Credit and Debt Management Survey 2008

Transcription

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

2 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 Subjective Evidence Statistical Evidence 2.4. A Summary of Lending Trends Secured Lending 2.5 The Over-Indebtedness Debate Arrears Trends in Write-offs by Major Lenders 2.6 Personal Insolvency: bankruptcy and Voluntary Arrangements 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 Credit Terms and Credit Management Practice Motives for the Supply of and Demand for Trade Credit Credit Management: The Impact on Corporate Performance 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 Factoring and Invoice Discounting 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 Customer Life-Cycle 2

3 4.2.2 Account Life-Cycles 4.3 Elements of Best Practice in Collections and Implications Credit Information and Scoring Technologies Customer contact and Customer Retention and Collection Collection department practices Use of external debt collection agencies for telephone, letter and doorstep contact; litigation Benchmarking 4.4 Summary 4.5 Short Case Interviews Collections Department Medium Sized Bank Commercial Credit Card Consumer Credit Card Medium Sized Retail Bank 4.6 Large Volume Collections: Interview Survey Delinquency Cycles 4.7 Case Studies 2003: large volume collection activities Case A: Debt Recovery Division of a Major Bank Case B - Credit Card Provider Case C: Large Volume Lender Retail Card, Personal Loans Case D: International Bank Collections and Recovery Debt Management and Collection in the Utilities Sector Best Practice in Collections and Recovery: Evidence from US Utilities Key Performance Indicators Used in Debt Management Best Practice in Collections and Recovery: The Water Sector Areas of Disadvantage Credit and Debt Management Practice in the Water Industry General Information Direct billing and other methods Telephone Contact Scoring and Customer Profiling 4.9 Use of Debt Collection Agents DCA: Case Study 4.10 Debt Sale and Purchase: Trends and Developments Case Study: Debt Buyer 5. A Survey of Debt Collection Agents and Debt Buyers References 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 3

4 CHARTS AND TABLES Table 2.1 Categories of Measurable Lending in the UK (Source: Keynote Ltd) Chart Debt Client Characteristics 2006 (source: Citizens Advice Bureau Survey 2006) Chart Consumer Credit Outstanding (source: Bank of England) Chart Consumer Spending Growth (source: Bank of England) Chart Total Personal Debt July 2007 (source: Bank of England) Chart Total Lending to Individuals Per Month (source: Bank of England) Chart Mortgage Equity Withdrawal M (source: Bank of England) Chart Mortgage Equity Withdrawal as a % of Disposable Income (source:????? Chart Approvals for Secured Lending to Individuals (thousands) (source: Bank of England 2007) Chart Month Growth Rate of Secured Lending Approvals to Individuals (source: Bank of England 2007) Chart Monthly Value of Approvals for Secured Lending to Individuals (source: Bank of England 2007) Chart Month Growth Rate of Value of Approvals for Secured Lending to Individuals (source: Bank of England 2007) Chart Monthly Number of Approvals for Secured Lending to Individuals (source: Bank of England 2007) Chart Month Growth Rate of Number of Approvals for Secured Lending to Individuals (source: Bank of England 2007) Chart Monthly Value of Approvals for Secured Lending to Individuals (source: Bank of England 2007) Chart Month Growth Rate of Value of Approvals for Secured Lending to Individuals (source: Bank of England 2007) Chart Monthly Amount of Total Sterling Secured Gross Lending to Individuals and Housing Associations (in sterling millions) (source: Bank of England 2007) Chart Monthly Amount of Sterling Repayments of Secured Lending by Individuals (in sterling millions) (source: Bank of England 2007) Chart Monthly Amount of Total Sterling Unsecured Gross Lending to Individuals (in sterling millions) (source: Bank of England 2007) Chart Monthly Amounts Outstanding of Total Sterling Net Unsecured Lending to Individuals (source: Bank of England 2007) Chart Monthly Amount of UK Resident Banks (inc. Central Bank) Sterling Credit Card Repayments by Individuals (in sterling millions) (source: Bank of England Chart Monthly Amount of UK Resident Banks (inc. Central Bank) Sterling Credit Card Repayments by Individuals/Monthly Amounts Outstanding of Total Sterling Net Credit Card Lending to Individuals Chart End Month Weighted Average Interest Rate, Bank & Building Societies (source: Bank of England 2007) Chart Debt to Income Ratio (source: ONS and Bank of England 2007) Chart Income Gearing (source: ONS and Datastream 2007) Chart Debt to Wealth Ratio (source: ONS and Bank of England 2007) Chart Credit Card Lending (source:??? Chart Other Unsecured Lending (source:??? Chart SecuredLending (source:??? Chart Ratio of Write offs to Credit Card Lending (source:??? Chart Major UK Banks Annual Write Off Rates (source: Bank of England 2007 Chart Personal Bankruptcies and Individual Voluntary Arrangements (source: DTI 2007) Chart Personal Bankruptcy Ratio (Source???) Chart Consumer County Court Judgements (Source: Registry Trust) Chart Fraud Trends (Source: CIFAS 2007) Chart Fraud Trends (Source: CIFAS 2007) Chart Register Size in Great Britain ( ) (Source: Companies House) Chart Company Birth Rate ( ) (Source: Companies House) Chart Company Insolvencies ( ) (Source: Companies House) Chart The Relationship between Insolvencies and the Write-off Rates of Banks (Source: Bank of England) Table 3.2 Variables used to Forecast Insolvencies (Source: CMRC) Table Bank and Building Society Lending to Industrial and Commercial Companies (Source: Bank of England) Chart Contributions to Annual Growth Rate from Non Financial Corporations (Source:?????) Chart New Leasing and HP Business Finance by Client Size and Business Investment (Source: FALA and ONS) Chart Small Business Borrowing and Deposits at Year End ( Billions) (Source: Bank of England) Chart Changes in Sources of External Finance for SME s (Source: ESRC Centre of Business Research) Chart Aggregate Capital Gearing of UK companies (Source: ONS and Bank calculations) Chart Aggregate Capital Gearing of UK companies (Source: ONS and Bank calculations) Chart Capital Gearing/Total Debt/Total Assets (Source: Creditscorer) Chart Income Gearing/Operating Profit (Source: Creditscorer) Chart The Importance of Trade Debtors to the Balance Sheet (Source: Creditscorer) Chart DSO and Creditor Days Trends ( ) (Source: Creditscorer) Chart Net Trade Credit Trends (Source: Creditscorer) Table Motivations for Trade Credit Extension (Source: CMRC) Chart The Use of Trade Credit and Payment Behaviour A Strategy Map (Source: CMRC) 4

