) and customers in arrears can be          accounts. The approach/sequence is then slightly varied for

rehabilitated. Significant resource is put into keeping             a sub-set of accounts (challenger strategy) and the

account information up to date particularly contact                 outcomes are monitored and tested against the champion

information, employment status, income and assets. This             strategy statistically. If the challenger outperforms the

information is used to modify the treatments that may be            champion it becomes the new champion that in turn is

automatically determined by the scoring systems.                    tested against new challengers.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                           95
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                                    Chart 4.3.2.1 – Champion vs Challenger Strategies in Collection



                                   Champion 80% accounts                                       Challenger 20% accounts


                                                    £’s Outstanding                  Risk Score        £’s Outstanding
                                  Risk Score
                                                   Low     Medium    High                           Low     Medium    High

                                  Low                                                Low

                                  Medium                                             Medium

                                  High                                               High



                            Collection
                            Strategy
                                                 Letter             Letter            Letter                   Letter
                                                                                      Phone                    Phone
                      Time                       Phone              Phone             Phone                    Phone
                                                                                                               Doorstep 
                                                                    DCA               Legal
                                                                                                               DCA
                                                 DCA                                  DCA                      Sale




By adopting different collection sequences with different                             Organisations have implemented systems that are able to
timings     across    a     segmented          collections     portfolio              identify quickly if an account is going into arrears and
collections performance can be continually improved. The                              decide      an    appropriate          collection   strategy.   Various
effect of changing the collections sequence provides an                               information support systems are now available to help the
uplift to collections performance simply by removing the                              organisation make timely and suitable decisions.
predictability of the collections sequence from the
perspective of the debtor. A debtor that can predict the
                                                                                      Collection support systems have the following features:
sequence of actions to recover payment will rationally wait
until the end stage before paying or until collection efforts                                •    A diary function which records contacts with an
‘get serious’. If the collections sequence is constantly                                          account holder and the actions taken;
changed, then this can stimulate the debtor into better
payment     habits.       Champion-challenger           can     increase
effectiveness by targeting actions that solicit the best                                     •    Queuing systems to control the processing and

response from customer segments and removing collection                                           progression of overdue accounts: different queues

stages that have been shown to add little value in the                                            initiate different actions; different queues for

collection process. The process of continual improvement                                          different account types; choice of queue can be

may involve creating ‘specialist’ collection teams that                                           determined by risk scores; timing of next action

focus on particular debt stages or particular customer                                            can be automatically set and implemented;

segments.                                                                                         prioritisation within a queue by value, age, risk of




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         default etc.; automatic sending of reminder                    •    Use of automated collection systems using
         letters;                                                            decision support information to prioritise debts
                                                                             and determine the appropriate collection strategy;
    •    SMS messaging is used to invite inbound calls.
         Inbound calls are deemed a very successful                     •    Management information for documenting and
         strategy for resolving payment problems;                            monitoring actions taken and responses by
                                                                             debtors; collectors' performances; early detection
    •    Collection staff will be monitored on cash
                                                                             of non-compliance incorporating the use of
         collected, promises kept, ATPs arranged, call time
                                                                             scorecards to identify individuals most likely to
         etc. Collection staff now works in a competitive
                                                                             default and the probability that they will repay.
         environment and will often receive bonuses based
                                                                             The ‘timing’ of actions is deemed to be very
         on performance.
                                                                             important and lenders are researching the impact
                                                                             of varying delinquency cycles;
4.3.3. Collection department practices
                                                                        •    There is recognition that ‘debt resting’ may be an
                                                                             appropriate strategy for certain accounts. If a low
Leading edge collection departments tend to have the                         risk customer has been affected by an unexpected
following characteristics:                                                   ‘event’, such as divorce or employment change
                                                                             then it may be more cost effective to allow the
                                                                             customer to recover his/her financial position
    •    Centralisation       of    the      collection   function
                                                                             before collection action is taken;
         especially in the early stages and specialisation as
         the debt progresses;                                           •    There is more use of ‘behavioural’ and ‘collection
                                                                             scoring’    to   segment     customer-bases     and
    •    Use of 'champion/challenger' approach to ensure
                                                                             determine the escalation process for each debt,
         that collection strategies are constantly updated
                                                                             i.e. debts may not all pass through the same
         and    effective;     statistical    analysis    of   C/C
                                                                             sequence of actions. In order to be effective, these
         strategies;
                                                                             collection strategies have to be monitored and
    •    Customer tailored collections paths are more                        tested continually in a champion-challenger
         likely; different strategies for different ages of                  environment. New strategies based on customer
         debt       using   different     collection   approaches;           risk profiles and ‘propensity to pay’ scores are
         emphasis on rehabilitation of customers and cash                    implemented and monitored to establish possible
         recovery;                                                           sources of cost saving and efficiency in
                                                                             collections activities;
    •    Use of on-line customer information systems and
         credit reference agencies to provide payment                   •    Implementation of activity-based costing to
         histories;                                                          monitor cost effectiveness of actions versus
                                                                             recovery;




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    •    0nce non-compliance established early contact                             In interviews, Debt Sale was usually undertaken post-
         with    debtors   via     the        telephone;   use   of                write-off. Usually debt would be written-off after being
         power/predictive dialling telephone technology;                           out-placed once or twice unsuccessfully. At this stage
         investment in new contact modes that encourage                            portfolios of written off debt would be sold by tender to
         the debtor to make inbound calls. For instance,                           organisations specialising in debt purchase.
         SMS     messaging       and     or     Interactive Voice
         Response (IVR) calls;
                                                                                   One lender was offering portfolios of around £20million
    •    Early categorisation of debtors who 'can't pay'                           plus for sale several times per year. The price of these
         from those who 'won't pay';                                               debts would range from 2% to 10% of face value.

    •    Early establishment of a realistic payment plan;                          Portfolios are often broken down into segmented ‘buckets’
                                                                                   and sold for differing prices, but many lenders expressed
    •    Negotiation with debt management organisations
                                                                                   the view that they had little confidence in the pricing
         and IVAs.
                                                                                   mechanisms for debt.              Almost all of the lenders
                                                                                   interviewed expressed an interest in selling debts at an
                                                                                   earlier stage, i.e. pre-write-off. Most lenders that sell debt
Debt sale is on the increase and all the lenders that were
                                                                                   take some steps to maintain their ‘brand image’. There is,
interviewed were actively participating in the debt sale and
                                                                                   of course, some ‘reputation’ risk if debts are sold for
purchase market. The market for debt sale is increasing
                                                                                   collection by more aggressive or ‘unscrupulous’ collectors.
since the time horizon of the lender and the DCA is
                                                                                   The role of brokers was beginning to result in some price
different and facilitates the customer shifting from a short-
                                                                                   uplift.
term payment plan (credit card) to a longer term
arrangement (DCA arrangement to pay).




                                                    Chart 4.3.3.1 – Lender Time Horizons




                        Debt Lifecycle                                Loan Established

                                                                                         Bad Event, e.g.  divorce

                                                                       Debt Cleared
                                                                                                 Arrears
                                                                                                           Collections 
                                 Repayments re‐start                                                        Litigation 
                                                                                                             Activity


                                                                                                           Time

                                         Reached divorce settlement                    Default
                                                                       Write Off




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4.3.4. Use of external debt collection                              4.3.5. Benchmarking
       agencies for telephone, letter and
       doorstep contact; litigation
                                                                    Benchmarking is now utilised widely in credit management
                                                                    in order to gauge and monitor the relative performance of
There has been a significant rationalisation of the use of
                                                                    the credit/debt management department. Benchmarking is a
collection agents and constant performance benchmarking
                                                                    continuous process which involves measuring activities
between agents and between agents and in-house collection
                                                                    against other similar organisations in the industry sector,
activities. Our previous studies reported that clients were
                                                                    comparing individual performance against the industry
insisting on having closer contact with collection agents
                                                                    leaders and comparing internal performance indicators
via integrated information systems. Close monitoring of
                                                                    through time. This process allows the identification of
the outcomes of placing with agents. More recently,
                                                                    demonstrably better practice which will lead to measurable
perhaps due to the pressures of Basel II systems, lenders
                                                                    improvements in performance. “Companies must be
are keen to remove delinquent debt from their books via
                                                                    flexible to respond rapidly to competitive and market
debt sale (ownership transfer) rather than placing for
                                                                    changes. They must benchmark continuously to achieve
commission collection.
                                                                    ‘best practice’ (Michael Porter, Harvard Business Review,
                                                                    December 1996).

Where placement occurs, collectors use in-house and
external collection agents in more sophisticated ways.
                                                                    The    quantitative   side     of     benchmarking    involves
Lenders will typically use a panel of around 6 DCAs and
                                                                    establishing and defining Key Performance Indicators
possibly 2 trace and collect specialists for ‘absconders’.
                                                                    (KPIs) that will be comparable through time and across
The panel of DCAs will be monitored closely and their
                                                                    organisations in the sector. The KPIs measure the
collection success measured. Usually the lender will have
                                                                    performance of an organisation and/or a function within an
direct access to customer-level information as it is worked
                                                                    organisation. For debt management departments, for
within the DCA. This includes access to all computer
                                                                    instance, measures of account delinquency, bad debt levels,
systems and diary records along with collection ‘outcome’.
                                                                    roll rates or aged debt profiles, operating costs, collection
Complaints against the DCA will also be monitored closely
                                                                    cost per customer or per activity, call centre absenteeism
and may be one criteria (along with recovery rate) by
                                                                    etc. can be measured periodically tracked over time and
which debt is allocated to the DCA in then future.
                                                                    compared with the results of other organisations in the
Benchmarking is undertaken to further assess the relative
                                                                    benchmarking group. KPIs should be continually and
performance of individual DCAs including the client’s
                                  st                                consistently measured across organisations and across
internal DCA. First placed debt (1 placement) typically
                                                                    time. The KPIs help to establish internal goals that all
has a recovery rate of 1-3% of face value. Debt may be
                                                                    employees in the department can identify with e.g. reduce
placed a second time if the first placed agency is
                                                                    bad debt by x% this year. Once the KPIs have been
unsuccessful. Second placed debt has a recovery rate of 1%
                                                                    measured and compared then the relative positions of each
or less. Of course the recovery rate is dependent on the age
                                                                    participating   organisation    can     be   established.   The
of the debt when passed out.
                                                                    benchmarking group can then focus on the qualitative




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attributes of the departments processes and practices to            4.4.       Summary
determine        what   management   practices,   techniques,
technology employed etc, contribute to the performance of
                                                                    The picture then, is of large organisations setting up
the ‘best in class’. ‘Best practice’ information can then be
                                                                    sophisticated customer focussed operations aimed at
discussed and shared within the group. An important part
                                                                    'reforming' debtors, if possible, so that the relationship with
of benchmarking is recognising that the data (KPIs) is a
                                                                    them can continue and generate future profits. This has
result of processes and practices and that these must be
                                                                    been partly a response to increased competition amongst
modified and ‘tweaked’ according to ‘best practices’ in
                                                                    lenders, the emergence of 'consolidation companies' and
order       to      improve    performance        continually.
                                                                    recognition that changing life-styles and patterns of work
“Benchmarking is needed for continuous improvement and
                                                                    have precipitated periods of 'over-commitment' by debtors
should be an on-going, dynamic process”                             which need be managed longer-term. Collection cycles
                                                                    have become much shorter in financial services but opened
                                                                    opportunities for debt buyers. Basel II rules has resulted in
The steps involved in benchmarking are summarised
                                                                    reclassification of debtor portfolios in financial services
below:
                                                                    with the development of new default probability models.


    •    Decide what the measure (KPIs)/benchmark
                                                                    The centralisation of collections activity in organisations
         making sure that the criteria aligns with the
                                                                    may produce an environment in which more sophisticated
         department mission/goals;
                                                                    decision   support    systems      including     statistical   and
    •    Measure and document your own performance                  propensity models, such as behavioural scores, can be used
         historically and going forward;                            to formulate the most effective collection strategies by
                                                                    encapsulating the company's previous experience of what
    •    Identify the ‘best’ in the industry (or at least an
                                                                    works and creating variability in collection sequences.
         organisation that is outperforming you in at least
         one dimension);

    •    Analyse and compare results taking care to                 The introduction of enterprise wide data sharing has arisen
         establish that the KPIs are truly comparable               because of the emphasis being placed on having a
         between companies;                                         'customer-level'     view    and      detailed      management
                                                                    information systems. The expansion of closed user groups
    •    Study the practice and processes to establish why
                                                                    in the UK means that firms have access to better
         they are a superior performer;
                                                                    information on other lenders experience of a debtor, and
    •    Implement new practices to improve your own                can include this in their decision making process. The
         performance;                                               differences in information costs of in-house and out-placed

    •    Monitor and measure your KPI’s and start the               debt collection are thus reduced.

         process again.




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Sophisticated credit management in-house will inevitably            A trend towards using fewer agents with closer contact and
reduce the 'quality' or 'collectibility' of debt that is out-       integrated information systems suggests that there will be
placed. Many debts passed to debt collectors will already           fewer/larger and more sophisticated collection agents in the
have been through telephone and letter based collections            future.
procedures, and may even effectively have already been to
one debt collector, if the company has a debt collection
                                                                    4.5. Short Case Interviews 2007
subsidiary. It may be that such firms will only want to
make use of a sub-set of the debt collectors service which
they cannot provide for themselves, for example, door-step          During the spring and summer of 2007, a series of
collection.                                                         interviews were carried out with major lenders involved in
                                                                    the banking, mortgage and credit card sector with a view of
                                                                    updating our case studies on the trends in collections and
As well as the obvious affect of making it more difficult to
                                                                    recoveries and soliciting opinion on the current position
make a profit with charges based on the value of debt
                                                                    and expectations. Interviewees were asked to comment on
collected, this decrease in the 'quality' of debt may further
                                                                    the level of indebtedness in the UK and the risk factors.
impact on the competitiveness and efficiency of the
'external' debt collection industry. The larger debt
collection operations that have traditionally taken the bulk
                                                                    4.5.1. Collections Department: A Medium
                                                                           Sized Bank
of their business from the banks and credit card industry
have in the past been able to develop scoring systems
based on their own history of recovery and bad debt write-          The collections department of the bank handle debt from 3
offs. The development of scoring models however, requires           products: credit cards, personal loans and current accounts.
that the data sample, based on a history of account                 Mortgages and commercial lending are handled by a
experience, have sufficient variation between 'good' and            separate unit.
'bad' accounts. The move towards more sophisticated
collection systems by the credit providers has meant that
                                                                    The collections unit is undergoing some change in order to
the type of debt that is eventually passed on to debt
                                                                    develop a full ‘customer view’ since the data-bases are
collectors is debt that has already been worked and is likely
                                                                    currently organised by product. Collection is undertaken
to be skewed heavily towards the 'bad' end of the debt
                                                                    via a call centre inclusive of 150 seats and an in-house debt
spectrum. That is, there is insufficient variation in the
                                                                    collection agency (operating with a different name to the
quality of debt coming through their books to permit a
                                                                    lender). A pre-delinquency team attempt to identify cases
meaningful statistical analysis and predictive modelling.
                                                                    showing signs of delinquency and contact via call centres
Effectively the client companies are reducing the
                                                                    may be made in order to take preventive action or give
information content of the data by making use of it in their
                                                                    advice.
own behavioural models prior to outsourcing.




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The reasons cited for non-payment are over-commitment               passed to the internal DCA and a more manual and skilled
and a changing attitude towards debt. The appears to be             process is initiated. Tracing may be used at this stage.
less stigma attached to debt and debtors are better informed        There is an internal litigation team and they are
about their options and are aware of how long it will take          experimenting with litigation scoring. Litigation is used to
to ‘buy time’ Rate of interest rises are having an impact on        recover debt and/or achieve charging orders. After 180
arrears and IVAs. As a result, accept rates are being               days the debt is written-off and placed with an external
tightened as are credit limits.                                     DCA- a core of 4 DCAs are used. Commission is 10% on a
                                                                    first placement and 20% on a second placement. The
                                                                    internal DCA is benchmarked against external DCAs and
Debt that arrives for collection is segmented (strategic
                                                                    roll rates are monitored.
segmentation) according to risk (high, medium, low) and
outstanding balance and each case will be allocated with a
call and letter sequence. The segmentation is informed by            At the moment, only small volumes are sold and are
behavioural scores using CRA and in-house data. Around              usually debts that are 360+ days old. The price is generally
50% of cases do not have a accurate telephone number.               around 2-4p in the £. The problem with debt sale is the
Debt that is 100 days old is sent to the internal DCA.              pricing issue for debt at different stages and the data
Champion challenger is used and being developed                     required for pricing
alongside    activity   based     costing.   There   has   been
investment in telephony and alternative contact methods,
                                                                    The main developments are using scorecards to determine
e.g. SMS to generate inbound calls and Interactive Voice
                                                                    collection paths; analysing recovery rates against the costs
Response (IVR) systems. Outbound IVR is also used to
                                                                    of activities; control over IVAs; increasingly automated
verify transactions when fraud is suspected. Collectors do
                                                                    early collections with IVR technology; focussed and
not get cash bonuses.
                                                                    segmented collections.


The emphasis of early collections is to educate the
                                                                    4.5.2. Commercial Credit Card
customer and achieve payment. Call centre collectors can
take payments by debit/credit card; direct debit, etc. If a
promise to pay is achieved then a follow-up will take place         Corporate credit cards are split into merchants (card

within 7 days. The customer will be warned about late               acquiring) and card issue (company cards). Merchants

payment charges where applicable. If there are 2 missed             receive commission on credit card sales and charge backs

payments (60 days) a default notice will be issued and              through purchasing. Company cards are used primarily for

logged with the CRAs. Individuals that are identified as in         expenses of key personnel in the company. The majority of

financial difficulty are referred to counselling and a ATP or       customers are referred to the credit card division via the

payment plan will be negotiated. An external partner is             main bank (70%). Large accounts with credit limits in

used to manage any IVAs with more effort being placed on            excess of £300,000 are assigned an account manager.

maximising the returns and trying to get customers to
establish ATPs internally. After 100 days, the debt is




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                       102
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The management of card accounts is highly automated.                work is being undertaken to price risk across the portfolio.
The card portfolio is categorised by trade and risk with risk       Fraud losses have been reduced through chip and pin
scores generated using an external CRA. Security may be             (although foreign ATM’s often don not use chip and
requested against risky credit limits. In house behavioural         pin).Cloning and organised fraud is still a problem. The
scores are used to monitor credit limits and pick up                company card operation utilises the services of DCA’s
fraudulent transactions. The behavioural scores use                 early in the collection process. Three DCA’s are used in
external CRA data, the bank branch networks and ccj                 competition. Debts of greater than £10,000 will be
information to update risk scores. Scores are used to               investigated by an internal team. Debt sale is not common
measure risk and detect fraud.Where possible, customers             but around £150,000 of corporate card debt was sold in
are signed up to direct debit payments. The merchant side           2006. Bad debt write-offs have been reduced as a result of
of the business has a revolving debt book of around £10.1           improvements in application scoring and risk scoring and
million with around £2.6 million written off in 2006 and            more sophisticated use of credit limits. The improvements
£5million recovered.                                                in and automation of collection systems has resulted in
                                                                    lower bad debt provisions.


An account that misses a payment or direct debit is
segmented into a category based on risk score and balance           4.5.3. Consumer Credit Card
outstanding along with analysis of the reason a DD was
returned. Contact with the customer is made within 3 days           A step shift in the approach to collections occurred as a
with a phone/letter combination. Merchant card debt is not          result of large increase in delinquency, arrears, cases being
always clean because of charge-backs and will involve               referred   to   debt    management      organisations    and
specialist knowledge from the collectors. The internal              bankruptcies during the period after January 2005. A task
collection team operate a small scale call centre with debts        force was set up in order to re-examine the quality of the
of more than £200 being referred to in-house debt                   lending book and the collection strategy. There appeared to
collection if initial contact is unsuccessful. The merchant         be problems in every risk sector (bucket) of the portfolio.
side has an internal investigation agency that may use visits       New debt management software was commissioned around
in order to assess the appropriate actions. Legal action such       this time at a cost of over £25 million. The problems with
as charging orders and baliff services are used as recovery         the portfolio were linked to over-indebtedness of the
strategies. If charges on assets and other legal enforcement        customer base and a mis-classification of customers into
is unsuccessful then the debt is written off and passed to a        risk buckets i.e. prime, near prime and sub-prime. This
DCA. The merchant side has a problem with fraud with the            resulted in the collections having no clear picture of
merchants often being the victims of fraud. The nature of           indebtedness and risk. Repayment plans and delinquency
insolvency has changed with more cases of CVA’s being               continued to increase to March 2005.
encountered with rates of recovery versus costs worsening.