5 Chart % of Accounts Paying beyond the Due Date (Source: CMRC) Chart % of Companies Paying on Time (Source: CMRC) Chart % of Invoices Paid on Time Sector Analysis (Source: CMRC) Chart % of Invoices Paid on Time Sub Sector Analysis for the Manufacturing Sector (Source: CMRC) Chart Average Debtor Days (Source: CMRC) Chart Payment Beyond the Due Date (Source: CMRC) Chart Debtor Days - Size Analysis Chart Debtor Days - Turnover Analysis Chart Debtor Days Sector Analysis Chart Debtor Days Sub Sector Analysis Chart Interest Charged on Overdue Accounts Chart % Firms Affected by Late Payment Chart Receivables Beyond 30/90 Days Chart Accounts Beyond 30/90 Days - Sector Chart Accounts Beyond 30/90 Days Table Profile of firms suffering from Bad Debt Chart Types of Customer who are Slow Payers Chart Assertions about Late Payment Chart Possible Policy Measures Table % of Companies Pursuing Late Payments through the Courts Table Awareness of the Late Payment Legislation Chart Awareness of the Late Payment Legislation Chart Domestic Factoring Trends (Source: FDA) Chart Domestic Invoice Discounting Trends (Source: FDA) Chart Export Factoring and Invoice Discounting (Source: FDA) Chart Firms using Invoice Finance (Source: Bank of England) Chart Growth in Demand for Factoring (Source: FDA) Chart Credit Insurance Growth (Source: ICISA) Chart World Market for Credit Insurance (Source: ICISA) Chart Use of Credit Insurance by SME s (Source: ICISA) Table Reasons for not using Credit Insurance (Source: CMRC) Table Reasons why companies use Credit Insurance (Source: CMRC) Table Traditional Benefits of Credit Insurance (Source: CMRC) Chart Customer Life-Time Management Chart The Customer Account Life-Cycle Table Account Management Functions (Source: CMRC) Chart Scoring in Account Management Chart Applications to Collections Chart Debt Management and Collection Trends Chart Scoring to Determine Collection Strategies Chart New Debt Management Approaches Chart Motives for Credit Scoring in Consumer Credit Chart Modelling for Collections Strategies Chart Behaviour Scoring: Principles Chart Behaviour Scoring Chart Example Behaviour Score Card Chart Behavioural Scoring and the Account Life-cycle Chart Champion vs Challenger Strategies in Collection Chart Lender Time Horizons Chart Delinquency Cycles Chart Computer Systems Sued from Application to Collection Chart Entire Billing Process (Source SAP Business Intelligence) Chart Factors Impacting on Debt in the Utilities Sector Chart Revenue to Recovery Customer Impact Chart A Guide to Good Practice Chart Number of Customers using Prepayment Meters Chart % of Directly Billed Customers Chart % of Directly Billed Customers by size Chart A Large Volumes Collections Operation Chart A Credit Management Model (1) Chart A Credit Management Model (2) Chart Recovery Paths and Steps Chart Collections: An Integrated Approach Chart Turnover Trends in UK Debt Collection market Chart Net Worth Trends in UK Debt Collection market Chart Example of DCA Collections Process Chart DCA Service Optimisation Table 5.1 Debt Collection And Other Services Offered By Respondents Chart 5.1 Client Base Trends For The Debt Collection Market Chart 5.2 Number Of Debts Placed In Market Chart 5.3 Market Size For Consumer Debt Chart 5.4 Market Competitiveness For Consumer Debt Table 5.2 Number Of Debts Worked Per Month Whole Sample Table 5.3 Value Of Debts Worked Per Month Whole Sample Table 5.4 Number Of Clients And Debts Worked Per Month Agency Size Breakdown Table 5.5 Total Value And Total Number Of Debts Placed Agency Size Breakdown Table 5.6 Sectors For Debt Collection Activities Table 5.7 Growing And Declining Sectors For Consumer Debt Table 5.7 Value Of Debts From Largest Client Chart 5.5 Quality Of Consumer Debt Chart 5.6 Age Of Consumer Debt Chart 5.7 Number Of Clients Worked For Chart 5.8 Debt Purchase Market Growth Chart 5.9 Growth In Prices Paid In Debt Purchase Table 5.8 % Of Purchased Debt Sent For Collection Table 5.9 % Of Purchased Debt Sent For Collection Table 5.10 % Of Purchased Debt In Litigation Table 5.11 % Of Total Debt Referred To Court Chart 5.10 % Of Agents With Accounts Operating Under An Iva Table 5.12 Number Of Iva s Agreed To In Last 12 Months Table 5.13 Number Of Iva s Agreed To In Last 3 Years Table 5.14 Number Of Iva s Agreed To In Last 3 Years Table 5.15 Defaults Which Have Been Rescheduled In Last Year Table 5.15 Number Of Iva s Agreed To In Last 3 Years Table 5.16 Bankruptices In The Last Two Years 5

6 1. Executive Summary 1.1 Consumer Lending and Household Debt The growth in household debt, both in absolute terms and The growth in household debt, both in absolute terms and relative to household income, continues to cause some concern. As the economic climate changes servicing debt may become more problematic for a larger proportion of the UK household sector particularly as mortgage repayments rise and the opportunities for refinancing and restructuring current debt decline with the tightening of lender credit policies. Increases in financial distress and insolvency in the corporate sector could threaten jobs and household income in an already fragile economy. directly related to the growth in the number and type of credit card products available to consumers. Increased competition in financial services has fuelled the increase in available credit products and the degree of product differentiation. Households owe sums equivalent to 160% of disposable income. There are increasing signs that many households are struggling to service their debts judging by the growth in the use of private sector and voluntary sector debt management services. The record levels of personal bankruptcies as well as the steady rise in the indebtedness of households, the dramatic increase in the number of fraud cases, and excessive bad debt losses have prompted the industry as well as the government to once again examine the fundamentals of the consumer lending business. Increases in arrears levels, bad debts and insolvencies have peaked historically during and/or at the end of recession due to losses of income. What is particularly striking about the recent growth in bankruptcy and other indicators of financial stress is that the trend increase occurs against a background of generally good macroeconomic and monetary conditions, GDP growth, low interest rates, high levels of employment and strong asset prices. The 90 s peak occurred against a backdrop of economic decline and nominal interest rates in the region of 13-14%. The rise in household debt in Britain gained headlines in 2005 when, for the first time, it rose to over 1trillion. By the first quarter of 2007 the level of outstanding debts was around 1.4 trillion. This total figure includes secured lending, the majority of which is first mortgages and additional equity release. This amounts to around 80% of the total consumer lending. Unsecured lending, consumer credit, however, has grown rapidly over the past decade Gauging the extent of the household debt problem requires balancing the evidence provided by objective data from national statistics and the Bank of England with the vast amount of quasi-subjective information provided by debt advice groups, lobbyists and surveys of the opinions of debtors and lenders. There has been much, often alarming, press and media coverage that suggests something of a crises in household finances. These headlines are often fuelled by surveys of individuals that are in financial difficulty and the apparent increase in debt related problems being reported to counsellors, debt advice groups, the Citizens Advice Bureau and varies consumer lobbies. The increased availability of credit products and the competition for customers has facilitated a considerable market for the restructuring of debts i.e. moving debts to lower interest rates (balance transfers) or more typically extending the time period of the debt with lower monthly 6