Company cards include credit cards, charge cards and
business cards. The interest rates are variable but more




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                         103
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A number of trends emerge. A scoring system has                     sophisticated with a move to develop recovery scores and
reclassified customers and the collection process is moving         assess the NPV of ATP’s. Debt is allocated to in-house and
from being a ‘event-driven’ process to a ‘time-driven’              external DCA’s and to debt sale. Commission rates are in
process with more sophisticated management information              the region of 10-12% and debt is old for around 1-2 p in
being used to report daily on the level of delinquency.             the £. The level of trust in the debt sale market is not high
Lenders are under more pressure to reduce the number and            due to pricing uncertainty. There has been more activity in
value of debts over the 90 day range as a result of Basel II        door step collection.
rules. This in practice has led to re-aging of debt if the
customer can make some payments if not the full balance.
                                                                    IVA’s and bankruptcies are on the increase and the
                                                                    company are developing a strategy to deal with IVA’s that
The operation has made considerable investment in the               balances increasing returns with keeping the IVA from
collection process in terms of debt management software,            failure. In card default cases the company is now more
telephony and scoring systems. Attempts to generate a               likely to seek a charging order on any assets of the
data-base that gives a full ‘customer view’ have not been           customer via the county court.
completed but are in progress. This has had an impact on
the sophistication of scoring which, it is believed requires a
                                                                    Fraud continues to be a problem with ‘card not present’
customer level view in order to benefit collections.
                                                                    causing the biggest challenge. Application and other fraud
Collection strategies and champion-challenger techniques
                                                                    has been countered with chip and pin.
are used throughout the collection stages. Collection staff
are motivated by incentives and bonuses based on £’s
collected, number of accounts processed. Bonuses are paid
                                                                    The challenges for the future are to increase revenue;
to teams on the basis of performance against collection
                                                                    develop more accurate risk scores, collection scores, ‘self-
forecasts and to individuals on the basis of relative
                                                                    cure’ scores and debt pricing mechanisms and close
performance in the team. Collectors are organised by a
                                                                    dormant accounts. The development of ‘self-cure’ scores,
classification of debt types and stages in the process.
                                                                    roll rate scores, write-off and recovery scores are all being
Collection staff have discretion to negotiate with the
                                                                    investigated. It is recognised that scoring systems play an
customer on re-aging and ATP’s
                                                                    important   part   in   determining     optimum   collection
                                                                    strategies and fast track accounts through different
                                                                    collection paths. There is now a preference to keep as
Call centre activity has been moved overseas including
                                                                    much of the process in-house as possible.          There is
South Africa, the USA and India. DCA’s are used with a
                                                                    recognition that external CRA data is of better quality and
core of 5 being selected (including a DCA in the USA).
                                                                    more comprehensive.
Call centre work requires more sophistication in targeting
calls because there are diminishing returns to call centre
activity. The objective is to increase the penetration rate on
dialling and combined with activity based costing work out
optimum penetration rates.      Scoring is becoming more




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                        104
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4.5.6. Medium Sized Retail Bank                                      payments to customers that are not divulged to the lender;
                                                                     overvaluation of properties, off-plan properties sold but

The bank has a full range of financial products 50% of               never completed; re-mortgaging scams are all examples of

which are internal and 50% offered via third parties (e.g.           the latter frauds.

credit cards). Internally offered products are current
accounts, personal loans and mortgages. 65% of mortgage
                                                                     Payments on the loan portfolio are all paid by direct debit.
business is generated by brokers and 50% of personal loans
                                                                     If a DD is unpaid the debtor will receive a letter-phone
via the internet. A large proportion of new customers do
                                                                     combination of contact in order to get payments up to date.
not have an existing relationship with the bank.
                                                                     If a loan remains unpaid for 90 days it is passed to an in-
                                                                     house DCA who will spend 2 weeks trying to establish a

Application    scoring      has    evolved     to   include    an    repayment pattern. The debt will then be passed to a broker

‘affordability’ model in order to minimise over-committed            who sends it to DCA’s on a commission based collection

customers. The model uses share data to estimate gross               path. The broker receives 21% commission. Debts will be

income;    living   costs    and    total    debt   (CRA      debt   written off after 6 months and sold to debt buyers via the

information). The bank will decline applicants if the model          broker.

predicts a debt servicing problem. At the moment the bank
perceive that only a small number of households in their
                                                                     The collections operation has increased both in scale and
portfolio are struggling but lending has been tightened,
                                                                     sophistication. Roll rates and arrears have been increasing.
particularly to younger age groups. The main reasons cited
                                                                     A behaviour score and balance determines the collection
for non-payment is financial mismanagement and over-
                                                                     path of a debt. Champion challenger analysis informs
commitment. That is the debtor profile is an individual
                                                                     further segmentation. Collection staff have doubled in size
with an income and possibly property but problems with
                                                                     and the company has invested in debt manager software.
debt servicing. Arrears levels are now more sensitive to
                                                                     Debt is rescheduled on the unsecured portfolios where
economic conditions and interest rates, a sign of fragility.
                                                                     possible


The biggest perceived risk for the future is a house price
‘correction’ and a growth in the culture of bankruptcy and
IVA’s . Currently around a third of IVA’s fail and the
others generate a return only after 2-3 years. Fraud losses
are increasing, especially ‘soft fraud’ (fraud that is not
classified as such). Compromised credit and debit cards,
identity theft, card ‘not present’ fraud and cloned cards
used abroad (i.e. not chip and pin) are all areas of concern.
Mortgage fraud is high, particularly associated with inner
city new builds. This is likely to be organised fraud. The
buy to let market is an area subject to fraud. Incentive




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                        105
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4.6.     Large Volume Collections: Interview                        4.6.1. Delinquency Cycles
         Survey 2003


During the period May to July 2003 interviews were
                                                                    After delinquency cycle 4 (i.e. 3-4 missed payments) the
arranged with the major lenders that have contributed to
                                                                    account may be passed into a collections/recovery
this study over the past 5 years along with some other
                                                                    environment. This will also include customers who have
major financial institutions participating for the first time.
                                                                    ‘broken promises’ or failed to respond. This usually
The expectation prior to the 2003 survey was that there
                                                                    involves   a   name      change     for     the   customer.   The
would be some changes in practices but these would be
                                                                    correspondence will now come from an internal Debt
incremental rather than radical. However it was soon
                                                                    Collection Agent that goes under a different name from the
apparent that some quite radical shifts in the organisation
                                                                    lender or from an internal solicitor. At this stage a default
of collection and recovery functions had occurred and that
                                                                    notice will be issued. Thus debts are being escalated
collection strategies and approaches to the customer had
                                                                    quicker into a default and recovery situation. The emphasis
also shifted quite noticeably. These changes are reflected in
                                                                    will now be on recovering arrears through repayment plans
the updated case studies and comment presented below.
                                                                    which may be longer term and recover lower proportions
The main shifts in collection strategies were as follows:
                                                                    of the outstanding debts. Some lenders do NPV type
                                                                    analyses to establish whether it is more beneficial to

(1) There has been a movement towards early detection of            negotiate a settlement involving a lump sum payment (a %

delinquency and earlier and repeated contacts with the              of the total outstanding) as opposed to low monthly

customer in order to establish any problems and                     repayments over a longer period. This activity is clearly

rehabilitate the account back into ‘order’. The cycle from          more suited to the financial services sector than the

early arrears to write-off has become much shorter but              utilities. There is a considerable amount of debt

accounts and debts ware worked ‘harder or more                      rescheduling taking place amongst the large lenders in

aggressively in the early stages. A typical example of              order to rehabilitate customers. The default rate on

escalation of actions is presented in figure 2.15. The point        arrangements to pay (ATP’s) is less than 12%. Again at

0 represents accounts that are up to date and in order.             this stage considerable effort will be geared to establishing

Accounts in early arrears are contacted in 4 ‘delinquency           contact via phone, free phone-in, text message etc and to

cycles’ both phone and letter combinations. The early               gaining    information    on      the     debtors’   employment,

cycles are geared to identifying problems, gaining                  circumstances, financial and ‘asset’ position. Establishing

customer level information, prompting for payment and               whether the debtor has employment and assets is important

reaching ‘reasonable’ agreements with the customer. Such            in determining decision regarding litigation.

arrangements will be geared to getting the customer to pay
the arrears in full or establish promises to clear arrears
within a relatively short period of time.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                               106
Credit and Debt Management – 2008 Survey



                                                Chart 4.6.1.1 – Delinquency Cycles


           Account management                   Internal Debt Collection           External DCA Write-off
                                                                                              Debt Sale

           0        1        2        3     4        5          6   7        8                           210 Days


                                 Late Payment Penalties Imposed
           Account
           in order
                                          Delinquency Cycle                       Recovery Cycle


After a number of delinquency cycles the debts will then                Activity-based costing is an area where most lenders were
be passed on to external debt collection agents and may be              aiming to implement. As one collection manager
placed a second time if the first DCA is unsuccessful. At               commented, “we need to know more specifically what
this stage the debt may also be written-off and sold. The               action generates what return and the cost of each action.
whole process from early arrears to write-off will take less            At the moment we know the cost of broad areas of actions
than 9 months. One lender ‘charged-off’ debt at 90 days.                and can evaluate their cost effectiveness but we need to
That is the debt is passed on to external collection after 90           drill down further whilst avoiding ‘paralysis by analysis’.
days delinquency.


                                                                        (3) The ‘timing’ of actions is deemed to be very important
(2) There is more use of ‘behavioural’ and ‘collection                  and lenders are researching the impact of varying
scoring’ to segment customer-bases and determine the                    delinquency cycles. There is recognition that ‘debt resting’
escalation process for each debt i.e. debts may not all pass            may be an appropriate strategy for certain accounts. If a
through the same sequence of actions. In order to be                    low risk customer has been affected by an unexpected
effective these collection strategies have to be monitored              ‘event’ such as divorce or employment change then it may
and   tested   continually       in   a   champion-challenger           be more cost effective to allow the customer to recover
environment. New strategies based on customer risk                      his/her financial position before collection action is taken.
profiles and ‘propensity to pay’ scores are implemented
and monitored to establish possible sources of cost saving
                                                                        (4) Increasingly lenders as well as working early
and efficiency in collections activities. Activity-based
                                                                        collections more intensively attempt to identify customers
costing helps to establish the cost-return trade-off for each
                                                                        that may be heading for financial problems. Certain types
collection activity. That is, monitor and measure the
                                                                        of behaviour triggers may prompt a call to the customer to
‘success of actions’ against the ‘cost of actions’. The
                                                                        try and pre-empt any problems. For instance a customer
emphasis is on ‘working smarter’.
                                                                        with a change in the pattern of spending          such as an
                                                                        increases in payments going out of the account, new direct
                                                                        debits or standing orders etc.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                              107
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The customer may be contacted by the lenders ‘money                 bonuses based on collections performance others hold
management service’ in order to help the customer evaluate          competitions for best collections performances and award
the level of indebtedness and take actions or restructure           non-cash prizes.
finances in order to prevent future difficulties. Lenders are
thus being more proactive and attempting to assess the
                                                                    (7) Call Centre and Collection staff undergo a significant
customer’s ‘total indebtedness’ or broader financial
                                                                    period of training in negotiation, customer relationship
position before identifying a ‘solution’.
                                                                    management and collection/recovery skills. Most enders
                                                                    suggested the period of training lasted up to 6 months
(5) An increased emphasis on generating customer-level              before a collector had sufficient skill/knowledge to work
information in order to improve the contact rate with               cases independently. Training was both formal class room
customers i.e. phone and mobile numbers, email addresses            and on-the-job using a ‘buddying’ approach.
etc and information on any changes in customer
circumstances, employment, behaviour, indebtedness with
                                                                    (8) The use of Debt Management services by customers
other lenders and products.
                                                                    with debt problems has been increasing. Many customers
                                                                    will seek the advice of the Citizen’s Advice Bureau,
(6) Collection and account management staff work more               national debt line etc and/or allow a fee charging Debt
flexibly in terms of hours and activity. Collection staff are       Management         organisation   to   negotiate   payment
less likely to be specialists are certain delinquency cycles        arrangements with all of the customers’ creditors. Another
but work across all cycles. As one financial services               approach would be to seek a ‘consolidation loan’ from one
organisation commented, “we are now driving out                     of the many organisations that advertise these as a ‘way out
specialist teams, the collection process is the same no             of debt’. One lender revealed that out of 300,000 live
matter which route the debt is coming in from. Collection           ‘collections/recovery cases they had over 20,000 customers
and recovery shouldn’t be a fragmented set up”. Collectors          making repayments via a debt management organisation.
will have the discretion to negotiate arrangements to pay           This represented an increase of 3000 debt management
and promises. Collection staff will be monitored on their           cases in one year. Another lender indicated an increase in
performance, particularly the collection rate or £’s                debt management cases of 200% in a period of just over 2
collected per hour/month etc. Solutions negotiated and              years. Consolidation loans or arrangements to pay may
promises kept may continue to be monitored but the                  extend the period for re-payments up to 20 years. Most
emphasis has shifted to cash targets. One lender produces           lenders suggested that they were taking a ‘harder line’ with
league tables of the collection rates of every individual           debt management and negotiating on repayment plans. A
collector and pays bonuses on league table positions.               figure of 2% recovery per month from ATP agreements
Another lender has a ‘balanced scorecard’ for measuring             was cited as the target.
and monitoring collection staff on an individual and team
basis. The formula includes measures such as income
recovered per hour, percentage of time on and off the
phone, ‘solutions’ impact. Some lenders award cash




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                       108
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(9) Most lenders will use external debt collection agents           within the DCA. This includes access to all computer
(DCA’s) along side their internal DCA. Usually debt will            systems and diary records along with collection ‘outcome’.
be out-placed to external agents after having been through          Complaints against the DCA will also be monitored closely
the entire process internally. Thus the debt will have gone         and may be one criteria (along with recovery rate) by
through the collection cycle, internal DCA/solicitor and            which debt is allocated to the DCA in then future.
then be passed externally if there has been no success. Few         Benchmarking is undertaken to further assess the relative
of the large lenders undertake any litigation internally            performance of individual DCA’s including the client’s
                                                                                                      st
unless it is clear that the borrower has some worth i.e.            internal DCA. First placed debt (1 placement) typically
assets/regular income stream. Some lenders will often do            has a recovery rate of 1-3% of face value. Debt may be
tests and litigate a sample of say 500 accounts in order to         placed a second time if the first placed agency is
evaluate the success rate and cost effectiveness. Recovery          unsuccessful. Second placed debt has a recovery rate of 1%
rates are around 2-3% of balances from litigation.                  or less. Of course the recovery rate is dependent on the age
Litigation, however, may be an option in the recovery               of the debt when passed out. One lender suggested that
strategy for external agents.     In practice few external          their DCA’s often recovered up to 6%. Normally debt will
DCA’s litigate to recover debt but use letter/phone cycles          be 120 days overdue by the time it gets to an external agent
and ‘doorstep’ collections or visits. The latter can be useful      but this varied from 90-270 days in our interview sample.
in gathering further information about the debtors’
financial position and assets. Most DCA’s will, however,
                                                                    Given that the lender works the debt intensively in-house
threaten litigation as a recovery strategy. Most large
                                                                    prior to out-placing it is surprising that DCA’s have any
lenders will have a ‘service level agreement’ with the DCA
                                                                    success at all. One lender suggested that external DCA’s
that sets out they type of approaches that the DCA can use
                                                                    still manage to collect because of (1) a further change of
to recover the client’s debt. All of the DCA’s processes will
                                                                    name (2) a different approach to collection and more threat
be vetted. This is designed to protect ‘reputation/brand’.
                                                                    of litigation (3) because of ‘timing’ i.e. by the time the debt
DCA’s will usually receive a significant amount of
                                                                    reaches the external DCA the customer may have had a
‘customer-level’ information and risk scores or ‘charge-off
                                                                    chance to recover their financial position. This is
reason code’ in order to inform their recovery strategy.
                                                                    particularly the case for individuals who have had a sudden
This, however, means that the lender has a ‘cost’ associated
                                                                    change of circumstance e.g. divorce, unemployment etc.
with ‘servicing’ the DCA arrangement and may evaluate
this in future when making decisions about ‘out-placing’
versus ‘debt sale’. Some use a ‘scoring model’ to decide
                                                                    (10) Debt sale is on the increase and all the lenders that
whether to ‘place’ or ‘sell’.
                                                                    were interviewed were actively participating in the debt
                                                                    sale and purchase market. Debt sale was usually
                                                                    undertaken post-write-off .Usually debt would be written-
Lenders will typically use a panel of around 6 DCA’s and
                                                                    off after being out-placed once or twice unsuccessfully. At
possibly 2 trace and collect specialists for ‘absconders’.
                                                                    this stage portfolios of written off debt would be sold by
The panel of DCA’s will be monitored closely and their
                                                                    tender to organisations specialising in debt purchase. One
collection success measured. Usually the lender will have
                                                                    lender was offering portfolios of around £20million plus
direct access to customer-level information as it is worked




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                          109
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for sale several times per year. The price of these debts           to the customer is firmer in collection actions and in
would range from 2% to 10% of face value. Portfolios are            establishing whether the customer has assets and an
often broken down into segmented ‘buckets’ and sold for             income stream. The debts are worked intensively, by the
differing prices. Almost all of the lenders interviewed             relevant customer service/account management teams,
expressed an interest in selling debts at an earlier stage i.e.     prior to being passed to the DRD. The focus of the DRD
pre-write-off. Most lenders that sell debt take some steps to       team is 'the customer' rather than the product where the
maintain their ‘brand image’. There is, of course, some             debts occur.
‘reputation’ risk if debts are sold for collection by more
aggressive or ‘unscrupulous’ collectors.
                                                                    Thus the Debt Recovery Division receives for collections
                                                                    action unsecured debt that has been deemed by their
4.7.      Case Studies 2003: large                                  internal clients to be non-rehabilitable i.e. where the
          volume collection activities                              customer relationship has irretrievably broken down
                                                                    (missed 3-4 payments) and the sole objective is now to
4.7.1. Case A: Debt Recovery Division of a                          collect the debt. Thus the recovery team receive debt from
       Major Bank                                                   fixed term loans, overdrafts, variable period/rate loans,
                                                                    credit card debt, secured consumer loans, secured and

As a result of the major re-structuring of the customer             unsecured business loans and trade debt. Debt values can

service/collection operations a leading bank established a          range from £25 up to £1m+. The average values are in the

Debt Recovery Division approximately 4 years ago. This              region of £1500 to £4000 and are between 90 and 150 days

was seen as a continued trend towards centralisation in             old prior to being passed into recovery. The team currently

collections to exploit economies of scale. The division acts        handles around 300,000 live cases with approximately

as collectors for all the sections of the bank and for all          20,000 new cases per month. Total balances outstanding

financial products, predominantly unsecured debt. The               are in excess of £700 million of which around £10m per

bank has introduced a counselling service to counteract the         month is recovered.

flight of customers to money advisors and debt
consolidation businesses. This is promoted as a ‘money
                                                                    The department comprises of over 130 staff including 80
management service’ and is designed to identify possible
                                                                    recovery staff, 20 qualified legal staff and 30 support staff.
problems and resolve them to prevent the customer being
                                                                    All   staff    are    trained   in   collection   techniques,
passed into recovery i.e. it is pre-emptive. However if the
                                                                    communication and negotiation skills. The objective is to
relationship with the customer breaks down the account
                                                                    be the creditor that makes the 'best first contact' with the
will be passed to DRD i.e. 3+ arrears, no contact, broken
                                                                    debtor. A bespoke debt recovery IT system is used in
promises.
                                                                    conjunction with a solicitors software package (an
                                                                    automated time recording, billing and case management

The purpose of the DRD is to maximise recoveries at                 system). Collection strategies are undertaken through

minimum cost. The emphasis of this division is on                   different trading styles i.e. the use of 'in-house' agents

recovery not customer retention and therefore the approach          trading under a different name to the bank and in-house




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                         110
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solicitor companies. This 'separateness' from the bank is           used to guide strategies and segmentation. There is an
considered integral to the effectiveness of the debt recovery       intention to make more use of 'debt surveillance' i.e. taking
operation. Up to 7 different names are used to approach the         no action until the debtors' financial circumstances change
customer.                                                           and the use of debt sale to external agents. A problem for
                                                                    collectors is the use of 'death' as an excuse for not paying.
                                                                    This is a sensitive issue and collectors have to be careful
The recovery staff attempts to recover debt through single
                                                                    when verifying the death of a customer/debtor i.e. Death
settlements or through an agreed instalment plan. The
                                                                    Certificate as proof. The success of DRD has led them to
collection strategies include the use of predictive diallers,
                                                                    experiment with collecting debts on behalf of other
interactive voice response, and automated lettering (under
                                                                    organisations rather than being an exclusive operation for
the different trading headings). An escalation process is
                                                                    the bank i.e. to act like an external agent.
adopted to reflect the severity of the non-payment
                                                                    In-house tracing of debtors is undertaken although external
situation. Where repayment is not effected via early contact
                                                                    agencies are used on a trace and collect basis.
and it has been established that the debtor has assets, then
litigation may be pursued as the primary recovery route.
Any repayment plan that is negotiated has to take account
                                                                    External agents are used increasingly on a trace and collect
of the reality of the debtor's financial position and ability to
                                                                    basis when in-house processes have proved to be
pay.     Debts   are   segmented     by   type    and    debtor
                                                                    unsuccessful. Up to 10% of all accounts that have been
characteristics and the appropriate collection/recovery
                                                                    referred to DRD are placed directly with external agents
route is then ascertained. Debt characteristics might
                                                                    without any recovery activity. This process allows the
include: source of debt, debt size, time since last payment
                                                                    DRD to monitor its own performance against the external
etc and debtor characteristics might include: age of debtor,
                                                                    collection agents. The policy is to use only 'four of the
employment,        homeowner,      telephone,      extent    of
                                                                    largest and most effective UK agents'. The performances
indebtedness etc. Credit reference information is available
                                                                    can then be used for benchmarking internal processes.
on-line to support decision-making.
                                                                    Agents have to sign a strict Service Level Agreement
                                                                    aimed at protecting the bank's image.