7 repayments but, ultimately, at a significantly higher rate (consolidation loans). There is considerable evidence of households juggling finances via balance transfer, the use of loan consolidation products, making payments on instalments of secured credit agreements with unsecured credit (e.g. mortgage payments with credit card cheques). The Credit Reference Agency, Experian reported that 8.2 million individuals are in serious debt; 2.1 million are struggling with repayments; 2.5 million are concerned about their ability to manage debt and 2 million do not know the extent of their debts. A notable feature of borrowing in recent periods, since around 1998, is the extent of mortgage equity withdrawal as a source of borrowings. This primarily concerns releasing funds tied up in property for expenditure outside of the housing market (i.e. not used for house purchase of home improvements). The considerable growth in property prices since 2000 has created significant amounts of equity relative to initial mortgage. Clearly, households have been able to finance consumption (and unsecured debt re-payments) on the back of rising house prices. The buy-to-let and sub-prime (self-certified) mortgage market appears to be particularly vulnerable in the UK as well as the US. The quality of lending in these areas is suspect. The terms Liar Loans and ninanj (No Income No Assets No Job ) are phrases used to describe such lending in the US press but the quality of sub-prime mortgage portfolios in the UK is equally a risk to the housing market Reported statistics on debt 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 payments if we take only the credit active population then, in 2007, households are spending around 30% of their income servicing debt, up from around 20% 10 years ago. The Council for Mortgage Lenders report that the number of mortgages in short-term arrears rose to 125,100 in June 2007 which was slightly down on the previous year. The Bank of England s Financial Stability Report (2007, October) concludes that arrears will be concentrated in a small proportion of households with low income/high debt and that the number of arrears spanning the majority of the income and debt distribution is small but with changes in interest rates and growth in indebtedness there is a growing tail of vulnerable households The ratio of write offs-to-amounts outstanding for credit cards is also increasing steadily with a remarkable peak in the first quarter of The secured lending write-offs show a considerable increase in 2005 and 2006 with a peak similar to the end of They have started to decline in The levels of personal insolvency as gauged by the number of bankruptcies and individual voluntary arrangements show a quite spectacular increase since The beginning of this upward trend pre-dates the changes in bankruptcy law introduced in April 2004 although there is a clear acceleration in the levels of declared insolvencies post The Act appears to have encouraged individuals on the path to bankruptcy to declare early. The number of CCj s against consumers has grown rapidly since 2004 and reached a ten year high by the end of 2006 with 843,853 judgment orders. The growth has continued in 2007 with almost 250,000 judgements in Q1 and therefore the total could reach 1 million judgements by the 7

8 end of the year compared to just over half a million in Registry Trust estimates that around 70% of judgements are credit related the remaining 30% being for unpaid tax, utility bills and motor tax. Interviews with major lenders found that county court action in order to gain a charge on the assets of a debtor were becoming common practice. 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 with 57,321 detected cases reported to CIFAS and identity fraud, although slightly down had 57,302 reported cases. Recent international banking regulations (Basle II agreement) have drawn much attention to the re-evaluation of consumer credit risk (default probabilities) and portfolio risk management. The Basel II rules have given an impetus to banks to move debt more quickly from their books to external debt collection agents and debt buyers. The number of company insolvencies (compulsory and creditors voluntary liquidations) in the England and Wales was 3,194 in the last quarter of 2006, nearly half of the figure that was observed in the third quarter of Although the trend fluctuated around 3,500 insolvencies per quarter between 1995 and 2007, the figures have been much lower than the levels of the early 1990s recession. The seasonally adjusted figures provided by the Insolvency Service show 3,032 liquidations in the second quarter of 2007, representing a 4.2% decrease on one year ago. A forecasting model of aggregate corporate insolvencies shows that in the long term insolvency rate increases when income gearing or real CCJ values increase, and when the employment rate or real money stock decrease. 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. 1.2 Commercial Lending and Insolvency There has been a trend increase in the number of active companies registered with Companies House. The stock of active businesses approached 2.3 million in According to Companies House the number of new incorporations has been growing rapidly year on year e.g 43% In total, unincorporated businesses and SME s account for a significant proportion of the business stock. This is estimated to have grown by more than 1.4 million since The stock of small businesses is estimated at 3.8 million. SME s account for 52% of aggregate business turnover and 56% of private sector employment according to the SBS. The relatively high levels of indebtedness in the corporate sector coupled with recent interest rate increases and a decline in business confidence suggest that corporate insolvencies are set to increase by over 20% in the next 2 years. More recent data derived from an analysis of UK Company accounts suggests that the ratio of total debts to total assets has risen quite sharply since When we analyse ratios reflecting the ability of firms to cover their interest repayments on debt we observe a similar rise since This suggests that there are a large number of companies that are not generating sufficient profit to cover their interest payments. The considerable growth in private equity-backed leveraged buyouts has 8