Champion challenger approaches are used to identify the
optimum recovery processes. Thus letter text and telephone
                                                                    New business is allocated to external agents on a
scripts, frequencies of letters/calls etc are varied to identify
                                                                    percentage split based on how they have performed over
the most effective process relative to the debt and debtor
                                                                    the last 3-6 months, the better the agent performs the
type. Activity-based costing is used to monitor actions
                                                                    bigger percentage they receive. Accounts are taken off
against recoveries in order to optimise the cost/recovery
                                                                    agents after 6 months if they have not received any
ratio. A document imaging system is being introduced in
                                                                    payments. However the accounts are then transferred to
order to track customer contacts on-line. It is envisaged
                                                                    other agents for a further 18 months making 24 months in
that the use of the internet in collections will take-off in the
                                                                    total. The agents are paid a commission on successful
future       and       fundamentally          change        the
                                                                    cases. Most of the agents use a field force for doorstep
economics/approaches to collection. Behavioural scoring is
                                                                    collection.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                        111
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                                                                    constantly re-appraising scoring methodologies for account
                                                                    applications, fraud and collections in the context of their
In summary, "each of the style and methods used within the
                                                                    developing systems. Scoring is currently used for
collection process are different and unique, and are very
                                                                    application processing, authorisations, collection scoring,
deliberate in terms of attempting to convince the debtor
                                                                    behavioural scoring and recently a propensity to repay
that due to their continued non-payment, their situation is
                                                                    score has been developed.
becoming more serious".



                                                                    There has been an increased emphasis on the customer
The Company does not sell debt and rarely uses litigation
                                                                    assistance element of customer management. Customers
as a recovery option. Litigation is used very selectively and
                                                                    going into arrears are kept within the CRM system and
judgements are enforced by attachments of earnings,
                                                                    staff attempt to negotiate and manage 'solutions' with the
charging orders and warrants of execution.
                                                                    customer. This is aimed a rehabilitation and gradual
                                                                    progression into good payment habits. The emphasis in
4.7.2. Case B: Credit Card Provider                                 recent years has switched to a ‘US style’ of collection
                                                                    where staff are incentivised to ‘collect cash’ and league

Company B, a major financial services organisation which            tables of collections performance are produced, monitored

has over 10 million and runs a centralised collections              and bonuses allocated on the basis of collections. Staff can

facility which also handles accounts which have exceeded            receive bonuses up to £9,000 per annum on the basis of

their credit limits and looks at accounts in these areas for        cash targets and ‘promises kept’. CRM staff are trained to

signs of fraud. The department has its own 'in-house'               recognise that delinquency may only be temporary and that

collection agent that trades under a different name from the        customers should be retained in the CRM system if at all

bank and uses external agents for collection. They have             possible. Passing the debtor to collections usually marks

recently rationalised their use of agents to 6 'best in class'      the end of the customer relationship. Thus the focus of

collection agents. At any point in time approximately 1.8           CRM is to understand the reasons that an account is out of

million accounts will be delinquent (overdue by at least 1          order and implement a strategy to return the account to

day).                                                               order. Different strategies are adopted with the debtor
                                                                    based on behavioural scores and age and size of debt.


The company has recently replaced their computer systems
with a new system jointly developed with a commercial               CRM staff have a tool-box of solutions; defer payment, re-

partner, this is a 'customer service' system rather than a          age the account, establish a repayment programme, change

collection system. The Company has also implemented                 credit limits. The process could keep the account in the

Fair, Isaac's TRIAD. TRIAD is used predominantly as a               CRM system for 6 months before collection activity is

customer relations management tool rather than a                    implemented. Work is being undertaken to develop an

collections tool. They have introduced software for late            intelligent agent that automatically suggests the 'best'

collections (’Debt Manager’). The Company develop,                  solution for a customer. The company use segmentation

research and implement scoring methodologies and are                and champion challenger strategies in CRM management.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                         112
Credit and Debt Management – 2008 Survey




Major trends in the last 3 years have been (1) focus on             reports. Reports such as profit & loss accounts versus
gaining contact early (2) increasing contact rate through           budgets can be viewed at different levels (e.g. cost centre,
accurate phone number, mobiles (3) use of text messaging            nominal account) allowing the user to go to the level of
to ask the customer to phone in (4) more resource put into          detail they need on a particular query. The MIS department
collection activity (i.e. staff). (5) an emphasis of evaluating     has developed desktop macros to perform routine tasks.
actions versus recovery and researching the optimum                 This has led to a significant reduction in the number of
‘timing’ of actions. (6) taking a harder stance with debt           staff needed for routine work.
management organisations in negotiating repayment terms.


                                                                    Collection is split into two main sections; customer
The company currently uses a collections management                 assistance (Credit) and late collections (internal debt
package to control the collection process, an in-house              collection agency). Supporting the activity is a Business
system for the Recovery section and a litigation package            Improvement team that provide management information,
(Debt Manager). The litigation package will take care of            implement and test new strategies. Problem accounts are
standard paperwork such as the issuing of warrants,                 now detected much earlier that a few years ago and
thereby leaving the collectors free to deal with exceptions.        solutions put in place. After 4 collection cycles the account
The objective of collections is 'to collect out as much as          will be passed straight into the internal collection agents
cheaply as possible'. There is almost no use of litigation          processes.
with a preference now for 'debt surveillance' the use of
agents and 'debt sale'.
                                                                    The Power Dialling section usually makes the first
                                                                    attempts to contact the customer in the early stages of
A power dialler is used for outgoing calls and a telephone          arrears, although it is also being used in mid range arrears,
management system is used for incoming calls. This                  tracing gone-aways and providing "welcome calls" to new
system provides on line statistics on productivity. Queues          account holders. Operators work part time on 4 hour shifts
are managed by scoring systems.                                     with break time allowed. Working the power-dialler is seen
                                                                    as an intensive job that cannot be maintained for long
                                                                    periods. The working mode also fits well with the pattern
The company has made significant investments in the MIS
                                                                    of hit rates for call connection. The aim at this stage in
system i.e. 'we have invested heavily in measurement'. The
                                                                    collections is to manage the customer not the debt.
key to success is regarded as measurement, learning and
                                                                    Customers are now encouraged to 'phone-in' using a free-
knowledge. Solutions versus outcomes are monitored and
                                                                    phone number to discuss arrears positions.
reported on. Performance drivers are identified and
monitored The monitoring of champion challenger
strategies has become more sophisticated. The front end to          The section does make use of agency staff and recognises
the reporting system is customised, offering department             that with permanent staff there is a balance to be found
specific options. Managers can view budgets, actual profit          between the quality of staff and the length of time they are
& loss figures, productivity, staffing reports and exception        likely to stay with the job. New staff are given a 12 week




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                        113
Credit and Debt Management – 2008 Survey




training course followed by ongoing training sitting with           this section, although the supervisors can monitor collector
an experienced collector and training in the collection             performance through the MIS system. One aim here is to
system. The section has supervisors and floor walkers who           get the accountholder to see the Company as the preferred
are able to provide assistance with lengthy or difficult calls,     creditor, i.e. the one they will pay first. Some
although there has been a trend towards a lower number of           accountholders pay cards bills first in any case, so that they
supervisor referrals over time.                                     can retain their credit card. A main aim here is to limit the
                                                                    loss to the business, either assisting cardholders in keeping
                                                                    to a repayment plan perhaps by reducing or stopping
Outbound power dialling is usually done in the evenings
                                                                    interest, or if a repayment plan cannot be achieved, to
between 6 and 9 and on Saturday mornings. Daytime calls
                                                                    decide the most effective method of recovery.
are made using the account holders work number and
evening calls using the home number. On being connected
operators are given an initial screen of account information        A new member of staff will be learning the role over a
which includes the last two actions taken with the account,         period of up to 6 months, although the exact time is
and the operator can bring up other information including a         dependent on the individual collector.
full diary of contact as necessary, solutions and promises.
Emphasis is being placed on collecting data on customers
                                                                    Collectors use TRIAD for champion/challenger strategy
through this process and providing assistance staff with a
                                                                    trials.
'customer-level' view.



                                                                    Once an account has reached a position where solutions are
Although the Power Dialling section try different strategies
                                                                    not being kept it will move into the in-house debt
on calls, the current system gives them no way to track the
                                                                    collection agency, although the route taken by an
results of their strategies automatically. The new systems
                                                                    individual account depends on the collector's judgement.
being implemented have improved this situation so that
                                                                    The 'in-house' agency is a wholly owned subsidiary with its
actions and responses can be tracked.
                                                                    own registered company name. The use of the agency,
                                                                    giving the impression to the customer of external
The focus of customer assistance is managing the customer           involvement in the debt collection process, is seen as being
not the asset. Customers are segmented according to the             extremely effective. The company also use 6 external
type and age of arrears and approached with different               agents and benchmark their performance against the in-
strategies based on 'balance and behaviour score'.                  house agent. Debts are allocated outside on the basis of
Behaviour types are also treated differently in the 'contact-       recent performance. Monthly performance statistics are
pay' environment.                                                   monitored closely.



Interpersonal skills are a key competency in this area, as          The Company is looking to use debt sale more in the future
staff need to negotiate with the account holder. The                on earlier stage delinquencies.
emphasis is mainly on individual collector judgement in




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                         114
Credit and Debt Management – 2008 Survey




4.7.3. Case C: Large Volume Lender-                                      A number of computerised systems are used to manage the
       Retail Card, Personal Loans
                                                                         accounts from application time through to collections, as
                                                                         illustrated below. The system is highly automated to deal
Company C offer three types of product; a retail                         with high volumes of accounts with automated inbound
chargecard, unsecured personal loans and a reserve                       procedures and predictive dialer outbound.
account. The average delinquent balance of a personal loan
account (£6,500) is significantly higher than those on card
accounts (£800) and this can influence the strategy for                  Company C use packaged systems supplied by Experian (a

dealing with arrears in the different account types. The                 major credit reference agency). An application processing

company deals with around 2.5 million active accounts and                system is used to process applications for credit with

has over 50 million account records. Like many retail cards              accepted applications being passed to the account

the company find that customers use this as a last resort                management system. The account management system

borrowing facility and delinquency has risen. However,                   monitors for various types of delinquency, including going

recover income as a percentage of arrears has grown in                   into arrears and cardholders exceeding their credit limit.

recent years as a result of restructuring collection processes           Behavioural scores are produced for accounts on a regular

and strategies. The approach has become more aggressive                  basis, and these are used in areas such as setting of shadow

in timing and collection effort in early stage delinquency.              limits (the maximum credit limit an account would be

Accounts are charged off into collection/recovery after 90               allowed), processing credit limit changes and deciding

days arrears.                                                            strategies for dealing with arrears.




                              Chart 4.7.3.1 – Computer Systems Used from Application to Collection



                                         AUTOSCORE
                                         - A p p lic a tio n
                                           P r o c e s s in g


                                             CARDPAC                               T R IA D
                                             - Account                             - B e h a v io u r a l
                                               M anagem ent                          s c o rin g /s tr a te g y



                                                  O L C (O n lin e C o lle c tio n s )
                                                  - C o lle c tio n s
                                                    M anagem ent




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                            115
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The behavioural score classifies the risk associated with           The aim throughout the collection process is to establish
the account as high, medium or low. Company C a                     contact with the account holder and make arrangements for
behavioural scoring and strategy package to control the             payment. Initial contact is initiated 5-10 days after a
decision making processes in account management and                 payment has been missed preferably by phone, or if this is
collections. The company subscribes both good and bad               not possible, by letter. The next statement will also carry
account information to a closed user group at a credit              an arrears message if payment has not been received. If
reference agency, so account information from other                 there is no response to these measures a stronger letter is
lenders is available to their decision systems.                     sent. If an account progresses to 2 or more payments in
                                                                    arrears it will be considered for charge-off or debt
                                                                    recovery.
If an accountholder misses a payment the collections
system is activated and an indicator on the account is set to
reflect its arrears status. This indicator, together with others    The telephone/letter cycle will only continue for 60 days
indicating for example an over limit situation are used in          and then an in-house solicitor will send a letter; a notice of
deciding whether to include the account in the stop list sent       default will be issued after 75 days and the account
to stores. Many of the accounts in this early stage of arrears      charged-off for recovery after 90 days. After 30 days
will make a payment to resolve their arrears without further        overdue a late payment charge of £15 is added to the
action; they may be account holders who have gone on                account. This action has been perceived as having a very
holiday and forgotten to pay their bill first, for example.         positive effect on collections.
Accounts which regularly pay late will be moving in and
out of arrears as they go through a monthly cycle. At this
                                                                    Company C differ from the other collections departments
stage there is a high proportion of debt rescheduling. The
                                                                    documented above in that they are more a marketing tool
collections system interfaces with the strategy management
                                                                    to the firms retail business whereas for the other firms
system to decide on how to progress an account through
                                                                    financial services are their main business. This has
collections.
                                                                    implications for the way in which they handle arrears and
                                                                    payment in general. For example, Company C will
Accounts in arrears are classified by risk or a ‘propensity         encourage customers to use Direct Debit for either full or
to pay score’ and placed into queues for contact with each          minimum payment, offering a reduced interest rate to those
queue containing accounts with similar characteristics e.g.         who do. This is not a profit maximising strategy for card
high risk accounts with low balances. There can be up to            products generally as the provider earns interest on any
200 different queues, with accounts put forward for action          balance not paid off each month so full payment would not
from each on a review date basis. Accounts are                      be encouraged.
automatically moved to a different queue as a result of
customer contacts, so that they are in the correct queue for
their next scheduled contact. The behavioural score and
account balance are key in prioritizing actions.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                         116
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As elsewhere there is an emphasis on customer care, but             A new recruit to the department is first given a two week
this seems to be strengthened further by the marketing              induction to the company as a whole, followed by a period
orientation; the aim is always to rehabilitate. The Debt            of up to five weeks structured training under the guidance
Management department deal with Citizens Advice                     of a more experienced mentor. The exact length of the
Bureaux, who offer advice to their customer and submit a            training period is determined by the recruit’s abilities.
payment plan to Company C, and also with CCCS, an
organisation offering professional financial advice and debt
                                                                    The telephone team deal with incoming calls and will work
counselling with a fee to the creditor of 15% of the debt.
                                                                    the outgoing contact queues between calls. It is normal
Financial difficulties account for 25-30% of Company C’s
                                                                    policy to try telephone contact first, but if this has not been
debts. In these cases account holders are offered a lower
                                                                    successful after 3 days then letters are used. The evening
payment or interest is suppressed, with a review of the
                                                                    shift also work primarily on telephone contact.
situation taking place after 3 months. At that point if there
still a possibility of improvement the account will be
scheduled for review after a further 3 months. If there is no
                                                                    Company C have a power dialler which is used in
sign of improvement the debt is passed to debt recovery.
                                                                    telephone contacts. The dialler will work a selection of
Contrary to experience elsewhere Company C did not find
                                                                    queues generated by the collection system. Operators are
the setting up of an in-house debt recovery company with a
                                                                    aware of the type of queue being processed so that they can
separate identity effective so debt recovery is done through
                                                                    be prepared for a particular type of call, and the operator
outside companies.
                                                                    will not be given a mixture of calls from widely different
                                                                    queues mixed together. This is helpful in that the operator
                                                                    is not having to make dynamic changes of tactic for each
The department consists of 67 staff in Early/Mid
                                                                    call, thus increasing effectiveness.
Collections and 19 in Debt Management and Recovery. All
charged-off debt (90+ days) is passed to external DCA’s.
Company C is moving towards a more flattened                                                                                     nd
                                                                    The Company use 6         DCA’s 2 of which are for 2
management structure and away from ‘specialist teams’.
                                                                    placement. In addition they use 2 trace and collect
                                                                    agencies. Performance measurement is undertaken and
                                                                    benchmarking. The external DCA’s may manage some of
The departmental      manager gets      a report on      the
                                                                    the ATPs which have been set up internally. The Company
performance of the company and communicates news on
                                                                    sells written-off debt including ‘goneaways’ and IVA’s.
the business as a whole and on local issues to the staff via
monthly team briefings. The computer systems provide
information on the status of each processing queue and the
activities of each team to enable the manager to identify
bottlenecks and adjust things accordingly. Staff are
encouraged to make suggestions for improving the
department through a formal suggestion scheme.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                             117
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Q: What techniques do you use to develop score-cards?               replace it and a new Challenger is introduced in an iterative
                                                                    way.
A: We use a number of techniques in developing
scorecards. The main one is traditional regression analysis
and most of our scorecards have been developed using this
                                                                    This function is also available in Strategy Manager during
technique either by ourselves or by third parties such as
                                                                    application processing and we plan to use it to challenge
Experian. We also use neural networks (e.g. for fraud
                                                                    whether our policy rules are effective by taking on
detection). In the past we have experimented with genetic
                                                                    controlled samples of accounts who would normally fail
algorithms as a methodology.
                                                                    some criterion and monitor their performance.



Q: What types of score are used, how many different
                                                                    Q: What type of monitoring do you do?
scores are there, what outcome is modelled?
                                                                    A: Standard reports from TRIAD showing recovery
A: We have application scores to predict the likelihood of
                                                                    income and numbers of accounts at each stage of
someone becoming 'bad' (30 days in arrears). We have
                                                                    delinquency. We also use roll rates to show movements
behavioural scores which are used in collections to predict
                                                                    between delinquency stages. We have performance data on
the likelihood of someone becoming delinquent or
                                                                    all customers showing all application details and scores
‘propensity to pay’. These are used in segmenting cases for
                                                                    and their actual outcome.
different action sets. At 60 DPD we have a propensity to
pay scorecard that predicts the likelihood of someone
paying their arrears again. The scores are used for                 4.7.4. Case D: International Bank –
                                                                           Collections and Recovery
segmenting for different actions.

                                                                    Company D represents the collection activity for 4 banks

Q:   Do    you   use   Strategy     Management/Champion-            under its ownership in the UK. The collections operation

Challenger approaches?                                              deals with unsecured finance: personal loans, current
                                                                    accounts, credit cards. Outstanding balances on these
A: 'Strategy Manager' is used in application processing and
                                                                    products are typically £6000 for loans, £500 on current
is our main decision manager incorporating the application
                                                                    accounts, £1700 on credit cards. The collections operation
scorecards and our overriding policy rules (e.g. decline for
                                                                    deals with 180,000+ accounts per annum.
CCJs).


                                                                    Delinquent accounts arrive in collections at various stages
Champion-challenger is currently used in our collections
                                                                    of delinquency depending on the product. Loan accounts
environment (TRIAD) to select a random percentage of
                                                                    will be dealt with when they reach 5 days past due; current
accounts for different action sets. The outcome of these
                                                                    accounts 30-45 days depending on a behavioural risk
different actions are then monitored and compared to the
                                                                    score; credit cards 2 days past due or according to risk
Champion (e.g. increased recovery income, more accounts
                                                                    score. Scores are determined at the bank level and the
rehabilitated) and if they are better than the Champion they




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                        118
Credit and Debt Management – 2008 Survey




TRIAD system is used to set strategies and champion-                poor information will be passed to external DCA’s. The
challenger test. The collection system uses Debt Manager.           success rate on litigation is 2-3% of balances recovered.



The collection team have a power dialler, case/diary                The department uses 8 external DCA’s, 6 deal with trace
system, online CRA data, ability to take payments by                and collect. The bank sells debt to 4 debt buyers. The debt
switch and can negotiate ATPs. Initially the department             is allocated randomly to DCA’s but in future the
contacts and tries to collect under the banks name and uses         department will allocate on the basis of DCA performance.
phone/letter cycles. Debts are segmented by risk and value          At the moment there is no integration of information
to determine actions. Higher risk accounts will receive up          systems with the DCA’s. Commission rates are 20-25% for
                                                                     st                         nd
to 3 calls in a short time period. The collection operation         1 placed debt and 35% for 2 placed debt. After 270
recently reviewed its strategy and has taken a more                 days the debt will be withdrawn if the DCA has been
aggressive stance. This was in response to a number of              unsuccessful. Increasingly the department is selling debt at
perceived trends: customers are not longer worried about            2-3p in the £.
indebtedness, there is less stigma, they use fee paying
counsellors   more    frequently,   average   balances    are
                                                                    There are 120 FTE’s working on inbound and outbound
increasing month on month, IVA’s and bankruptcy is
                                                                    telephone collections. The internal DCA has 20 FTE’s; 15
increasing,   instalment     payments   offered   by     debt
                                                                    staff work ‘specialist collections’ ; 8 work on tracing, 8 on
management companies are too small.
                                                                    fraud and 20 in litigation. A team of 6 manage external
                                                                    DCA’s and debt management organisations. Staff are
After 60-90 days a default notice is issued if there have           trained for 6 months in policies, procedures, negotiation
been no payments. This is dealt with by an in-house                 both on the job and in class. The staff have cash collection
solicitor under the solicitors’ name. ATP’s may be                  targets, and are monitored on promises and talk time.
negotiated at this stage. At 135-140 days the debt will be
passed to the first internal DCA. The system is highly
                                                                    The department is looking at activity-based costing,
automated with little human intervention with automated
                                                                    producing    a   ‘customer-level’    view,    and    process
strategies. Write-off occurs at 180 days so this period 140-
                                                                    benchmarking.
180 represents an attempt to gain an arrangement and
rehabilitate the customer.



The department has an in-house litigation team and around
6,700 accounts per month move into litigation. The
litigation team are charged with gathering information on
assets and income in order to ascertain if the account is
worth taking to court for recovery. Accounts where there is




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                         119
Credit and Debt Management – 2008 Survey



4.7.5. Debt Management and Collection in                            The purpose of the Utilities Benchmarking Forum was to
       the Utilities Sector
                                                                    define and measure a series of comparable Key
                                                                    Performance Indicators covering debt management issues
This section draws on information from a number of                  in the utilities sector; to identify and share best practices;
sources. The CMRC has run benchmarking groups from                  and to identify and quantify drivers of performance
major companies supplying gas, water and electricity                improvement. The Forum collected and compared detailed
which has generated data on the billing, collection and             data on all aspects of debt management which was
cycles. Information on practices and processes supporting           subjected to some sophisticated statistical analysis of the
collection and recovery were shared by the group. More              data.
detailed interviews were conducted with companies in the
water industry. These case studies are reported along with
a synthesis of ‘best practice’.                                     The data sets were split by household/consumer supply and
                                                                    business/commercial supply. This analysis in this section of
                                                                    the report focuses on household supply. The detailed
The Utilities sector by definition have large volumes of            questionnaire was organised in terms of activity under the
customer accounts and debts to manage in that all                   main headings of: customer acquisition; customer billing;
households and businesses utilize their services. The               live account management; final account management; cost
process generally follows that charted below ; metering,            effectiveness; and results. The results section measures bad
billing, collections and recovery. The vast amounts of data         debt/sales; days sales outstanding, aged debt profiles,
and information generated at each stage suggests that there         customer retention/attrition.
is much scope for using data analytics and automated
processes to support debt management.


                             Chart 4.7.5.1 – Entire Billing Process (Source SAP Business Intelligence)




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                         120
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Although the forum collected and compared data on a large             Multivariate statistical analysis was been undertaken to
number of dimensions of the debt management operations                examine the patterns of variation in key variables such as
the following key performance indicators provided much                the bad debt ratio, using techniques such as multiple
focus of attention:                                                   regression analysis. The purpose of this analysis is to
                                                                      determine what factors drive the differences in bad debt
    •    days sales outstanding
                                                                      levels between services, over time and in relation to debt
    •    bad debt as a percentage of sales                            management practices and customer-base characteristics.

    •    age of debt profile                                          For instance, we are able to model the bad debt ratio taking
                                                                      into account the simultaneous effect of many determining
    •    tracing results on "gone away" customers
                                                                      characteristics.
    •    number of "gone aways"

    •    contact calls per hour                                       A model of the factors impacting on debt levels i.e. debtor

    •    percentage of outbound calls on power-dialler                days; aged debt profile; levels of uncollectible and bad
                                                                      debt; write-off - was developed to guide statistical analysis
    •    percentage of customers on direct debit
                                                                      and good practice. This is summarised in the chart below:
    •    percentage of customers with known phone
         number

    •    percentage of accounts with held bills.



                                     Chart 4.7.5.2 – Factors Impacting on Debt in the Utilities Sector



                                   Factors Impacting on Debt in the Utilities Sector
                                  Customer Type                   Billing Cycle
                                  Employment Stability            Accurate ‘Read’ 
                                  Income Stability                Accurate Billing (Customer Details; Usage/Tariff)
                                  Deprivation/Geo‐demographics    ‘Clean’ Bill
                                  Customer Risk /Debt Profile     Timely Billing
                                  Marital Status                  Dispute Resolution
                                  Property Type
                                                                  Payment Arrangement
                                  Customer Mobility               Payment tailored to risk
                                  Change of Supplier              Payment tailored to income (available £’s)
                                  Change of Address               Deposits arranged according to risk
                                  Change of Region                Convenient payment methods
                                  Change in Circumstances         Maximise cash‐flow (NPV)

                                  Customer Knowledge              Customer Contact
                                  Accurate Address                Collections strategy
                                  Accurate Phone Numbers          Contact ‘Success’ rate
                                  Name of Bill Payer              Call effectiveness
                                  Head of Household               Solutions negotiated/ATP
                                  Household Occupants             Dispute resolution
                                  Property Tenure                 Promises kept
                                  Service Usage                   Cash Collected
                                  Change in Usage                 Outsource decision
                                  Acorn Code/Geo‐demographics




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                          121
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Each of these factors is thought to impact on the customer          Accurate billing will have a bearing on debt profile since
debt profile. Some of these factors relate to management            an accurate bill will be subject to fewer disputes and
practices and the efficiency of the collections processes;          queries which delay the collection process. Bills which
others relate to the ‘nature’ of the customer-base and the          relay on meter readings may be held up and queried if an
company’s ability to gather and maintain intelligence on            accurate meter reading has not taken place. Bills may be
the customer. Often the former (collection efficiency) can          estimated and/or be based on an inaccurate reading. The
be ‘constrained’ by the latter (poor customer information).         proportion of estimated bills or the proportion of customers
Clearly much of credit management and collection activity           yet to have a meter reading will impact on the debt profile
is dependent on having a good customer relationship                 of the customer-base. Where there are disputes the more
management data-base. Of vital importance is accurate               quickly that they are settled the more quickly revenues can
‘customer information’ that is details of the person charged        be collected. The aim is to collect due revenues at the first
with paying the bill at the address and accurate contact            billing and therefore maximise cash flow and minimise
details i.e. address, phone number, mobile number, work             collections costs.
phone number, email address etc. This activity, of course,
involves tracking changes in occupancy and movements of
                                                                    Employment, income and property information, as
indebted customers. Activity is geared to attempting to
                                                                    suggested above, will be useful in gearing payment method
minimise the proportion of the customer-base that is ‘gone
                                                                    to customer type and ascertaining whether security or a
away’ or ‘unknown’ and verifying properties that are
                                                                    deposit should be requested. The task is to ease the
‘vacant’ or ‘unoccupied’. Gas and Electricity customers
                                                                    payment for the customer where appropriate and/or make
can change supplier at the same address whereas water
                                                                    payment as convenient as possible to avoid arrears and
customers only change supplier by moving into another
                                                                    delinquency. For some utilities this may involve using a
supplier region. Knowledge of the customer’s employment
                                                                    pre-payment meter or usage on a ‘pay as you go’ basis.
status, income and assets (i.e. property owner) is important
                                                                    Clearly water companies, who have an un-metered
for both tracking changes in customer circumstances and
                                                                    customer-base, predominantly, do not have this option.
tailoring payment methods and tariffs to customer risk
(available £’s) and, of course tailoring the payment method
to suit the customer’s circumstance. Service suppliers
should attempt to maximise the present value of cash-
flows. For instance, if a bill is due for payment in total at a
particular point in time then it should if possible be
collected at that time. Arrangements to pay over a longer
period (budget accounts, monthly direct debit) effectively
reduce the NPV of revenues.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                        122
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Collections activity, should an account become overdue,             Common elements of ‘best practice’ as perceived by US
depends on having customer information and accurate                 practitioners can be summarised as follows: Collection and
billing/usage information. Customer information should              ‘revenue recovery’ activities are regarded as central to the
guide the collections approach and billing information will         success of Utility Company performance and are organised
facilitate the resolution of disputes. Collections activity         around clear and simple ‘mission statements’ which all
should involve ‘informed’ and ‘prompt’ action after the             employees are aware of and focused on. Mission
initial sequence of billing and reminder. Early contact via         statements tend to be ‘customer focussed’ which recognise
phone will establish the customer’s ‘problem’ with                  that effective collections and low write-offs ultimately can
payment, resolve any dispute or payment method problems             lower prices for the customer-base. As one utility
and ‘collect’ immediately or establish a promise to pay.            remarked, “we want to minimise the percent of accounts
More sophisticated operations will prioritise collections           overdue, we aren’t doing customers a justice by letting
actions or letter/phone sequences based on risk scores and          them get so far behind”
account balances. Debt progression will be based on
risk/behaviour profiles in order to minimise collection
                                                                    An example of the key elements of such a mission
costs. The collections performance will be a function of the
                                                                    statement was: “to keep rates low for customers and
accuracy of customer contact details and current phone
                                                                    improve    net   income    by   –   minimising     write-offs;
numbers. Decisions on later stage debt progression i.e.
                                                                    maintaining a safe, cost-effective operation; ensuring that
outsourcing to DCA’s or legal action should be based on
                                                                    every customer pays for the service that they use”
cost-recovery probabilities.



4.7.6. Best Practice in Collections and                             The idea is that all actions are aligned to ‘corporate goals’.
       Recovery: Evidence from US                                   An individual employee is encouraged to understand how
       Utilities
                                                                    their own work ‘fits’ or contributes to overall goals


Interviews were undertaken with members of the
                                                                    Best practice involves ensuring effective policies and
International Utility Group, a group of US Utility
                                                                    processes throughout the life-cycle on the customer – from
Companies offering combined services, gas, electricity and
                                                                    customer recruitment through to debt recovery. At all
water. A follow up interview was conducted with the credit
                                                                    stages of the life cycle the customer’s risk has to be
and collections managers of a US Water Company. The
                                                                    assessed, measured and monitored. Risk assessment is not
purpose of this series of interviews was to document
                                                                    a ‘one-off’ activity but is undertaken at the ‘front-end,
current collections and recovery practices in the US
                                                                    middle and back-end’. Clearly such risk assessment
Utilities, assess and document perceptions of ‘best
                                                                    requires a considerable customer intelligence data-bank
practice’ and analyse current collections performance and
                                                                    that can be analysed where relationships between risk and
trends in the key performance indicators used for
                                                                    payment can be understood and modelled and ‘behaviour’
benchmarking.
                                                                    scores implemented.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                         123
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The life-cycle can be categorised as:                                   There may be several alternatives in relation to the amount
                                                                        and conditions of the deposit e.g. advance payments,
(1) ‘front-end’ that deals with new or returning customers
                                                                        deposit in instalments. For instance a customer may be
applying for the service. The processes involved in setting
                                                                        required to pay a deposit if (a) they have filed for
up a new account involve positively identifying the
                                                                        bankruptcy (b) there is a possibility of default on payment
customer, risk scoring the customer using a credit bureau
                                                                        in the future (c) an existing customer has moved into
application score and analysing the risk history of the
                                                                        delinquency (d) the account has been back-billed for usage
premises being supplied. There may be amounts owing
                                                                        because of theft (e) the customer has an unpaid bill from
from the customer of ‘premises’ that would be settled
                                                                        previous service (f) the customer only wants the service for
before a new account is established. In the latter case,
                                                                        a short period. Typically deposits are calculated as 2
depending on the circumstances, the owed bill might be
                                                                        months usage.
settled or waived prior to connection of supply. Based on
risk scores the new account may be set up only after a
deposit is made.



                                        Chart 4.7.6.1 – Revenue to Recovery – Customer Impact



                                           Revenue Recovery Customer Impact
                                                                                    % of Customers
                                                                                        -100%
                                            Active Accounts
                                         Final Notices Mailed                           - 12%
                                  Accounts For Collection Action
                                    Field -47%             OTC- 53%                     - 6%

                                           Collection Actions
                                        Effective Field   OTC contact                   - 3%
                                        Work – 42%        – 58 %


                                               Disconnects                              - 0.8%

                                                Past Due                                - 0.4%
                                                  Final Bill
                                                   Write-off                            -0.2%




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                           124
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(2)   ‘Middle’    relates   to   account      management   and      million reduction in correspondence, 12% reduction in in-
maintaining customer service. The key to good revenue               bound calls, 59% reduction in disconnections and field
management is accurate and consistent billing, the setting          visits, 25% reduction in delinquency over 30 days and 40%
of payment arrangements appropriate to customer risk and            in delinquency over 60 days, and a 12% reduction in DSO.
circumstances (including additional deposits if required),
and effective collections actions (outbound calls and field
                                                                    Collection actions are evaluated and any ‘loopholes’ in the
actions) first billing, final notices, service charges etc. An
                                                                    processes are identified and dealt with. Of course, the US
example of the collection process is given below with the
                                                                    utilities undertake benchmarking activities in order to
approximate percentage of the customer base which
                                                                    identify variations in performance and to learn to improve
progresses through the account management and collection
                                                                    practices and processes.
process:



                                                                    (3) ‘Close Service’        involves closing the account by
Behavioural scoring underpins account management and
                                                                    providing the customer with a final bill and includes
collection actions. Collection actions include final notices
                                                                    dealing with cases that have filed for bankruptcy. Actions
issued, outbound collection calls and field visits. Other
                                                                    classified as ‘pre-write-off recovery’ will be undertaken
actions that might be implemented as a result of behaviour
                                                                    such as final demand letters, tracing, transferring balances
scores could be requests for additional deposits or
                                                                    to active accounts, the use of external DCA’s, fraud
establishing a payment arrangement with the customer.
                                                                    investigations.
The risk score dictates whether or not to incur the costs of
collection activities. One utility found scoring useful when
evaluating ‘final account’ customers. The behavioural               4.7.7. Key Performance Indicators used in
scoring system generated a ‘final account score’. This                     Debt Management
score was used to make a ‘will pay/won’t pay’ prediction
and assign more resource to the ‘won’t pay’ segment and
                                                                        •    Bad Debt Loss Ratio =
prioritise collection actions.
                                                                        Net Uncollectibles divided by revenue

                                                                        •    Delinquency ratio =
Scoring process and customer data-bases are used to :
improve      applicant      identification;    make    deposit          Total Number of delinquent customers divided by

management more effective; reduce delinquencies; reduce                 active customer-base

the number of disconnections; reduce the costs of                       •    Days Sales Outstanding
collection activities; minimise the number of calls and
                                                                        •    Aged Debt Profile
contacts related to collection activities i.e. make them more
effective; increase the level of customer satisfaction;                 •    Operating Costs per employee
reduce charge-offs/write-offs; calculate reserves more
                                                                        •    Customer Accounts per Credit Employee
accurately. As a result of the implementation of scoring
systems in the collections process one utility claimed a 1.6            •    Average Cost of Collection per Customer




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                       125
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    •    Collections Effectiveness Index =                                                    This guide to good practice in the water sector was derived
                                                                                              from structured interviews and consultation carried out
        ____ ( 1- non current receivables ) * 100______
                                                                                              with representatives from the UK water industry. The
(last month’s total A/R + sales for current month) – current A/R)
                                                                                              purpose of these interviews was to provide a check list of
         the proportion of overdue amounts at the end of                                      feasible/desirable activities, processes and information
         the month relative                to the total amount of                             requirements deemed necessary to implement an effective
         receivables available for collection during the                                      collections operation. Larger operations clearly have the
         month.                                                                               scale economies to implement certain systems and
                                                                                              processes which may not be the case in the smaller supply

4.7.8. Best Practice in Collections and                                                       companies. Later in the report we document the current
       Recovery: The Water Sector                                                             practices of a representative sample of water supply
                                                                                              companies against this check list.

In this section we provide some detailed survey and case
study evidence on credit management practice in the water                                     Case studies from these interviews are reported later in this
sector. First we detail a guide to ‘good practice’                                            report. Detailed questions were asked relating to customer
synthesized from the various interviews and data. We then                                     type and knowledge, billing cycles, payment methods and
evaluate current practice against this checklist.                                             arrangements, customer contact and account management,
                                                                                              collections and recovery and training, technology and
                                                                                              software.


                                                             Chart 4.7.8.1 – A Guide to Good Practice

           
                                                              A Guide to Good Practice
                Customer Type and Knowledge                     Billing Cycle                                  People, Training and Technology
                Characteristics                                 Tariffs and Segmentation                       People
                Name of Payee                                   Ensure tariffs are correct                     Mission statement
                Date of Birth                                   metered/un‐metered                             Training (classroom,on‐the‐job)
                Marital Status                                  household/commercial                           Empowerment and discretion
                Accurate Address                                identify ‘vulnerable’ customers                Qualifications
                Accurate Phone Number(s)                                                                       Specialisation where appropriate
                Previous address                                Billing                                        Targets and incentives where appropriate
                Household Occupants                             Billing clear and understandable
                Property Type
                                                                cater for disadvantaged                        Technology/Software
                Property Tenure
                                                                (e.g. Braille, large print)                    Automation and integration where possible
                Employment Status
                                                                    ‐ clarity of debt progression procedures   Manual intervention
                Homeowner Status
                                                                         for the customer and employees        Optimise flow processes
                Data‐base management                            Timely billing                                 Document processes/procedures
                Acorn/Mosaic/Geo‐demographics                   meter reading to billing efficiency            Data‐base management and ‘scoring’
                Deprivation/Geo‐demographics                                                                   Champion‐challenger facility
                Customer Risk Profile                           Queries and Disputes                           Management Information System
                Changes of contact details                      Accurate and regular meter readings
                Data update and enhancement strategy            Review tariffs applied
                                                                Minimise ‘estimated‘ readings
                Absconder management                             Query and dispute resolution
                Track house moves                               phone in helpline
                Track gone‐away/vacant                          letter answer efficiency
                Identify ‘unknown’, empty property              call‐in (face to face) facility
                In‐house/external tracing capability            segmented contact centre
                Returned bill coding                            employee discretion/empowerment
                Returned bill strategy
                Verify persistent non‐payers in occupation




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                        126
Credit and Debt Management – 2008 Survey




              Payment Methods and Arrangements                          Collections and Recovery
                                                                        Collection
              Payment Methods                                           Chase action 
              Direct Debit Penetration                                      ‐ Speed of response
              Strategies for payment from non‐bank account customers
                                                                            ‐ Reminder Strategy 
              Direct deductions from benefits
                                                                            ‐ Letter Sequence, Clear ‘Instructions’, Clear ‘debt progression’
              Instalment/Budget Account Arrangements
              (weekly/fortnightly/monthly)                                  ‐ Phone/Letter alternatives
              ‘Switch’, ‘over‐the‐phone’ payments                       Powerdialler/Caller linked to account data‐base
              Internet payments                                         Diary/case management system
              Payment tailored to income (available £’s)                Alternative contact methods (Phone/SMS/Personal Visits)
              Deposits arranged according to risk                       Segmented Delinquents
              Convenient payment methods                                Behavioural/Collection Scores
              Charitable trust                                          Prioritisation of actions and sequences
                               in‐house                                 Effective ‘timing’ of actions
                               external                                 Effective sequence and wording of written notices
                               Shared
              Maximise cash‐flow (NPV)
                                                                        Escalation Strategy
                                                                           ‐ Behaviour score – debt progression sequence

                                                                        Litigation
              Customer Contact and Account Management                   Pre‐court action predictive modelling
              Timely response to overdue/queries                        verification of debt
              Phone contact (alternative numbers)                       verification of customer income
              Minicom                                                   verification of customer ‘assets’
              Power‐dialler/Caller linked to account data‐base          Policy on recovering court costs External Debt Collection
              Strategy for ‘engaged’, ‘voicemail’ etc                   Prompt action                      Ensure Code of Practice (CSA membership)
              ‐ Letter strategy                                         Approach to court options          Benchmark DCA panel
              In‐bound customer contact and management                  charges on income                  Access to performance information
              Phone help‐line                                           charges on property                Access to debt ‘outcome’ information
              Document imaging and management system                    Garnishee                          Contractual arrangements
              Account management system                                 Warrants                           Terminated/open debt policy
              Out‐bound calling facility and management                 Oral examination                   Strategy on placement (1st, 2nd, litigation etc)




4.7.8.1. Areas of Disadvantage Specific to Water                                       Contact rates with customers are high. Of course, most
                                                                                       companies providing a product or service can ‘choose their
                                                                                       customers’ i.e. reject high risk customers, price the risk,
There are a number of areas that prevent and/or constrain                              and insist on advance payment and or security/collateral.
water supply companies from adopting the ‘best practice’
model    in    collections      and      recovery.      Sophisticated
collections operations rely on detailed customer level                                 Some key factors in relation to ‘customer information’ and
information to build automated collection systems driven                               ‘early’ collections activities or ‘sanctions’ are not available
by ‘behavioural scoring’ models. Collection activities are                             to the collections operations of water supply companies.
prioritised and varied according to customer risk and                                  Water companies are constrained by regulations governing
balances outstanding. Management information systems                                   the water supply contract and the (sequence of) actions that
facilitate the varying of collection strategies and debt paths                         can be taken in the event of payment default (e.g. ban on
for each customer and the costs-benefits are analysed for                              disconnection). Some investments in collection technology
continual improvement. Collection activities are proactive                             and software may only be feasible for large scale
and intense in early stage arrears (30 days overdue).                                  operations (e.g. the technologies employed by large
                                                                                       volume lenders).