9 increased the role of debt in capital structures. It is estimated that value of investments LBO s in 2007 was around 22 bn. Of course, financial distress and insolvency in the corporate sector threatens jobs and household income in an already fragile economy. The late payment of commercial debt as a phenomenon is enduring. The CMRC Quarterly Review monitors payment behavior across a sample of 2000 enterprises. Accounts which pay at or near the due date are currently reported at 54% by sales value. This leaves 46% of all sales accounts being reported as overdue by our panel of respondents. In terms of the number of customer accounts, the proportion of customers paying at or near the due date is slightly lower. 46% of our survey panel state that customers at an account level pay on time. This equates to 54% of all customer accounts currently being paid late. Recent survey statistics show a deterioration in B2B payment behavior. This trend is likely to continue since smaller firms rely increasingly on trade credit when bank credit is restricted. The Late payment of Commercial Debts (Interest) Act has had an impact of the extent of outplacement to the DCA sector. The fact that DCA s can impose an interest charge and recover some collection costs has made out-placing debt more cost effective for the commercial sector and particularly SME s. of centralised in-house collection and recovery functions and the development of technology and information systems devoted to account management; the speed of response of the major lenders in dealing with delinquent accounts and a shortening of the time period to write-off. Basel II rules have encouraged the lenders to shift debts off 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. The Credit Services Association reported that their member organisations handle around 15 billion of debt on a commission basis which consisted of over 20 million individual cases. This represents a rise of 10 billion since The CSA membership bought around 6 billion of debt in 2007 making of total of over 21 billion being passed to the DCA sector. The CSA estimate that their market will be worth over 24 billion in A source of potential revenue growth for the DC industry is as a provider of a wider range of out-sourced business services across the credit life-cycle. Outsourcing receivables management has increased, particularly for commercial debt. Government and the public sector are beginning to utilise the services of DCA s. The growth in the internet B2C and B2B has translated into more collection activity on a global scale. 1.3 Debt Collection Agents and Debt Sale A number of trends and industry dynamics have impacted on the out-placed debt collection and debt purchase sector. These include: the surge in consumer debt and increase in the volumes of delinquent debt that have to be processed; the increased emphasis on cost effectiveness and performance benchmarking; the continued re-engineering 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 their 'in-house' collection agents. Debt Collection Agents have turned to buying debt as an alternative to collection on commission in 2004 there were over 60 debt buyers although the DBSG suggests that currently there are around 40 regular buyers in the market. The growth in the market has been facilitated by the supply-side. 9

10 In the UK it is difficult to estimate the total size of the debt sale market since the market continues to evolve quite rapidly. The market size in 2005/6 was around 6bn face value selling at an average price of around 8p in the pound. By 2006/7 this had increased to 7bn and commentators are expecting the market to peak at around 10bn. Debt sale is still dominated by distressed debt portfolios i.e. debt that the financial sector would normally write-off and/or is severely delinquent is sold to the highest bidder for collection/recovery. It is clear that lenders have developed an interest in selling younger debt as a means of improving cash-flow and because of the costs of servicing the debt collection sector when debt is placed on a commission basis. The major lenders and the 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 sales are distressed debt which can attract only 2-5% of face value but there is evidence of sellers selling debt earlier, as in the US, typically days past due. The changes in accounting rules, Basel II and resultant changes in internal default definitions and capital requirements have had an impact on the propensity of lenders to sell debt. A further development is the sale of debt that has already been managed to achieve an arrangement to pay via a debt management company. This type of debt can attract pence in the pound. The development of a reseller market is expected to create further growth in the market. The main sources of debt sale are credit cards, loan and overdrafts, retail credit, motor finance and increasingly mortgage arrears. Further growth in the Debt Purchase market is likely to come from the sale of non-delinquent receivables, reselling and from commercial debt. A problem that is probably hampering the growth of the debt sale market is that of pricing. Interviews with major lenders suggested that there is some lack of trust in the market as a result of extant price variations. If debt is to be sold at earlier stages and /or segmented by quality then there has to be a mechanism for pricing the individual debts and the debt portfolio. The development of a broker market for debt sale and purchase has provided some uplift in prices. 1.4 Survey of DCAs 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. The statistics suggest a healthy growth in the market for debt collection with 75% of agencies indicate that market size is increasing in This compares to just 45% in % of agencies believe market competitiveness to be increasing. 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 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. Overall in the sample, the average value of a debt placed across the 10

11 entire sample has increased from less than 1000 in 2003 to 2400 in There appears to be growth in a number of sectors. The sectors that are generating a faster growth for the outplaced debt industry are the fixed line telephone sector and broadband providers. Collections within the retail sector 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 with 72% of respondents indicating this to be a growth market. In % of respondents thought that the quality of outplaced 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. Over 60% of collection agents generate their business from under 50 clients and generally collection agents are dealing with fewer clients than in receive 38p in the pound under an IVA and would accept a minimum of 32p. In terms of default rates collection agents were asked to state the the percentage of IVAs which had defaulted over the last 3 years. The default rate has more than tripled during the last three years and now stand at 13%. 1.5 Large Volume Debt Management Organisations faced with large volume debt management operations are setting up sophisticated customer focused operations aimed at 'reforming' debtors, if possible, so that the relationship with them can continue and generate future profits. This has been partly a response to increased competition amongst lenders, the emergence of 'consolidation companies' and recognition that changing life-styles and patterns of work have precipitated periods of 'over-commitment' by debtors which need be managed longer-term. The largest buyer of debt purchased a face value of 458 million compared to just 28 million in 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 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. The average length of time for an IVA is among the sample is 4.75 years. Agents also indicated that they expect to The introduction of enterprise wide data sharing has arisen because of the emphasis being placed on having a 'customer-level' and/or customer-life cycle view of each customer and detailed management information systems. The expansion of data-sharing closed user groups in the UK and the development of indebtedness indices means that lenders have access to better information on other lenders experience of a debtor, and can include this in their decision making process. The differences in information costs of in-house and out-placed debt collection are thus reduced. Collection cycles have become much shorter in financial services but opened opportunities for debt buyers. Basel II rules have resulted in reclassification of debtor portfolios in financial services with the development of new default 11

12 probability models. Internally lenders have moved to a time-based rather than event-based view of the debtor and emphasise re-aging or rescheduling debt away from collections and back into account management where possible and transferring ownership of delinquent debt. buyers in the future. A increasing role for debt brokers is expected to increase the scale of the broking market. 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 activitybased costing facilitates the evaluation of collections effectiveness. Sophisticated credit management in-house will inevitably reduce the 'quality' or 'collectibility' of debt that is outplaced. 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 12

13 2. An Overview of Consumer and Corporate Lending In this section, we analyse the main trends in consumer lending in the UK by examining aggregate time series statistics. First, we provide a categorisation of the types of lending activities by the major financial institutions and the corporate sector Categories of Lending 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). The banks, building societies, finance houses, retailers, local authorities and insurance companies make various forms of lending to both commercial and personal borrowers. Commercial organisations extend trade credit to their commercial customers and may make sales on deferred payment basis or credit accounts to individual households (e.g. Utilities, Cable TV). These debts are the potential source of business for the 'out-placed' debt collection industry. 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 13