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                           127
Credit and Debt Management – 2008 Survey




These issues are summarised below and will be                          The problem of ‘gone-aways’ can be more pronounced for
documented in our check-list of ‘good practice’ later in the           this sector because the customer feels under no obligation
report:                                                                to inform the supplier when moving property (unlike
                                                                       telephones, gas and electricity where the supplier may
                                                                       move with the customer)
No choice over ‘customer’ (applicant)

Water supply companies are unique in that they have a
                                                                       No customer ‘risk assessment’ on connection or in
commitment to supply every household regardless of risk
                                                                       ‘account management’
or payment behaviour. They cannot credit vet new
customers or retrospectively risk score existing customers.            Lack of a contract and customer level information means
No security deposits can be requested in relation to supply.           that water companies cannot employ ‘risk and behavioural
                                                                       scoring’ methods that are used in most other collection
                                                                       environments to prioritise actions and debt path sequences
No contract with the customer
                                                                       thus minimising collection costs. Behavioural scores
Water companies supply water without having a ‘contract’               require payment behaviour information along with
with the customer. This, amongst other things, means that              customer characteristics information.
they can only gather information about the customer if the
customer volunteers it. Basic information such as name and
address   of   the      customer,      phone   contact    details,
employment     status      etc   are   often   unknown.     Such
information is regarded as essential for most other
‘collection’ operations.




                                        Chart 4.7.8.2 – Number of Customers using Prepayment Meters




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                         128
Credit and Debt Management – 2008 Survey




No pre-payment meter option                                         Behaviour scoring unsophisticated

Gas and Electricity supply companies manage customer                Behavioural scoring requires both frequent payment
risk by installing pre-payment meters for customers with a          behaviour data and basic customer characteristics data (see
history of payment difficulties. This is an option not              above).
available to water supply companies. The growth in the
usage of pre-payment meters is summarised in the chart
                                                                    Champion-Challenger
below:
                                                                    Champion-challenger collection strategies are used by
                                                                    large lenders. Varying collections approaches and the
Minimal      level   of   customer       information   prior   to
                                                                    ability to test new strategies is seen as essential for
‘delinquency’
                                                                    effective collection. Water companies have to adopt a
In most collection environments effort is placed on                 predictable sequence of collections actions (by regulation)
proactive collections. This involves identifying customers          and don’t have the decision support infrastructure to adopt
with payment difficulties and resolving the problem prior           champion-challenger.
to delinquency. Should a customer go into early stage
delinquency (e.g. 1 missed payment) then early efforts to
                                                                    Relatively small outstanding balances
recover arrears are made. Water companies will have
limited information about a customer until the customer             Initially a customer in arrears with water charges will have
has defaulted on a payment. Chasing actions therefore               a relatively small outstanding balance (£300-£400).
takes     place   much    later   than    in   other   collection   Collection actions may not be cost effective.
environments and it is only at this stage that some
customer level data can be gathered.
                                                                    Continuous charging therefore accumulating debt

                                                                    Water charges accumulate year on year and can build into
Infrequent billing/payment behaviour
                                                                    a substantial debt for a customer that has neglected to pay.
Infrequent billing and payment (unless on monthly) makes            The higher and older the debt, the more difficult it is to
it more difficult to assess customer risk and build timely          collect
‘behavioural scores’. Behavioural scoring, as mentioned
earlier really requires data from frequent transactions (e.g.
monthly bills and payments). Water companies do not have            Limited or ineffective ‘early’ sanctions for non-payment

the volume and frequency of information to build effective          Water supply companies have no sanctions to prompt
scores.                                                             payments other than court action. Effective use of the
                                                                    courts requires detailed customer level information on
                                                                    income and assets and may be more cost effective when
                                                                    large volumes of actions are processed.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                       129
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Debt    accumulated     before   effective   action   can   be
                                                                    4.7.9.2 Direct billing and other methods

implemented and/or enforced

By then time a debtor gets to court the debt may have               As can be seen below, the majority of companies bill the

accumulated to a significantly higher level making it more          customer base directly with 9 of the 18 respondents

difficult to collect.                                               indicating that direct billing accounts for 100% of activity.


                                                                                                           Chart 4.7.9.1
4.7.9. Credit and Debt Management
                                                                                                   % of Directly billed customers
       Practice in the Water Industry                                  100
                                                                       90
                                                                       80
                                                                       70
                                                                       60
The data presented in this section is derived from a study         %   50
                                                                       40
carried out on a sample of sixteen water sector companies.             30
                                                                       20
Areas covered included the structure of the debt recovery              10
                                                                        0
department in relation to customer base, timings and




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                                                                                                                                                     ea
                                                                                                                                                      M
                                                                                                                                                     M
                                                                                                                                                    M
effectiveness of debt recovery operations, bill referral,                                                       Respondent ID


county court actions, the use of scoring and customer
profiling, knowledge of the customer base, tracing and              However, when this variable is broke down by size of
outsourcing and the payment options offered (frequency              customer base large companies in the sample average 89%
and methods). The charts below show the responses from              of customers directly billed compared with almost 100%
each individual firm and the high, low and mean figures for         for the small water provider. One large company reports
each variable. Not all companies responded to all questions         that at present, only 57% of their customer-base represent
either because the question was not applicable and/or the           direct billing. This breakdown can be seen in the chart
data was not available. The identities of responding firms          below.
have been made anonymous for the purpose of this section.

                                                                                                           Chart 4.7.9.2
4.7.9.1 General Information
                                                                                                   % of Directly billed customers
                                                                       100
In this section, information was sought from each company               90
                                                                        80
regarding their domestic and commercial customer base                   70
                                                                        60
and the extent to which customers are billed directly versus       %                                                                                         Small
                                                                        50
                                                                        40                                                                                   Large
local authorities or other agents. Information was also                 30
                                                                        20
recorded on the level of staffing in each recovery                      10
                                                                         0
department. For the purposes of analysis the responding                                  Min                        Max                            Mean
                                                                                                             Respondent ID
companies have been divided into two categories, large
companies (turnover in excess of £1 million) and small
companies (turnover less than £1 million).




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                       130
Credit and Debt Management – 2008 Survey




A number of respondents (8) indicated that they bill via their
own local authority with the highest percentage billed using                                                Chart 4.7.9.3
this channel being 14% for one individual company. On
average 4.92% of bills from the larger firms (by customer-                                  % of Customers billed via local authorities

                                                                          16
base) in the sample are via a local authority compared with
                                                                          14
just 0.21% for smaller companies. Clearly the use of LA                   12

                                                                          10
collection would be beneficial for the water sector and reduce        %    8

overall collection costs (i.e. because of duplication) if the right        6
                                                                           4
kind of commercial arrangement could be agreed with the                    2
                                                                           0
LA’s. Currently many water suppliers regard LA collection as




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not being cost effective.                                                                                       Respondent ID




                                                                                                            Chart 4.7.9.4

                                                                                             % of Customers billed via other agents/
Other agents or water companies are also used by 7 of the                                           other water companies
                                                                           35
sample with one company indicating 32% of all billing via                  30

                                                                           25
this method. None of the smaller water companies in the
                                                                           20
                                                                      %
sample currently use agents or water companies to bill their               15

                                                                           10
customer base.
                                                                            5

                                                                            0




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                                                                                                            Chart 4.7.95

                                                                                                    % of Directly billed customers
                                                                          100%
                                                                                                                                                       % o f custo mers
A full summary of the information on billing to each                      90%
                                                                                                                                                       billed via o ther
                                                                          80%                                                                          agents/o ther
                                                                                                                                                       water co mpanies
respondents’ customer base can be seen in the chart to the                70%
                                                                          60%                                                                          % o f custo mers
right. As can be seen to the rightt, the majority of                      50%                                                                          billed via lo cal
                                                                                                                                                       autho rities
                                                                          40%
companies bill the customer base directly with 9 of the 18                30%
                                                                                                                                                       % o f directly billed
                                                                          20%
                                                                                                                                                       custo mers
respondents indicating that direct billing accounts for                   10%
                                                                           0%
100% of activity.                                                                   1   2   3   4   5   6   7   8    9   10 11     12 13 14 15 16
                                                                                                            Respondent ID




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                           131
Credit and Debt Management – 2008 Survey



                                                                                                                        Chart 4.7.9.6
Companies responding to the survey were asked about
their internal collections activities and whether or not they                                              Customer base per staff member
                                                                                60000
have an internal recovery department. All 16 companies
                                                                                50000
indicated that they have an internal debt recovery




                                                                no. customers
                                                                                40000

department. 10 companies stated that they have an internal                      30000

field recovery department and 6 companies indicated that                        20000


they have an internal collection agency. The results of the                     10000

                                                                                   0
ratios of customer base to staff can be seen below.




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                                                                                                                         Chart 4.7.9.7

When the number of staff per 1000 customer is analysed                                                             Staff Per 1,000 Customers
                                                                                   0.1
there is a slight difference between the two samples. Larger
                                                                                  0.08
water companies have 0.04 per members of staff per 1000
                                                                                  0.06
customers and smaller firms have 0.05 members of staff             %
                                                                                  0.04
per 1000 customers. This represents an average of 22,225
                                                                                  0.02
customers per staff member (large firms) and 26,415
                                                                                       0
customers per staff member (small companies).




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                                                                                                                         Chart 4.7.9.8
The time taken in days for collection of debt along with the
                                                                                                                   Time from bill to 1st notice
% success at each stage is a strong indicator of the                              70

                                                                                  60
effectiveness in collections. As can be seen in the charts
                                                                                  50
below information was gathered on the timing of bills to
                                                                No.days




                                                                                  40

first, second and third notice and the success rate at each                       30

                                                                                  20
stage. On average it takes the water sector 20 days before
                                                                                  10

the first notice is issued. These findings are consistent for                      0
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both sizes of company in the sample (19.75 days – large;
                                                                                                                                                                  M
                                                                                                                                                                 M




                                                                                                                              Respondent ID
19.29 days – small).




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                       132
Credit and Debt Management – 2008 Survey



                                                                                                                                    Chart 4.7.9.9

                                                                                                                        Time from bill to 2nd notice
                                                                           70

Each company in the sample issues a second notice and the                  60

                                                                           50
average number of days it takes to issue is 35 days. Slight




                                                                 No.days
                                                                           40

differences are evident in the timing of the second bill with              30

                                                                           20
an average of 32 days for the smaller and 36 days for larger
                                                                           10

water utilities.                                                           0




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                                                                                                                                    Chart 4.7.9.10

                                                                                                                            Time from bill to 3rd notice
11 of the 16 companies indicated that they issue a third                   70

                                                                           60
notice to late paying customers. The average number of
                                                                           50
days among respondents it takes for the third notice to be       No.days   40

issued is 48 days. Greater differences emerge according to                 30

                               rd                                          20
the size of company at the 3 notice stage. It takes on                     10

average 56 days for the larger companies in the sample to                  0




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bill the third notice compared with just 44 days among the
                                                                                                                                                Respondent ID

smaller sector.



Where firms were able to provide information on the
success rate of billing at each stage the results showed an
average of 57% of bills being paid in the water industry on
first notice. An average of 38% of bills are successfully
paid at second notice and 42% at third notice.

                                                                                                                                        Chart 4.7.9.11
4.7.9.2 Telephone Contact
                                                                                                                            Bill to 1st telephone contact
                                                                           10
                                                                           0
Information was also sought on the time taken between billing               80

and first and second telephone contact with the customer. As                60

can be seen opposite, it takes an average of 58 days for the
                                                                            40

water sector to make telephone contact with the customer after
                                                                            20

the first bill.
                                                                                0
                                                                                    1       2       3       4       5       6       7       8       9    1    11    12    13 14     15   1   Min Ma Mea
                                                                                                                                                         0                               6      x   n
                                                                                                                                                 Respondent ID




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                       133
Credit and Debt Management – 2008 Survey




                                                                                                                                 Chart 4.7.9.12

                                                                                                                         Bill to 2nd telephone contact
                                                                                   100
Large companies take considerably less time to contact the
                                                                                    80
customer by telephone after the first bill (46 days)




                                                                  No. days
                                                                                    60
compared with larger smaller companies (53 days).
                                                                                    40
Telephone contact with the customer is made on average
                                                                                    20
70 days after the bill is first issued.
                                                                                     0




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                                                                                                                                 Chart 4.7.9.13

                                                                                                                     Bill to referral to external agency?
                                                                                   250


The companies were asked the time taken from the bill to                           200



                                                                     No. of days
referral to an external agency. As can be seen below it                            150


takes on average 131 days before referral. Larger                                  100


companies and smaller companies roughly take the same                               50


time in this case.                                                                   0




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                                                                                                                                  Chart 4.7.9.14

                                                                                                                          Bill to country court claims

                                                                                   250

The water utilities were also asked the time taken before a                        200

County Court claim is made.           Where applicable firms
                                                                  No. of days




                                                                                   150

indicated that on average it takes 82 days before a court
                                                                                   100

claim is made.
                                                                                   50


                                                                                    0
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                                                                                                                                 Chart 4.7.9.15

                                                                                                         How many County Court claims did you raise in
                                                                                                                         2002/03?
                                                                                   110000
                                                                                   100000
                                                                                    90000
                                                                                    80000
As can be seen there is a diversity in terms of the number                          70000
                                                                       Number




                                                                                    60000
of court claims made by respondents.                                                50000
                                                                                    40000
                                                                                    30000
                                                                                    20000
                                                                                    10000
                                                                                             0
                                                                                                                                                                                   Min


                                                                                                                                                                                               Mean
                                                                                                                                                                                         Max
                                                                                                     1

                                                                                                             2

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                                                                                                                                                     11

                                                                                                                                                          12

                                                                                                                                                               13

                                                                                                                                                                    14

                                                                                                                                                                         15
                                                                                                                                                                              16




                                                                                                                                          Respondent ID




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                      134
Credit and Debt Management – 2008 Survey



                                                                                                                                   Chart 4.7.9.16

When county court claims are analysed according to customer        3.5
                                                                           3
base there is clearly an increase in claims according to the
                                                                   2.5
customer base size (see below). There may well be scale
                                                                           2
effects that determine the cost effectiveness of court action.
                                                                   1.5
                                                                           1
                                                                   0.5
                                                                           0
                                                                               0                   500,000             1,000,000        1,500,000        2,000,000        2,500,000    3,000,000    3,500,000




                                                                                                                                       Chart 4.7.9.17

4.7.9.2 Enforcement                                                                                                         Number of warrants 2002/03

                                                                               14000

                                                                               12000

9 companies indicated that they enforce a warrant of                           10000



                                                                  Number
                                                                                8000
execution and the chart below shows the number of
                                                                                6000
warrants carried out be each respondent in 2002/2003.                           4000

                                                                                2000

                                                                                       0




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                                                                                                                                       Chart 4.7.9.18

                                                                                                           Number of attachment of earnings 2002/03
10 of the companies responding indicated that they enforce
                                                                               20000
an attachment of earnings on the customer.
                                                                               16000
                                                                  Number




                                                                               12000


                                                                                8000


                                                                                4000


                                                                                       0
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                                                                                                                                       Chart 4.7.9.19

                                                                                                               % of success of attachment of earnings
                                                                               100


                                                                                80


                                                                                60
                                                                  %




                                                                                40


                                                                                20


                                                                                   0
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Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                135
Credit and Debt Management – 2008 Survey



4.7.9.3 Scoring and Customer Profiling                                                                Chart 4.7.9.20

                                                                                     % of customers with known telephone numbers
                                                                       100

7 of the respondents to the survey indicate that they use
                                                                        80

scoring/profiling/customer segmentation as part of their
                                                                        60




                                                                  %
debt recovery process. 9 of the companies provided
                                                                        40

information on the percentage of customers that they hold
                                                                        20

telephone numbers for. On average the sector holds
                                                                         0

telephone numbers for 56% of their customer base.




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4.8.5 Identifying Good Practices in the                               Contact rates with customers are high. Of course, most
       Water Sector                                                   companies providing a product or service can ‘choose their
                                                                      customers’ i.e. reject high risk customers, price the risk,
                                                                      and insist on advance payment and or security/collateral.
In the previous sections of this report we have documented
and analysed the collections and recover practices of
leading edge organisations in the financial services in order
                                                                      The utilities in Gas and Electricity have options to manage
to establish current ‘best practice’. We have shown that the
                                                                      risk by pre-payment meters and, of course, can stop supply
collections and recovery operations of large volume
                                                                      in cases of non-payment thus minimising further losses.
lenders in the consumer credit industry are characterised by
                                                                      These companies supply on a contract basis and therefore
sophisticated    customer-base      information     systems,
                                                                      have a right to customer-level information when setting up
outbound call centres and automated decision-making
                                                                      an account, chasing delinquent payments and tracing
driven by behavioural scoring and constantly varying
                                                                      absconders.
collection/recovery strategies.


                                                                      Adopting all aspects of the ‘best practice’ model is not
These sophisticated collections operations rely on detailed
                                                                      feasible for water sector companies due to regulatory and
customer level information to build automated collection
                                                                      legal constraints and the technological investments that
systems driven by ‘behavioural scoring’ models. Collection
                                                                      require large scale activities. We have highlighted the areas
activities are prioritised and varied according to customer
                                                                      where the water companies are at a disadvantage when
risk and balances outstanding. Management information
                                                                      competing for household repayments generally and in
systems facilitate the varying of collection strategies and
                                                                      relation to the other utilities.
debt paths for each customer and the costs-benefits are
analysed for continual improvement. Collection activities
are proactive and intense in early stage arrears (30 days
overdue).




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                  136
Credit and Debt Management – 2008 Survey




In this section we focus on extant ‘good practice’ in               Case 1 – large volume, out-sourced collection operation
collections and recovery in the utilities sector and
                                                                    This water company operates in a geographical region that
specifically the water sector. The purpose is to distil and
                                                                    has a population of over 7 million. The customer base has
draw up a check-list of good practice relevant to the water
                                                                    2.8 million domestic customers and over 250,000
sector both as a benchmark from which to evaluate current
                                                                    commercial customers. The domestic customer base is
practice and guide future development. We can draw on
                                                                    predominantly     un-metered      (85%),      almost    17000
information from a number of sources. We conducted
                                                                    households are unknown i.e. billed as ‘the occupier’. The
detailed structured interview with the billing and
                                                                    company operate a ‘hardship’ fund for income-deprived
collections departments of a cross section of UK water
                                                                    customers where payments are matched £ for £ by the
companies in order to identify trends and developments in
                                                                    company in order to reduce and manage arrears.
collections and document the key elements of perceived
good practice.
                                                                    The billing and collection aspects of the business is out-
                                                                    sourced and has around 190 employees. Internal to the
4.8.5.1 Case Study Analysis
                                                                    water company is a small ‘revenue strategy’ team of 15
                                                                    people who decide the overall customer strategy and
During a series of detailed interviews were undertaken              policy;   deal   with   regulatory   issues     and    provide
with a cross-section of water supply companies. The                 management information and reports. The out-sourced
interview schedule was based on a combination of the large          operation deals with billing, debt recovery and has an in-
volume    lenders   questionnaire   and   the debt   focus          bound call centre with a further 3-400 staff. The call centre
questionnaire. The sample consisted of a selection of the           deals with routine payment arrangements and customer
largest and smallest water companies and reflected both             service. Staff can take payments over the phone and
rural/urban and north/south. Eight companies were                   actively encourage the setting up of direct debit by offering
interviewed in detail. The case study selection reported            a discount.
below brings out some of the salient features of ‘good
practice’ in water company collection and recovery
operations and highlights efforts made by the water sector          Bills are issued in February and March for payment on the
                                                                     st                     th    th
to emulate ‘best practice’ given current regulatory                 1 April. From the 15 -28 April reminders are issued
constraints. The full selection of detailed interviews are          and the call centre can react to calls about reminders. The
summarised in the check-list of good practice at the end of         customer-base is segmented into ‘poor payers’ and ‘better
this section. Commercial confidentiality precludes the              payers’ based on previous years experience, bad payers
reporting of detailed individual cases.                             being reminded first. After 21-28 days a legal notice is
                                                                    issued through an in-house solicitor. An in-house collection
                                                                    agency can be used for collections at this stage (going
                                                                    under a different name).




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                          137
Credit and Debt Management – 2008 Survey




Few summonses are issued and county court action                    Case 2 – smaller company, outsourced collection
according to the customer characteristics. The company              operation
attempt to segment by council/non-council, rented/owner,
                                                                    This company has close to 500,000 un-metered domestic
acorn classification, previous CCJ history, voters roll
                                                                    customers and 250,000 on meters. Meters can be fitted free
matching and information about the customer’s income and
                                                                    of charge but only 5% of the customer base per year switch
assets. Enforcement is usually by warrant and a small
                                                                    to meters and these tend to be low volume customers.
number of charging orders. The internal DCA has 13 staff.
The DCA receive debts after the legal notice i.e. at 45-60
days delinquency. Summonsing is usually carried out by an           The billing cycle for unmeasured domestic customers is
external DCA. External DCA’s are benchmarked against                documented in the tables below for half-yearly payers and
the internal DCA.                                                   instalment customers. In all there are 140 different
                                                                    payment plans. Approximately, 30% of the customer-base
                                                                    pay by 10 instalments, by direct debit. Although, currently,
Scoring is used but is quite crude and ranks customers
                                                                    no incentives are offered for direct debit. Metered
based on the previous years’ experience. A behaviour score
                                                                    customers have a reading twice annually and usually pay
of 0 to 100 is allocated to customers and can be used to
                                                                    on a budget plan with a fixed sum per month taken on
tailor collection sequences and operate a champion-
                                                                    direct debit.
challenger environment. Serious debtors are managed
through ‘Debt Manager’ software which has strategy and
champion-challenger functionality.



The company periodically try and update customer
information and phone number accuracy. If there is a
change of tenancy the company try and obtain information
basic customer level information. The company have an
out-bound calling strategy pre and post reminder and are
planning to build behavioural scoring into the system to
drive strategy. The company indicated that they ‘lack tools
for collection’ i.e. customer level data. Improvements in
data and data capture would facilitate a more flexible rather
than predictable collection sequence.



Payment methods are as flexible as possible and tailored to
customer income with an active policy of rehabilitating
delinquent customers back into good payment habits.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                        138
Credit and Debt Management – 2008 Survey




Unmeasured Billing and Recovery Cycle


Half-yearly Customers
                                 Min No of days                          Cumulative No days
                                 since previous                           since initial bill
                                      action

Bill                                     0                                          0
Reminder                                 21                                         21
Pre-court claim notice                   14                                         35
Pre-litigation letter1                   14                                         49
Pre-litigation letter2                   6                                          55
Court Claim                              8                                          63
Judgment                                 22                                         85
Post-Judgment letter1                    1                                          86
Post-Judgment letter2                    28                                        114
Enforcement letter1                      14                                        128
Enforcement Action                       14                                        142



Instalment Customers
                                  Min No of days                         Cumulative No days
                                  since previous                           since initial bill
                                      action

Booklet                                   0                                         0
Reminder (1 month arrears)                21                                        21
Pre-court claim and instalment
Cancellation notice                       14                                        35
Pre-litigation letter1                    6                                         41*
Pre-litigation letter2                    6                                         47
Court Claim                               8                                         55
Judgment                                  22                                        85
Post-Judgment letter1                     1                                         86
Post-Judgment letter2                     28                                        114
Enforcement letter1                       14                                        128
Enforcement Action                        14                                        142




Research and analysis by the Credit Management Research Centre, University of Leeds Business School   139
Credit and Debt Management – 2008 Survey




Approximately 74% of the customer-base pay or agree a                           They are involved with tracing and liase with debt
plan on receiving the first bill. After the second reminder                     collection agents. The company use a panel of 3 DCA’s and
20% of the customers either pay or contact customer                             recover debt form previous occupiers with debt. They
service. 4-5% of the customers receive the pre-litigation                       manage some post litigation instalment (repayment) plans.
letter and 7000 cases per year are pursued through the                          The advantage of DCA’s is that they have the technology –
courts. Normally 9-10,000 summonses are issued of which                         power    diallers,    monitoring    systems   and   collection
about 50% progress to judgment. The company have                                software. The company has not the scale of operation to
limited information about the customer to be able to assess                     justify investment in out-bound calling facilities and
whether court action might be worthwhile. Enforcing                             because of a lack of customer-level data.
judgments is a major problem and there are significant
debts that are over 48 months old i.e. ‘hardened debtors’. A
                                                                                Case 3 – large company, in-house operation
range of enforcement actions are tried from warrants to
charging orders to attachment of earnings. However, debt                        This is a large scale operation covering over 3 million
from ‘hardened debtors’ is building and 52% of                                  customers. Almost 3.5 million domestic customers are
outstanding debt is owed by only 15% of the customer-                           directly billed and around 700,000 have meters. The scale
base. The credit management function has 42 full-time                           of the operation in terms of collections and recovery
staff and 2 field staff. The credit management function is                      actions is summarised in the chart below (See chart below).
split into 3 teams (Credit Management, Litigation and
Enforcement, Income protection). The Credit Management
team deal with front-end collections, letter and phone                          The company processes large volumes of court claims and

contact and follow the process through to court action and                      enforcements. Around 3% of the customer-base is dealt

judgement.                                                                      with by 6 local authorities who collect water charges with
                                                                                property rent. Almost 40,000 accounts have unknown
                                                                                occupancy and the company has to attempt to find out
The Litigation and Enforcement team (10 people) apply                           occupier details for the billing and collection process as
available enforcement procedures for debt recovery. The                         well as tracing absconders.
third team (income protection) deal with special cases and
accounts that have fallen through other processes.

                                     Chart 4.8.5.1 – A Large Volumes Collections Operation


                                           Large Volume Collections Operation


                                                    140,000   1m Legal        50,000
                                                    Outbound Notices          Debt Related Visits
                                 2.5m Reminder                      260,000
                                                    Calls made
                                 Notices                            Telemessages
                                                                                                22,000 Attachment
                                                                                                Of Earnings



                                                                 CUSTOMER                     Revenue £ xx m
                                   xx m Bills                    RELATIONS
                                                                                              Bad Debt xx %




                                  3.8m Calls Answered                                     3,500 Charging
                                                                                          Orders Issued
                                                 Instalment        600         95,000
                                                 Cancellations     Commercial  Court Claims
                                                 180,000           Supplies
                                                                   Cut Off for
                                                                   Non Payment




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                     140
Credit and Debt Management – 2008 Survey




The company has a process-driven credit management
operation with specialist teams in different locations across
the supply region. Like most companies the billing and
collection cycle is adjusted to cater for metered and non-
metered, domestic and commercial customers. The
company has a large volume collection operation akin to
other large scale lenders. The salient features are illusrrated
below.
                                                  Chart 4.8.5.2 – A Credit Management Model (1)



                                                                                External Agencies

                                                                            CCA Visits (Field)




                                                          Collection
                              DEBT                         (Comm)                                                       PAYMENT
                                                                                     Litigation            Litigation
                                                      Collection                      Claims              Enforcement
                              DEBT                     (Dom)
                                                                                                                        SECURED


                              Collection


                              Litigation
                              enforcement
                                                                                Predictive Dialler
                              Support
                              Services
                                                                            Payment Processing




                                                        Chart 4.8.5.2 – A Credit Management Model (2)
                           


                                                   PERFORMANCE PLANNING
                                                                                                     STRATEGIC CHANGE




                                                 FRONT OFFICE                 DEBT
                                                   BILLING &                ENQUIRIES
                                                                                                         SERVICES




                                                 OPERATIONAL                CONTACTS
                                                  CONTACTS


                                                  BACK OFFICE             BACK OFFICE
                                                SALES & BILLING             CREDIT
                                                                          MANAGEMENT
                                  FIELD STAFF




                                                CUSTOMER METERING                CREDIT MANAGEMENT

                                                                        SALES

                                                                   COMPLAINTS REVIEW TEAM




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                               141
Credit and Debt Management – 2008 Survey




Behavioural Scoring

The company has developed a behavioural scoring system                                                                   It is important to ascertain the profile of the debtor prior to
to flag risky accounts and tailor appropriate action. The                                                                legal action to ensure that the action will be cost effective.
behavioural score, developed in-house, ranks customers on                                                                The profiling includes a behavioural score, the existence of
a 0-99 index according to payment history. The score can                                                                 previous CCJ’s, Acorn profile, deprivation index, home
be used to vary the debt path and the timing of actions                                                                  ownership and rateable value and employment status. A
according to risk so that risky customers are progressed                                                                 team of 40 staff are involved with dealing with the court
more quickly. The score can be used to segment the                                                                       system. The company use all options to enforce successful
customer-base for action on the power-dialler out-bound                                                                  judgements with charges on income or assets being the
calling and could facilitate champion-challenger collection                                                              most preferred. Debt management software is used to
actions backed up by a sophisticates MIS and data-base                                                                   process post-judgement accounts.
management technology and activity-based costing.


                                                                                                                         Case 4 – medium to large company, in-house operation
Litigation
                                                                                                                         This company has a customer base of approximately 1.2
The Company processes large volumes of accounts for                                                                      million accounts and covers both domestic and commercial
court action and litigation, approximately 80,000 per                                                                    accounts. Like the previous case the company has
annum. The company is moving towards a more                                                                              developed, in-house, a risk scoring system that drives and
sophisticated screening process before legal action is taken.                                                            prioritises collections actions.


                                                                  Chart 4.8.5.3 – Recovery Paths and Steps



                                            Recovery Paths and Steps
                                                                    Unmeasured                                                        Metered Multi                                Occupier
                       Unmeasured            Unmeasured                                      Metered
                                                                  Instalments/Multi                               Metered             Instalments/         Closed Accounts         Unknown
                        Domestic             Commercial                                      Domestic
                                                                     Instalments                                 Commercial           Budget Plan



                            UD1                   UC1                    UI1/MI1                MD1                  MC1                    MI/BP1                CA1                  OU1
                      Overdue Account       Payment Demand             Nothing Sent       Overdue Account       Payment Demand           Nothing Sent       Overdue Account          Occupier
                          App 101               App 110                  App 099              App 101               App 110                App 099              App 101            Unknown A/F
                           Day 14                Day 14                   Day 28               Day 21               Day 21                  Day 21               Day 14              App 159



                             UD2                                                                 MD2
                                                   UC2                   UI2/MI2                                       MC2                 MI/BP2                   CA2
                       Notice of Legal                                                      Final demand                                                                                OU2
                                               7 Day Letter         Overdue Inst Plan                              7 Day Letter       Overdue Inst Plan      Solicitors Letter
                            Action                                                             App 102                                                                             Inst. to Disc
                                                 App 092                 App 112                                     App 092               App 112               App 104
                           App 103                                                             Day 42                                                                                App 162
                                                  Day 35                 Day 49                                       Day 42                Day 51                Day 35
                           Day 35



                                                  UC3                                                                 MC3
                                            Audit Report to              UI3/MI3                  MD3           Audit Report to             MI/BP3                   CA3
                              UD3                                                                                                                                                      OU3
                                               assess if           Instalment Arrears     Solicitor'ss Letter      assess if          Instalment Arrears     Solicitor'ss Letter
                      Solicitor'ss Letter                                                                                                                                            Visit DCA
                                            disconnection                App 113                App 114         disconnection               App 113                App 114
                            App 114                                                                                                                                                  App 160
                                               possible                   Day 70                 Day 63            possible                  Day81                  Day 56
                             Day 56
                                                Day 56                                                              Day 52

                                                                                                                                                                       CA4
                                                  UC4                     UI4/MI4                                     MC4                   MI/BP4                   Send to
                                                                                                MD4                                                                                     OU4
                            UD4               Property Visit          Withdrawal of                               Property Visit        Withdrawal of                Trace &
                                                                                              Agency or                                                                            Martin E Visit
                          Agency or              Report              Instalment Plan                                 Report            Instalment Plan               Collect
                                                                                                 Sue                                                                                 App 260
                             Sue                App 093A                 App 107                                    App 093A               App 107                   Agency
                                                                                               Day 84
                           Day 77                Day 58                   Day 91                                     Day 54                Day 111                   Day 77


                                                                                                                                              MI/BP5
                                                    UC5                   UI5/MI5                                       MC5
                                                                                                                                      Account reviewed
                                            Solicitor'ss Letter     Solicitor'ss Letter                         Solicitor'ss Letter
                                                                                                                                        - If no payment,
                                                  App 114                 App 114                                     App 114
                                                                                                                                      re-pathed to MD3/
                                                   Day 79                 Day 112                                      Day 75
                                                                                                                                                MC5



                                                   UC6                   UI6/MI6
                                                                                                                      MC6
                                                Agency or               Agency or
                                                                                                                    Agency or
                                                   Sue                     Sue
                                                                                                                       sue
                                                 Day 100                 Day 133
                                                                                                                     Day 96




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                                                                                 142
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Typical debt paths are reported in Chart Case 4.1. Collections
actions can be varied according to risk so that a different
collection strategy can be adopted in a champion-challenger
type environment. The Company has an in-bound and out-
bound call centre operation and makes out-bound calls usually
in the evening. The collectors chase up payment, are able to
take payment over the phone (Switch), encourage direct debit
take up and/or arrangements to pay. An important aspect of
the work is to ensure that customer contact details are up to
date and as complete as is possible.



The company deal with 6 DCA’s, 2 of which specialise in
trace and collect. The DCA performance is monitored and
benchmarked to ensure continual improvement and to identify
areas where the DCA’s can perform better than in-house
collection/recovery efforts.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School   143
       Credit and Debt Management – 2008 Survey




Good Practice Matrix                                  CHECK LIST CODE:                       Not Present/implemented             =X
                                                                                             Partial/Planned                     =1
                                                                                             Significant/Partially Implemented   =2
                                                                                             Complete/Fully Implemented          =3



                                                                                                                         WATER COMPANIES
                                        Existing
                                        OFWAT              Regulatory
                                       guideline?          constraints                  Scale effects            1   2   3   4    5   6    7   8

Customer Type and Knowledge
                                                    Having no contract with
                                                    the customer limits the
                                                    amount and type of                                           2   2   2   2    2   2    2   2
Name of Payee                              -        customer level data
Date of Birth                              -                                                                     1   1   1   1    1   1    1   1
Marital Status                             -                                                                     1   1   1   1    1   1    1   1
Accurate Address                           -                                                                     2   2   2   2    2   2    2   2
Accurate Phone Number(s)                   -                                                                     2   2   2   2    2   2    2   2
Previous address                           -                                                                     1   1   1   1    1   1    1   1
                                                                                           Partial Information
Household Occupants                        -                                               In all cases          1   1   1   1    1   1    1   1
Property Type                              -                                                                     2   1   2   1    1   2    2   1
Property Tenure                            -                                                                     1   1   2   1    1   1    1   1
Employment Status                          -                                                                     1   1   1   1    1   1    1   1
Homeowner Status                           -                                                                     2   1   2   1    1   2    2   1
Data-base management
Acorn/Mosaic/Geo-demographics            YES        As above                                                     2   1   2   1    1   2    2   1
Deprivation/Geo-demographics             YES                                                                     2   2   2   2    2   2    2   2
                                                    No credit reference          Scoring limited by
Customer Risk Profile                      -        information                  data/information                2   1   2   1    1   2    2   1
                                                    Having no contract means
                                                    that customers do not feel
                                                    obliged to inform of                                         2   2   2   2    2   2    2   2
Changes of contact details                 -        vacation of property
                                                                                 Scale effects- requires
                                                                                 outbound as well as inbound     2   1   2   1    1   2    2   1
Data update and enhancement strategy       -                                     call centre activity




       Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                     144
          Credit and Debt Management – 2008 Survey




Absconder management
                                                                                      Use DCA’s and tracing
                                                                                      agencies – internal and     2   2   2   2   2   2   2   2
Track house moves                                        -                            external
Track gone-away/vacant                                   -                                                        2   2   2   2   2   2   2   2
                                                                  Labour and time-
Identify ‘unknown’, empty property                       -        intensive process   Scale effects               2   1   2   1   1   2   2   2
In-house/external tracing capability                     -                                                        2   1   2   1   1   2   2   2
Returned bill coding                                     -                                                        2   2   2   2   2   2   2   2
Returned bill strategy                                   -                                                        2   2   2   2   2   2   2   2
Verify persistent non-payers in occupation               -                            segmentation                2   1   2   1   1   2   2   2

Billing Cycle
Tariffs and Segmentation
Ensure tariffs are correct                               -                                                        3   3   3   3   3   3   3   3
-      metered/un-metered                                -                                                        3   3   3   3   3   3   3   3
-      household/commercial                              -                                                        3   3   3   3   3   3   3   3
-      identify ‘vulnerable’ customers                   -                                                        2   2   2   2   2   2   2   2
Billing
Billing clear and understandable                        YES                                                       3   3   3   3   3   3   3   3
-        cater for disadvantaged (e.g. Braille, large                                 Large investments in
print)                                                  YES                           billing systems             3   3   3   3   3   3   3   3
-         clarity of debt progression procedures for
customer and employees                                  YES                                                       3   3   3   3   3   3   3   3
Timely billing                                                                                                    3   3   3   2   2   3   3   3
-      meter reading to billing efficiency              YES   Large % unmeasured                                  3   2   3   2   2   3   3   3

Queries and Disputes
Accurate and regular meter readings                      -    Large % unmeasured                                  2   2   2   2   2   2   2   2
Review tariffs applied                                   -                                                        2   2   2   2   2   2   2   2
Minimise ‘estimated‘ readings                            -    Targets for % reads                                 2   2   2   2   2   2   2   2
Query and dispute resolution                                                                                      3   2   3   2   2   2   3   3
                                                                                      Scale effects of document
                                                                                      Imaging and processing      3   3   3   3   3   3   3   3
-      phone in helpline                                 -                            systems
-      letter answer efficiency                          -                                                        3   3   3   3   3   3   3   3
-      call-in (face to face) facility                   -                                                        3   3   3   3   3   3   3   3




          Research and analysis by the Credit Management Research Centre, University of Leeds Business School                                 145
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Collections and Recovery
Collection
Chase action
-      Speed of response                               YES                                      3   3   3    3   3   3   3    3
-       Reminder Strategy                              YES                                      3   3   3    3   3   3   3    3
-       Letter Sequence, Clear ‘Instructions’, Clear
       ‘debt progression’                              YES                                      3   3   3    3   3   3   3    3
-      Phone/Letter alternatives                        -                                       3   2   2    X   X   2   3    X
-       Powerdialler/Caller linked to account data-
       base                                             -                                       2   2   2    X   X   2   3    X
-      Diary/case management system                     -                                       2   2   2    2   2   2   2    2
-     Alternative contact methods
      (Phone/SMS/Personal Visits)                       -                                       2   2   2    2   2   2   2    2
Segmented Delinquents                                                                           2   2   2    1   1   2   2    1
-      Behavioural/Collection Scores                    -                                       2   1   2    1   1   2   2    1
-      Prioritisation of actions and sequences          -    Limited by regulation              2   1   2    1   1   2   2    1
-      Effective ‘timing’ of actions                   YES                                      1   1   1    1   1   1   1    1
-       Effective sequence and wording of written
       notices                                         YES                                      1   1   1    1   1   1   1    1