14 2.2. An Overview of Consumer Lending and Indebtedness: Trends The growth in household debt, both in absolute terms and relative to household income, continues to cause some concern. Much of the growth in consumer debt has occurred within a confident economy with economic growth, high levels of employment, growing asset prices, easy access to credit and low interest rates and inflation. Despite obvious signs of some financial stress within the household sector most households have managed to service their debts. The economic climate appears to be changing: financial markets have highlighted the potential fragility of some lending portfolios that appear to be riskier than was anticipated; lenders have tightened credit policies and borrowers are becoming more cautious; interest rate rises are impacting on both the household and corporate sector; confidence in the housing market continues to falter; oil prices are rising. Servicing debt may become more problematic for a larger proportion of the UK household sector particularly as mortgage repayments rise and the opportunities for refinancing and restructuring current debt decline with the tightening of lender credit policies. Trading out of trouble and buying time are not going to be options. Any uncertainties about future income and property values exacerbates the problem. It is estimated that consumer credit has been rising by over to 1 billion per month with total outstanding debt in the region of 140 billion in Households owe sums equivalent to 160% of income 2. Since 2000, consumer credit and debt has been the subject of several high profile 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 policy. Initiatives and issues relating to Sub-prime lending, Affordable Lending, The Survey of Low Income Families and Credit Constraints have attracted some prominence in government. The Competition Commission s investigation into the lack of competition in the Home Credit market highlighted asymmetries in available consumer-level information and the pricing of sub-prime products. The Data Protection Act raised many issues and problems for consumer lenders. Recent international banking regulations (Basle II agreement) have drawn much attention to the re-evaluation of consumer credit risk (default probabilities) and portfolio risk management. The Basel II rules have given an impetus to banks to move debt more quickly from their books to external debt collection agents and particularly debt buyers. At the consumer level, there are increasing signs that many households are struggling to service their debts judging by the growth in the use of private sector and voluntary sector debt management services. The record levels of personal bankruptcies, as well as the steady rise in the indebtedness of households, the dramatic increase in the number of fraud cases, and excessive bad debt losses have prompted the industry, as well as the government, to once again examine the fundamentals of the consumer lending business. Gauging the extent of the household debt problem requires balancing the evidence provided by objective data from national statistics and the Bank of England with the vast amount of quasi-subjective information provided by debt advice groups, lobbyists and surveys of the opinions of debtors and lenders. In the next section we examine the statistics. 14

15 2.3. Consumer Credit and Indebtedness The rise in household debt in Britain gained headlines in 2005 when, for the first time, it rose to over 1trillion. By the first quarter of 2007, the level of outstanding debts was around 1.4 trillion. 3 This total figure includes secured lending, the majority of which is first mortgages and additional equity release. This amounts to around 80% of the total consumer lending 4. Unsecured lending, or consumer credit, however, has grown rapidly over the past decade, directly related to the growth in the number and type of credit card products available to consumers. Increased competition in financial services has fuelled the increase in available credit products and the degree of product differentiation. Lenders are concerned to cover all segments of the personal credit market from platinum to sub-prime with offerings tailored to attract all types of borrowers and interest rates (APR s) priced to reflect the differing risks in each segment. The scramble for market share has led to a considerable increase in balance transfer activity where consumers are offered low or zero interest rates for a period of up to 12 months if they transfer the outstanding balance from one card to a competitor. Moreover, the increased availability of credit products and the competition for customers has facilitated a sizeable market for the restructuring of debts, i.e. moving debts to lower interest rates (balance transfers) or more typically, extending the time period of the debt with lower monthly repayments but, ultimately, at a significantly higher rate (consolidation loans) Survey and Subjective Evidence There has been much, often alarming, press and media coverage that suggest something of a crises in household finances. These headlines are often fuelled by surveys of individuals that are in financial difficulty and the apparent increase in debt related problems being reported to counsellors, debt advice groups, the Citizens Advice Bureau and various consumer lobbies. In early 2005, lenders saw a surge in payment arrears, particularly, but not exclusively, on unsecured lending products. The Financial Services Authority, in its Financial Risk Outlook 5, reported that average outstanding balances on unsecured debt had increased quite substantially for a large proportion of households. They suggested that around 53% of households had average unsecured debts of 7,065. The average balance on secured debts was reported as 67,662 for around 40% of households. There were, at the time, reported cases where individuals had over 100,000 of outstanding credit card debts set against annual income levels of around 20,000 and examples of relatively low income individuals who had large unsecured debts spread across as many as 20 different credit card lines 6. A survey by the National Consumer Council 7, in 2007, concluded that the majority of households are managing to service their debt commitments. They suggested that 57% of households have no problems in meeting financial commitments, that 31% struggle from time to time, that 12% have difficulty managing their commitments and that a subset of 1.6% of households are in serious difficulties. Converting these figures into numbers of households/individuals, 3 million are struggling to keep payments up to date; 1.5 million are falling behind with payments; and 0.5 million are in serious financial difficulty, i.e. serious arrears. The trends were of concern. The NCC suggested that mortgage arrears had increased 4%; repossessions had increased 32%; credit cards arrears had increased 8.5% from an already high level; and contact 15