Escalation Strategy                                     -    Limited by regulation              2   2   2    2   2   2   2    2
-   Behaviour score – debt progression sequence         -                                       2   1   2    1   1   2   2    1

Litigation
                                                             Limited by information
Pre-court action predictive modelling                   -    available                Partial   2   2   2    1   1   2   2    1
-      verification of debt                             -                                       2   2   2    2   2   2   2    2
-      verification of customer income                  -                                       2   2   2    2   2   2   2    2
-      verification of customer ‘assets’                -                                       2   2   2    2   2   2   2    2
Policy on recovering court costs                        -                                       2   2   2    2   2   2   2    2
Prompt action                                           -                                       2   2   2    2   2   2   2    2




       Research and analysis by the Credit Management Research Centre, University of Leeds Business School                   146
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Approach to court options                           -
-      charges on income                            -                                        2    2     2      2   2   2   2    2
-      charges on property                          -                                        2    2     2      2   2   2   2    2
-      Garnishee                                    -                                        2    2     2      2   2   2   2    2
-      Warrants                                     -                                        2    2     2      2   2   2   2    2
-      Oral examination                             -                                        2    2     2      2   2   2   2    2
                                                    -
External Debt Collection
Ensure Code of Practice (CSA membership)           YES                                       3    3     3      3   3   3   3    3
Benchmark DCA panel                                 -                                        2    1     1      1   1   2   2    2
Access to performance information                  YES                                       1    1     1      1   1   1   1    1
Access to debt ‘outcome’ information                -                                        2    2     2      2   2   2   2    2
Contractual arrangements                            -                                        3    3     3      3   3   3   3    3
Terminated/open debt policy                         -                                        X    X     X      X   X   X   X    X
Strategy on placement (1st, 2nd, litigation etc)    -                                        2    2     2      2   2   2   2    2
LOCAL AUTHORITY 1
People and Training, Technology and Software
People
Mission statement                                   -                                        1    1     1      1   1   1   1    1
Training (classroom,on-the-job)                     -                                        2    2     2      1   1   2   2    1
Empowerment and discretion                          -                                        1    1     1      1   1   1   1    1
Qualifications                                      -                                        1    1     1      1   1   1   1    1
Specialisation where appropriate                    -                                        2    2     2      2   1   1   2    1
Targets and incentives where appropriate            -                                        X    X     X      X   X   X   X    X




Technology/Software
Automation and integration where possible           -                                        1    1     1      1   1   1   2    1
Manual intervention                                 -                                        2    2     2      2   2   2   2    2
Optimise flow processes                             -                                        2    2     2      2   2   2   2    2
Document processes/procedures                       -                                        2    2     2      2   2   2   2    2
Data-base management and ‘scoring’                  -                                        2    1     2      1   1   2   2    1
Champion-challenger facility                        -                                        2    2     2      1   1   1   2    1
Management Information System                      YES                                       2    2     2      2   2   2   2    2




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4.9      Use of Debt Collection Agents                              volumes of business and/or invest in new internal
                                                                    collection and recovery operations. Price competitiveness
                                                                    has in turn led to consolidations in the debt collection
A number of trends and industry dynamics have impacted
                                                                    industry in order for them to gain efficiencies of scale and
on the out-placed debt collection and debt purchase sector.
                                                                    develop close and integrated relationships with key clients.
These include: the surge in consumer debt and increase in
                                                                    The sale and purchase of debt portfolios has opened up
the volumes of delinquent debt that have to be processed;
                                                                    avenues for the DCA’s but in turn requires more
the increased emphasis on cost effectiveness and
                                                                    sophistication in the pricing and collection processes. A
performance benchmarking; the continued re-engineering
                                                                    source of potential revenue growth for the DC industry is
of centralised in-house collection and recovery functions
                                                                    as a provider of a wider range of out-sourced business
and the development of technology and information
                                                                    services    across     the   credit   life-cycle.   Outsourcing
systems devoted to account management; the speed of
                                                                    receivables management has increased, particularly for
response of the major lenders in dealing with delinquent
                                                                    commercial debt. Government and the public sector are
accounts and a shortening of the time period to write-off.
                                                                    beginning to utilise the services of DCA’s. The growth in
The latter trend has been given much impetus by the Basel
                                                                    the internet B2C and B2B has translated into more
II rules that have encouraged the lenders to shift debts off
                                                                    collection activity on a global scale.
of their books more quickly and to opt for debt sale rather
than commission-based collection since the former
mechanism transfers ownership of the debt.
                                                                    There has been and continues to be a general trend
                                                                    amongst the large volume collectors to streamline and
                                                                    rationalise their use of 'external' collection agents alongside
The Credit Services Association reported that their member
                                                                    their 'in-house' collection agents. Our original 1998 survey
organisations handle around £15 billion of debt on a
                                                                    found that the large lenders would pass out debts, on
commission basis which consisted of over 20 million
                                                                    commission, to a large range of external collection agents
individual cases. This represents a rise of £10 billion since
                                                                    and on quite an ad hoc basis. At this time the lender viewed
2000. The CSA membership bought around £6 billion of
                                                                    the relationship with the customer as terminated and had no
debt in 2007 making of total of over £21 billion being
                                                                    further interest in the customer Little effort was put into
passed to the DCA sector. The CSA estimate that their
                                                                    monitoring the success rate of the different agents. Our
market will be worth over £24 billion in 2008.
                                                                    later surveys identified that that large volume lenders were
                                                                    beginning to prefer to have a closer and more sophisticated
There has been an increasing preference amongst lenders,            interface with a smaller number, say 4-5, main collection
(particularly credit cards) to sell debt to debt buyers rather      agents. Often the performance of each agent would be
than     place     for     commission-based        collection.      monitored according to the type and age of debt that they
Consolidations in industries that service the debt collection       were working and benchmarked against each other and
sector e.g. utilities, telecommunications, and          retail      against the performance of the in-house collection agent.
industries have impacted on the market for DCA services.            Some       were      operating   champion-challenger      style
Industry consolidations imply that organisations have               monitoring of the agent's performance. The lenders were
bigger portfolios and can negotiate lower prices for higher         keen to track the customer after they had been passed out




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                           148
Credit and Debt Management – 2008 Survey




to agents in order to monitor outcomes. This, to some
extent, requires that the collection agent's information
                                                                        A potential problem for debt collection agents is that these
system can integrate with that of the client. Thus the
                                                                        'in-house' operations, buoyed by their successes, are
lenders were attempting to develop seamless information
                                                                        (considering) taking debts from clients other than their
systems that could track the customer from account
                                                                        internal clients i.e. become competitors to the external
management/customer service through to collections, out
                                                                        agents. The response of the larger DCA’s has been to
to the collection agents and back into the lender where
                                                                        invest in technology, communications and expertise to
possible. The implication for the debt collection sector was
                                                                        develop a range of specialist services for segmented debt
that scale was becoming more important as was the
                                                                        portfolios. The growth in outsourced recovery services has
investment in I-T systems that would rival and or add value
                                                                        created new opportunities.
to those of their clients. As a consequence we were seeing
fewer but larger and more sophisticated collection agents
with closer working relationships/interfaces with their                 The lenders used to place debt for collection with DCA’s
clients.                                                                after a specific period of time and in-house collection
                                                                        cycle. The more recent trend is to experiment with placing
                                                                        at different stages of the collection cycle and employ the
As in-house collection functions were improving their own
                                                                        services of DCA’s at various stages of the billing and
speed of response and internal collection efforts it meant
                                                                        delinquency cycle as charted below.
that the DCA’s were receiving debts that were both
younger and that had been ‘worked’ harder. These trends
have continued into 2007 with the lenders looking for
further    efficiencies   and    additional     expertise   and
specialisation from the DCA’s.



                                              Chart 4.9.1 – Collections: An Integrated Approach




                     The New
                                                      Multiple Outsource Points
                     Approach



                           In‐house                                           Outsource
                                                                                                     Litigation &
               Customer            Billing & Sales    Arrears                   Debt
                                                                                                      3rd Party
              Acquisition               Ledger      Management                Collection
                                                                                                     Collections



                                                            Period of Delinquency




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                           149
Credit and Debt Management – 2008 Survey




Analysis the accounts of 177 known DCA’s we can track a
substantial increase in the average turnover and net worth
of these organisations.


                                  Chart 4.9.2 – Turnover Trends in UK Debt Collection market




                                    Chart 4.9.3 – Net Worth Trends in UK Debt Collection market




Research and analysis by the Credit Management Research Centre, University of Leeds Business School   150
Credit and Debt Management – 2008 Survey



4.9.1      DCA: Case Study                                                  An arrangement to pay can then be negotiated with the
                                                                            debtor with multiple payment options.             Champion

The diagram below represents the debt processing path of a                  challenger strategies are used to maximise the effectiveness

large DCA beginning with the matching of debtors to                         of collection actions.

information sources in order to profile and score the debtor
into a particular debt segment. The DCA uses multiple
                                                                            The lenders typically will monitor the performance of the
collection strategies with an emphasis of early contact with
                                                                            DCA closely and benchmark their performance versus in-
the debtor.
                                                                            house and other external DCAs. Information systems are
Contact is a sophisticated process that involves power-                     linked to the lender and the DCA service is optimised as
dialling and other telephony timed to achieve the best and                  charted below.
most cost-effective results.



                                     Chart 4.9.1.1 – Example of DCA Collections Process



  Staff Incentives, training and development


                                                                            Application of            Optimised 
                           Segmentation using       Different debt 
  Multiple data                                                             contact methods           collections 
                           account                  treatment paths for 
  source matching                                                           and tools at the          contributions when 
                           characteristics          different segments
                                                                            best times                contact is made




                                                                                                                                Optimised Collections
                                                     Multiple                Maximised                 Payment 
   Data                     Portfolio 
                                                     Collections             Contact                   Conversion
   Enhancement              Segmentation
                                                     Strategies




                           Type of debt,            Varied contact                                   Most effective 
 Full names, correct                                                        Use of predictive 
                           balance, previous        identities, letters,                             payment methods, 
 addresses, home,                                                           diallers, SMS and e‐
                           payment history,         intervals, postal                                optimised negotiation 
 work and mobile                                                            mail, “right time to 
                           location, presence of    tariffs, payment                                 tactics, effective 
 telephone no.s                                                             call” analysis
                           telephone no. etc        methods                                          default procedures



 Compliance




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Credit and Debt Management – 2008 Survey



                                           Chart 4.9.1.2 – DCA Service Optimisation




     Inputs                                       Actions                                               Outcomes

                                               Weekly Service Review
                                               All aspects of Client Administration
                                               Attendees: Account Manager,
   Client Feedback                             Client Services Manager
                                                                                                      Tactical Short Term Actions


                                               Weekly Collections Review                              Benchmarking and testing 
   League Tables
                                               Detailed consideration of all                          of new strategies
                                               collections metrics
                                               Attendees: Account Manager,                            Communication of issues to 
   Internal Data / KPI’s
                                               Sector Collections Manager                             the client
                                               Monthly Commercial Review                              Re‐mapping of business 
   Staff Feedback                              Overall review of all aspects of                       processes
                                               service and performance
                                               Sales Director, Operations                             Project based improvement 
   Complaints                                  Director                                               initiatives
                                               Quarterly Strategic Review
   Legislation and Regulators                  High level review of major projects                    Compliance reviews
                                               and future initiatives and
                                               improvements
                                               UK Board



                           Client Specific Intranet Site for all key data and information




4.10 Debt Sale and Purchase: Trends                                            In the UK it is difficult to estimate the total size of the debt
     and Developments                                                          sale market since the market continues to evolve quite
                                                                               rapidly. The market size in 2005/6 was around £6bn face

The debt sale/purchasing market has attracted much                             value selling at an average price of around 8p in the pound.

interest in the recent years and is perhaps the fastest                        By 2006/7 this had increased to £7bn and commentators

growing segment of the debt collection and management                          are expecting the market to peak at around £10bn. Debt

industry based on the potential value of debt available for                    sale is still dominated by ‘distressed debt’ portfolios i.e.

purchase. In the US the debt sale and purchase market is                       debt that the financial sector would normally write-off

well established By 2000 It was estimated that the face                        and/or is severely delinquent is sold to the highest bidder

value of debt purchased was over $60 billion in the US                         for collection/recovery. In the early stages of the debt sale

which had a collection value of around $3.6 billion. The                       market the pricing of ‘distressed debt’ was of little issue

market has continued to grow in the US and was over $150                       for the seller since any price attracted was a bonus for debt

bn in 2006.                                                                    already written-off. Such debt traded for 1 or 2 pence in the
                                                                               £. In 2006/7 it is estimated that the average price has
                                                                               increased to an range between 2-5 pence in the pound as a
                                                                               result of increased competition in the debt buyer market
                                                                               and more sophistication in debt pricing. The value of debt




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decreases with age and the numbers of collection cycles             The main sources of debt sale are credit cards, loan and
and placing that it has been through. However it is clear           overdrafts, retail credit, motor finance and increasingly
that lenders have developed an interest in selling younger          mortgage arrears. The utility and mobile phone companies
debt as a means of improving cash-flow and because of the           have sold debt. This debt is typically old and of low value.
costs of servicing the debt collection sector when debt is          Difficulties in collecting this type of debt have depressed
placed on a commission basis. If the costs of administering         prices. The credit card environment appears to be the most
debt collection services (servicing costs) are taken into           attractive sector. Here average value is in the region of £
account along with commission rates then it may be more             2000-4000. The debtor is likely to be employed with an
costs effective in some cases to sell debts outright. “As           incentive to ‘recover’ their position and return to being
financial institutions get more comfortable selling debt, we        credit active. Interviews with a major debt buyer suggests
believe they will sell a greater amount of performance debt         that the average balance on credit card debt has increased
that they want to get rid of for strategic reasons” R H             from £4000 to £8000 in the last 2 years. There has, of
Reitzel (quoted in the Kaulkin Report 2001, p 38).                  course, been some sale of IVA’s as the volume has
                                                                    increased but there have been concerns over the quality of
                                                                    the IVA (the debtor rarely has any assets) and the fees
Most of the Debt Collection Agents have turned to buying
                                                                    taken by the IVA practitioner. The market for commercial
debt as an alternative to collection on commission in 2004
                                                                    debt in the UK is currently small given the scale of
there were over 60 debt buyers although the DBSG
                                                                    corporate receivables but there is evidence that the market
suggests that currently there are around 40 regular buyers
                                                                    is beginning to grow e.g from corporate credit cards,
in the market. The growth in the market has been
                                                                    outsourced    receivables    management      operations    and
facilitated by the supply-side. The major lenders and the
                                                                    insolvency practitioners.
majority of financial services are now selling debt and
developing specialist departments to deal with debt sale
and respond faster to debt sale opportunities. The bulk of           A problem that is probably hampering the growth of the
sales are distressed debt attracting the 2-5% price but there       debt sale market is that of ‘pricing’. Interviews with major
is evidence of sellers selling debt earlier, as in the US,          lenders suggested that there is some lack of ‘trust’ in the
typically 180 days past due. The changes in accounting              market as a result of extant price variations. If debt is to be
rule, Basel II and capital requirements have had an impact          sold at earlier stages and /or segmented by ‘quality’ then
as a result of changes in internal default definitions. A           there has to be a mechanism for pricing the individual
further development is the sale of debt that has already            debts and the debt portfolio. Clearly in order to price debt
been managed to achieve an ‘arrangement to pay’ via a               something has to be known about the ‘default probability’,
debt management company. This type of debt can attract              the collection probability (including percentage recovered),
30-40 pence in the pound. The development of a reseller             the timing of possible recovery (i.e. collection period) and
market is expected to create further growth in the market.          the costs of collection/recovery. The type and source of the
                                                                    debt will have a bearing on its value in a debt sale. Of
                                                                    course, ultimately the value of the debt is a function of the
                                                                    net present value of the future cash-flow in relation to
                                                                    collection costs. The seller, of course, would wish to




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achieve the maximum price for the debt but has an                   Adding value to account data using scoring models to
informational advantage over the potential buyer. That is           understand the debtor profile and determine the NPV of
the seller is likely to have the information necessary to           future cash flows, effective customer contact and
accurately price debt but has an incentive not to reveal this       developing realistic and ‘collectable’ ATP’s is fundamental
to the buyer. Markets tend not to function well when price          to generating profitable business.
is not transparent. In the US this ‘pricing’ function has
been performed by intermediaries, ‘debt brokers’ who
                                                                    Further growth in the Debt Purchase market is likely to
specialise in portfolio analysis. Accounts can be ‘scored’
                                                                    come from the sale of non-delinquent receivables, reselling
independently on the basis of likely recovery rates. Brokers
                                                                    and from commercial debt.
have the ability to put together more attractive ‘packages of
debt’ emanating from different lenders. There are some
specialist brokers in the UK (eg.TDX and recent US                  4.10.1 Case Study: Debt Buyer
entrants) but currently most debt is sold in a tender-bidding
environment with inefficient pricing. Once the UK market
                                                                    Interviews with a large UK buyer focussed on the process
has further developed this type of expertise in packaging
                                                                    involved in purchasing and processing consumer debt.
and pricing debt then the market should mature and prices
                                                                    Then company employs over 350 full time staff but will
should achieve some uplift. Gauging the ‘quality’ of debt is
                                                                    grow to over 600. The company currently processes over 2
problematic at     the time    of purchase because of
                                                                    million accounts, predominantly from UK lenders but with
informational asymmetries between buyer and seller and in
                                                                    an increasing international portfolio with a face value of,
relation to the individual debtor. Not least an individual
                                                                    on average, £2000. The average face value has been
that has debts with one lender is likely to have debts with
                                                                    increasing with a larger proportion in the region of £4-5000
other lenders that could be consolidated by the debt
                                                                    for cards and £8000 for loans. The average price paid is in
purchaser. Internet auction markets still do not appear to
                                                                    the region of 2-5 pence in the pound but price variations
have the confidence of the debt sellers yet such systems
                                                                    have been increasing along with the average price paid
have the potential for creating an efficient market in debt
sale/purchase.

                                                                    Purchase is usually by tender and bidding after due
                                                                    diligence on the debt portfolio has been carried out. The
Debt buyers have typically invested in sophisticated I-T
                                                                    source of debt is predominantly distressed credit card debt
and customer scoring capabilities in order to maximise the
                                                                    with some loan portfolios and retail credit. The company
efficiency of the debt management and recovery process
                                                                    has not had success with utilities and mobile phone
and generate profit. This is likely to involve developing a
                                                                    portfolios. After the notice of assignment has been sent to
customer-level view. A major debt buyer indicated that
                                                                    the debtor the priority is speedy contact with the debtor by
over 20% of the debts that they receive are from debtors
                                                                    phone/letter combinations. The aim is to quickly establish
that are already known to them. That is, debtors tend to
                                                                    the debtors profile and financial circumstances and
have multiple debts spread across different lenders. A
                                                                    negotiate an arrangement to pay some or all of the
challenge for the debt buyer is to identify and consolidate
                                                                    outstanding debt Emphasis on negotiating a realistic deal
these multiple debts into a single arrangement to pay.




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that allows the debtor to begin making payments. This may
involve starting the debtor at a low repayment level and
increasing the monthly payments over time. In fact, 55%
of the accounts pay by direct debit and the overall default
rate is around 9%. The debtor is offered other options to
repay including cheques, post office cards, over the phone
collections. The main reasons cited for being in debt are
over-commitment; change in personal circumstances (ill,
divorced, loss of first and/or second income) .



Contact and information is key to a successful outcome.
Contact is mad primarily via a call centre and call centre
staff are trained to establish a relationship with the debtor
and negotiate the arrangement to pay. If an initial deal
cannot be established the options are to write-off, ‘rest’ the
debt for a period (up to 12 months), use a third party or
doorstep collector or explore litigation if the debtor has
assets. Almost 40% of debtors agree to a ATP after first
contact. The company has an internal tracing team to track
debtors that have changed address. Currently the company
does not use external CRA data or the sellers internal
scores but relay on their own internal account data.
However, access to ‘white’ customer information via the
CRA’s is seen as desirable in adding collections.



New accounts are ‘scored’ through an internal scoring
system to determine the probability of repayment and the
accounts are segmented by score and other aspects of
account profile. Further information on income and assets
is gathered via the call centre where possible. Internal
behavioural scores are employed to determine the likely
time scales of repayments and the profitability of the ATP.




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5.        A Survey of Debt Collection Agents and Debt Buyers

Our previous sections presented an overview of the size of the market for debt collection services and debt sale/purchase. The
research suggests a markets size in the region of £25 billion per year with an increasing share being taken by debt sale. The sector
has been characterised by rationalisation through technology investments and mergers and acquisitions. Fewer and larger agencies
have closer links with their clients through integrated information systems and benchmarking for continuous improvements in
collections and operational efficiency. Consumer and commercial debts derives from banks, finance houses, credit cards, retail
cards, utilities and telecoms and the public sector. In this section we report the results of a survey of individual debt collection
agents and debt buyers in the UK. This follows up our previous surveys in 2003 and 2001 and provides some trend information.



The DCA sector covers both consumer and commercial debt and offers collection on a commission basis or the outright purchase of
debt. In the latter case the debt buyer acquires all of the rights and duties of the original creditor. In the case of contingency debt
collection (commission-based) the ownership of the debt resides with the client and debts can be passed back to the client if
uncollected after a period of time. This creates a secondary and tertiary market for debts since these uncollected debts may be
placed with another DCA. Commission rates are a function of the age and type of debt Trade debt from B2B relationships may be
placed for commission-based collection. The DCA’s offer services such as tracing absconders, asset tracing, repossessions of
goods, litigation, and status reports and investigations.



5.1       Debt Collection Services



      •   46% of all agencies offer Debt Purchase, an increase of 27% since 2003.

      •   Repossession has increased by 25% to nearly half of all agencies.




In terms of Debt Collection services offered by agencies in 2007 significant differences can be seen since 2003 in Repossessions
(up 25%) and Tracing (down 15%), The offering of Process Services and Investigations/Status Reports has declined between the
two time periods. The largest difference between services offered in 2003 and 2007 is in Debt Purchase which is up by 27% among
the sample. 46% of all agencies offer this service in the marketplace.




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               TABLE 5.1         DEBT COLLECTION AND OTHER SERVICES OFFERED BY RESPONDENTS

                                            CONSUMER DEBT COLLECTION



    Consumer debt collection                           2003                   2007                % change




    Trace and collect                                  60.4%                  61.5%              1.1%

    Tracing                                            68.8%                  53.8%              -15%

    Court action                                       60.4%                  53.8%              -6.6%

    Card recovery                                      29.2%                  23.1%              -6.1%

    Repossessions                                      22.9%                  48.5%              25.6%

    Bailiff                                            10.4%                  7.7%               -2.7%

    Process serving                                    35.4%                  23.1%              -12.3%

    Debt surveillance                                  22.9%                  23.1%              0.2%

    Status reports and investigations                  58.3%                  46.2%              -12.1%

    Outsourced debt management                         41.7%                  46.2%              4.5%

    Debt purchase                                      18.8%                  46.2%              27.4%

    Consultancy                                        45.8%                  38.5%              -7.3%

    Training                                           33.3%                  23.1%              -10.2%




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5.2       The Market for Debt Collection Services



      •   67% of agencies indicate an increasing number of clients.

      •   55% indicate a growth of debts being placed in the market.

      •   No companies report a decline in the number of debts placed.




The respondents to the survey in the 2001, 2003 and 2007 surveys were asked whether their client base and the numbers and values
of debts were declining, stable or increasing.

As in 2001, 67% of respondents indicated that their client-base was increasing. Just over a quarter of respondents indicated that
their client base remained stable with 8% suggesting a decline in client base.



                     CHART 5.1          CLIENT BASE TRENDS FOR THE DEBT COLLECTION MARKET




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Respondents were asked to indicate on a 5-point scale whether the number of debts had been declining (1) increasing (5) in the last
financial year. The statistics suggest a healthy growth in the market for debt collection with 80% of respondents ticking the 4/5
categories on the scale and 55% indicating growth in the number of debts placed at the highest score of 5 in 2007. 46% of
respondents suggested that the market had remained stable and no companies indicated a decline in the number of placed debt.



                                 CHART 5.2          NUMBER OF DEBTS PLACED IN MARKET




5.3       Market Size



      •   75% of agencies indicate that market size is increasing in 2007.

      •   This compares to just 45% in 2003.

      •   99% of agencies believe market competitiveness to be increasing.




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A number of questions on the survey were designed to obtain information on the nature of the consumer debt collection market.
These questions ascertained opinion on the size/growth of the market overall, specific sources of out-placed debt, the age and
quality of debt that is out-placed and the overall competitiveness of the market for consumer debt collection. Respondents were
asked to indicate whether they thought that the overall market for consumer debt was increasing, stable or decreasing at present. As
can be seen from the chart on the scale from (1) increasing to (5) decreasing almost 75% of respondents indicated that they believed
that the market was increasing in 2007. This compares to just 45% in 2003.



                                  CHART 5.3          MARKET SIZE FOR CONSUMER DEBT




Although the size of the market was generally thought to be increasing the respondents felt that the market for out-placed consumer
debt remained very competitive.


5.3.1    Market Competitiveness for Consumer Debt


The vast majority of respondents indicated that the market for consumer debt collection was very competitive. 85% of firms ticked
4 or 5 on the scale to indicate a currently competitive marketplace. 99% of agencies believe the market competitiveness to be
increasing compared to just 85% in 2003.




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                           CHART 5.4        MARKET COMPETITIVENESS FOR CONSUMER DEBT




5.4       Value and Volumes in the Debt Collection Market




      •   The largest agencies report a 526% increase in average collective debt value from £228 million in 2003
          to £1.2 billion in 2007.

      •   The average individual debt value has more than doubled since 2003.

      •   The number of debts worked on per month has increased from an average of 1,200 to 19,000 in 2007.
          An increase of 1900%.

      •   Large agencies work on 40,000 debts per month in 2007 compared with just 1,000 in 2003




The number of debts worked by agencies each month across the entire sample has increased dramatically from between 1,200 in
2003 to 19,000 in 2007. Among the larger agencies this increase is most significant with agencies with over 100 employess
reporting a rise from 1000 debts per month to 40,000 debts per month.




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The chart below shows the distribution of debt collectors by the number of debts worked per month i.e. where at least one action
has been taken to collect the debt. In 2001 collectors in the consumer debt market dealt with considerably larger volumes of debt
than those servicing the commercial sector with over half working over 1000 debts per month. In 2003 this trend changed with a
lower volume of debts being worked in consumer collection than before. However in 2007 agencies are now clearly collecting a
higher number of debts per month with 56% of agencies stating that they work over 5000 debts per month.



                    TABLE 5.2          NUMBER OF DEBTS WORKED PER MONTH – WHOLE SAMPLE

                  Number of debts                                          2001          2003          2007




                  Less than 500                                            30%           50%           11%

                  501- 1000                                                18%           21%           20%

                  1001 – 5000                                              41%           14%           13%

                  Over 5000                                                11%           15%           56%




The table below summarises information on the average value of debt received in £s. Overall in the sample, the average value of a
debt placed across the entire sample has increased from less than £1000 in 2003 to £2400 in 2007.



                     TABLE 5.3          VALUE OF DEBTS WORKED PER MONTH – WHOLE SAMPLE

                    Value of debt                                         2001           2003         2007




                 Less than £250                                           35%            27%          2%

                 £251-£500                                                26%            16%          8%

                 £501-£1000                                               9%             5%           10%

                 £1001-£2000                                              22%            41%          38%

                 Over £2001                                               10%            11%          42%




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     TABLE 5.4           NUMBER OF CLIENTS AND DEBTS WORKED PER MONTH – AGENCY SIZE BREAKDOWN

Size of Agency (employees)       Average Number of Clients           Average Number of debts     Average Value of     a Debt
                                                                     per month worked            placed

                                 2003            2007                2003          2007          2003         2007

6 to 10                          100             80                  500           300           £1500        £150

11 to 25                         13              8                   2920          14000         £4000        £400

26 to 50                         35              98                  1010          25000         £758         £817

51 to 100                        56              112                 1300          11500         £1860        £5250

Greater than 100                 156             30                  1000          40000         £1087        £2370



The table below gives an indication of the total values and total numbers of consumer debts placed with the respondent debt
collection agents organised by size of the agent. As can be seen below the largest agents have seen a significant increase in the
value associated with the largest agencies operating in the market. In 2003 the largest agencies reported a total value of £228
million for debts placed. This figure in 2007 is now £1.2 billion.



        TABLE 5.5        TOTAL VALUE AND TOTAL NUMBER OF DEBTS PLACED – AGENCY SIZE BREAKDOWN

 Size      of   Agency    2001                                  2003                              2007
 (employees)

                          number             Value              number            value           number      value




 6 to 10                  13,000             £3,125,000         26,000            £6,500,000      3,600       £520,000

 11 to 25                 14,000             £10,000,000        68,000            £22,757,250     168,000     £67,200,000

 26 to 50                 177,000            £62,045,829        212,000           £130,000,000    300,000     £245,000,000

 51 to 100                200,000            £141,000,000       290,000           £200,000,000    338,000     £104,000,000

 Greater than 100         779,000            £210,000,000       911,000           £228,000,000    980,000     £1,200,000,000




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A factor affecting the collection success rate will obviously be the age of the debt that is being received into the collection agency.
The survey gathered information on whether the debt collection agents were handling primary, second or third placed debts and the
proportions of the total debt received that could be categorised under these headings. Again it is clear that some agents specialise in
first placed debt whereas others take a high proportion of second and third placed debt.



                                TABLE 5.6         SECTORS FOR DEBT COLLECTION ACTIVITIES

                                               Sector                      Average % of Total Business

                                                                           2003                  2007




                    Bank                                                   45                    47

                    Credit Cards                                           60                    48

                    Finance Houses/ Retail                                 40                    45

                    Local Authority/ Central                               55                    51

                    Utilities                                              82                    60

                    Telecoms                                               60                    30

                    Mail Order                                             40                    38




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Respondents were asked to indicate which were the fastest growing or declining sectors for out-placed consumer debt. Responses
were coded on a five-point scale from Declining (1) to Growing (5).



                       TABLE 5.7          GROWING AND DECLINING SECTORS FOR CONSUMER DEBT

                 Declining                                     Stable                                      Growing

                 1                        2                    3                      4                    5




                 2001     2003     2007   2001   2003   2007   2001     2003   2007   2001   2003   2007   2001   2003   2007




Banking          4.2      0        20.2   4.2    14.3   9.8    42       14.3   9.1    50     57.1   50.0   0      14.3   10.9

Credit cards     4.5      0        15.3   13.6   0      0      27.3     27.8   13.1   36.4   55.6   57.1   18.2   16.7   14.5

Finance          8.7      0        11.8   4.3    5      10.4   34.8     40     22.2   52.2   45     44.4   0      10     11.2
houses

Retailers        4.5      0        11.7   18.2   6.7    1.4    40.9     60     1.5    36.5   20     29.7   0      13.3   55.7




Utilities:

Gas              0        7.1      0      21.4   0      14.3   14.3     42.9   14.3   42.9   42.9   28.5   21.4   7.1    42.9

Electricity      0        7.1      12.8   20     0      22.2   20       42.9   11.1   26.7   42.9   22.2   33.3   7.1    31.7

Water            7.1      8.3      40.2   14.3   0      19.8   21.4     50     20.7   35.7   25     0.0    21.4   16.7   19.3

Telecoms:

Fixed line       7.1      0        0      7.1    40     0      28.6     40     1.7    35.7   13.3   63.8   21.4   6.7    34.5

Mobile           0        0        0.8    5.6    14.3   2.2    16.7     57.1   35.4   27.8   28.6   32.1   50     0      29.5




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There appears to be growth in a number of sectors judging by the responses on the 4 and 5 points on the scale. However, some
sectors are generating a faster growth for the out-placed debt industry. In 2007 the fixed line telephone sector is the most buoyant
sector with 98% of collection agents indicating a 4 or 5 on the growth scale. This compares to just 29% in 2003.



Collections within the retail sector shows the second largest growth among respondents with 85% of collection agents indicating
this to be a growing market. The credit card industry has continued the 2003 growth trend which is most likely a result of the
growth of this particular industry. 72% of respondents indicate this to be a growth market.



The water industry is the one sector which is reported to be declining in terms of growth in 2007.



Questions over the last seven years have solicited opinion on the age and the quality of out-placed consumer debt. These
characteristics clearly have a bearing on the difficulty of collecting these debts and the efforts and resources that have to be
employed to collect the debts.



As can be seen below, 39% of companies state that the total value of debts comes from their largest client.



                                  TABLE 5.7            VALUE OF DEBTS FROM LARGEST CLIENT

                                                                                              2007




                             Largest client                                                   39%
                                 nd
                             2        largest client                                          14%
                                 rd
                             3        largest client                                          9%




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5.5       Quality and Volumes in the Debt Collection Market



      •   51% of agencies in 2007 feel that the quality of consumer debt is worsening.

      •   66% believe that debt is getting older in 2007 compared to 11% in 2003.

      •   The majority of agencies have between 21 and 50 clients.




In 2003 43% of respondents thought that the quality of out-placed debt was generally worsening. This figure in 2007 is 51% in the
sample. 18% of respondents indicated that the quality of consumer debt was improving.



                                      CHART 5.5          QUALITY OF CONSUMER DEBT




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In 2007, 69% of companies feel that debt was generally getting older. This is compared to just 11% in 2003.



                                         CHART 5.6          AGE OF CONSUMER DEBT




Over 60% of collection agents generate their business from under 50 clients and generally collection agents are dealing with fewer
clients than in 2003. The table below summarises the data further.



                                   CHART 5.7          NUMBER OF CLIENTS WORKED FOR




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5.6       Debt Purchase



      •   The largest buyer of debt in 2007 paid £458 million compared to just £28 million in 2003.
          A 1600% increase in the last four years.

      •   63% indicate the Debt Purchase market is still growing in 2007.

      •   64% state that prices paid for purchased debt are increasing.

      •   Prices paid for debt are now more concentrated in 2007 and average 8p in the pound.




                                      CHART 5.8        DEBT PURCHASE MARKET GROWTH




The general growth of the debt purchase market continues in 2007 with 63% of companies indicating an increased market.
However, a quarter of respondents (25%) report the market to have stabilised compared to 18% in 2003.



A series of questions were included in the 2003 and 2007 surveys aimed at gathering further information on the debt purchase
activities of UK collection agents.




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The largest buyer of debt purchased a face value of £458 million compared to just £28 million in 2003. Of the total debt purchased
in 2007 an average of £30 million was collected during the last year.



In the sample prices paid for debts varied between 5p to 18p in the pound. The average price paid in the pound is 8p in 2007. This
shows more of a concentration of debt sale pricing since 2003 when the range was between 1p and 24p in the pound. As can be
seen below 64% of responding agents indicate that overall prices are increasing in the debt purchase market.



                          CHART 5.9          GROWTH IN PRICES PAID IN DEBT PURCHASE - 2007




Companies were also asked the percentage of debt purchased which is collected directly, restructured or resold. As can be seen in
the table below 89% of purchased debt is collected, 10% is sold on to another party and 1% is restructured.



                            TABLE 5.8          % OF PURCHASED DEBT SENT FOR COLLECTION

                             What percentages of consumer debt do you:               2007

                             Collect                                                 89%

                             Restructure/ refinance                                  1%

                             Resell                                                  10%




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5.7       Litigation and Bankruptcy



      •   16% of live consumer debts were under some form of litigation process in 2007.

      •   Only 3% of debts are collected via the court process.

      •   There were only 434 court actions from an average of 228,000 debt placements in the last yer.

      •   The number of IVA’s has increased by 700% in the last three years.

      •   78% of agents have accounts linked to an IVA.

      •   IVA Default Rates have more than tripled in the last three years.

      •   98% of defaults are re-scheduled by agencies.

      •   The average value of each bankruptcy has doubled in 2 years to £6000.




One of the most important aspects of debt collection is contact with the debtor. When individuals get into arrears they often become
increasingly difficult to trace. As can be seen the agencies were asked the percentage of their live consumer workload which was
goneaway and then successfully traced in the last financial year. 23% of consumer debts were reported to be goneaway with 17%
successfully traced. This means that 6% of all accounts were untraceable in the last 12 months.



                            TABLE 5.9          % OF PURCHASED DEBT SENT FOR COLLECTION

                                 Live consumer debts in 2007                         2007




                                 Gone away                                           23%

                                 Successfully traced                                 17%




As can be seen below 16% of live consumer debts were under some form of litigation process in 2007 – although agencies only
reported an average of 434 court actions per year. When this is considered in the context of agencies handling on average 19,000
placements per month, clearly the legal process is not being used significantly.




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                                  TABLE 5.10         % OF PURCHASED DEBT IN LITIGATION

                                  Live consumer debts in 2007                     2007




                                  In litigation                                   16%

                                  No. of court actions                            434



There were slightly more consumer debt referred to court during 2007 with an average of 1428 across the sample. Of these cases
only 3% of debts were received.

                                  TABLE 5.11        % OF TOTAL DEBT REFERRED TO COURT

                                  Live consumer debts in 2007                     2007




                                  Number referred to court                        1428

                                  % of total number of debts received             3%




5.7.1 Individual Voluntary Arrangements (IVA’s)


The collection agents were asked if any of their collectable debts were operating under an Individual Voluntary Arrangement. 78%
of the agencies responding to the survey had accounts which were linked with an IVA.

                    CHART 5.10           % OF AGENTS WITH ACCOUNTS OPERATING UNDER AN IVA




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The average number of IVA’s which collection agents had agreed to in the last 12 months stands at 354.



                          TABLE 5.12         NUMBER OF IVA’s AGREED TO IN LAST 12 MONTHS

                                                                                  2007




                               Number of IVAs                                     354

                               Total Average Value                                £1,268,667




The agents were also asked to indicate how these figures had changed in the last three years. As can be seen below the number of
IVA’s in 2004 stood at just 50 with an average total value of £185,000.



                            TABLE 5.13         NUMBER OF IVA’s AGREED TO IN LAST 3 YEARS

                                                                                 2004




                               Number of IVAs                                    50

                               Total Average Value                               £185,000




The average length of time for an IVA is among the sample is 4.75 years. Agents also indicated that they expect to receive 38p in
the pound under an IVA and would accept a minimum of 32p.




Research and analysis by the Credit Management Research Centre, University of Leeds Business School                         173
Credit and Debt Management – 2008 Survey




In terms of default rates collection agents were asked to state the the percentage of IVAs which had defaulted over the last 3 years.
As can be seen below default rates have more than tripled during the last three years and now stand at 13%.



                            TABLE 5.14         NUMBER OF IVA’s AGREED TO IN LAST 3 YEARS

                               Default rates of IVA’s                               2007




                               Last year                                            13%

                               Last 2 years                                         9%

                               Last 3 years                                         4%




98% of these defaults were rescheduled in the last year. 2% were written off.



                    TABLE 5.15         DEFAULTS WHICH HAVE BEEN RESCHEDULED IN LAST YEAR

                                                                                   2007




                               Re-scheduled                                        98%

                               Written-off                                         2%




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Credit and Debt Management – 2008 Survey



5.7.2      Bankruptcy


The responding agents reported an average of 250 bankruptcies in the last 12 months with an average total value of £1, 458,000.
This represented 1.35% of the total consumer debt workload.



                            TABLE 5.15        NUMBER OF IVA’s AGREED TO IN LAST 3 YEARS

                                                                                 2007




                                Number                                           250

                                Total value                                      £1,458,000




When asked to compare the figures of each individual debt there has been a progressive increase in the average individual of each
bankruptcy in the last two years. As can be seen below the average value of each bankruptcy is £6000 – almost doubling in size
from £3200 two years ago.

                               TABLE 5.16        BANKRUPTICES IN THE LAST TWO YEARS

                                                                                 Value




                                Average value currently                          £6000

                                Average value 1 years ago                        £5200

                                Average value 2 years ago                        £3200




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Credit and Debt Management – 2008 Survey




References
1
    Creditaction Debt Facts and Figures – October 2007


2
    Creditaction Debt Facts and Figures – October 2007


3
    Bank of England (UKV2QB) UK Personal Borrowing Outstanding
4
    Bank of England “Statistical Release” September 2007
5
    Financial Risk Outlook 2006, Financial Services Authority
6
    BBC News website – www.bbc.co.uk
7
    National Consumer Council “Debt Summit” November 2006
8
    Creditaction Debt Facts and Figures November 2007
9
    Council of Mortgage Lender 2007
10
     Citizens Advice Bureau Press Release September 2007
11
     Experian Press Release November 2007
12
     British Bankers Association Statistics September 2007
13
     Office for National Statistics and Bank of England October 2007
14
     Creditaction Debt Facts and Figures – October 2007
15
     Finance and Leasing Association Statistics 2007
16
     Euler Hermes Press Relase 2007
17
     World Factoring Yearbook (BCR) 2006)




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Description: Credit Management 2008 document sample