16 with advice agencies and debt management plans had increased by 43% and 48% respectively. A survey in 2006 by the Citizen s Advice Bureau, In Too Deep analysed 567 cases of debtors seeking advice. They suggest that debt is a continuing and often debilitating problem for an increasing number of people, with its effects often felt most strongly amongst the most vulnerable members of society. The CAB report an average increase in household debt of 30% between 2003 and 2006 with the average outstanding of over 13000, twice the figure reported by the FSA. Debts were, on average, 17.5 times the average monthly income. The majority of individuals in the survey were young (25-44) and single. The average household debt reported by Creditaction 8 in November 2007 was 8,681, which rises to 20,189 if only households with some unsecured debt are included in the denominator. The average outstanding mortgage was reported as 98,571. A recent report suggests the number of house repossessions have increased 50% in the last year to around 45, As borrowers reach the end of fixed interest deals taken out when interest rates were low, the number of repossessions could well increase further. New mortgage lending has fallen rapidly along with activity in the housing market. Most of the major lenders have reported increases in bad debts in the period Calls to the National Debt line have more than doubled since 2005 and stand at more that 300,000 per year. The CAB 10 reported that 1.7 million people sought debt counselling last year; 40% of whom had credit card and unsecured debt problems. They reported a 30% rise in cases of individuals struggling to pay energy bills. There is considerable evidence of households juggling finances via balance transfer, the use of loan consolidation products, making payments on instalments of secured credit agreements with unsecured credit (e.g. mortgage payments with credit card cheques). Chart Debt Client Characteristics 2006 (source: Citizens Advice Bureau Survey 2006) 16

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

18 The growth in credit outstanding is clearly closely linked to the level and growth in consumer spending over the time period. The chart to the right demonstrates the continued and strong growth in consumer spending in every period since 1994 and a continued but slowing growth in Consumer Credit Outstanding (excluding mortgages) Chart Consumer Credit Outstanding (source: Bank of England) % 8% Consumer Spending Growth Chart Consumer Spending Growth (source: Bank of England) Consumer Spending y on y 6% 4% 2% 0% 2% 4% Total Personal Debt bn, July 2007 In the context of total consumer borrowing, credit card debt forms only 4%, with mortgages and personal loans 4% 12% having the major share. Chart Total Personal Debt July 2007 (source: Calculated from Bank of England statistics) 84% Mortages Credit Cards Loans etc The chart to the right shows the relative shares of lending broken down as secured (mortgages) and unsecured (cards and unsecured loans) over the recent period. Thus, the growth in debt is associated predominantly with asset accumulation and house price growth rather than consumer spending Total Lending to Individuals Per Month August 2005 August 2007 total secured consumer Chart Total Lending to Individuals Per Month (source: Bank of England) Totals Outstanding (100%) secured ( 84%) consumer ( 16%) 18

19 A notable feature borrowing in recent periods, since around 1998, is the extent of mortgage equity withdrawal as a source of borrowings. This primarily concerns releasing funds tied up in property for expenditure outside of the housing market (i.e. not used for house purchase of home improvements). The considerable growth in property prices since 2000 has created significant amounts of equity relative to initial mortgage. The figures in Chart below examine the total additional amounts borrowed against properties and the percentage of disposable income withdrawn against existing equity and reveals a marked upward trend throughout the period and, after a sharp decline in 2005, further growth in 2006/7. Clearly, households have been able to finance consumption (and unsecured debt re-payments) on the back of rising house prices during this period. As a percentage of disposable income Chart shows a sharp upward trend since 1998, reaching almost 9% by the end of The previous high of 7.7% in 1988 coincides with the beginning of the last major UK recession. The sharp decline in 2005 coincides with a tightening of credit policy amongst the major lenders as a result of record high levels of arrears on credit products at the beginning of However, the growth in equity release in relation to income continued to grow in 2006, reaching 7% at the end of 2006, but has fallen again in 2007 to around 4.5%. This, however, is more likely to be a supply constraint, as a result of the tightening of lending terms, rather than a fall in demand. Chart Mortgage Equity Withdrawal M (source: Bank of England) Mortgage Equity Withdrawal m 20,000 15,000 10,000 5, , Chart Mortgage Equity Withdrawal as a % of Disposable Income (source: Bank of England/ONS) 10.0 Mortgage Equity Withdrawal as a % disposable income

20 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 Secured Lending Chart 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 after recovering from a bottom in January 2007 once again. However, both the bottom and the top peaks failed to reach the levels of the recent years up to This may well be explained by the increased interest rates in Number of UK Resident Banks sterling approvals and that of both Building Societies and Other Specialist Lenders sterling 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 Jan-02 UK Resident Banks Building Societies Other Specialist Lenders Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 taken some effect. The 12 month growth rates of the number of the total approvals and UK Resident Banks approvals followed almost the same route as expected from the majority share of the banks in secured lending. Despite UK resident banks majority and a negative growth rate (-0.5%), in August 2005, building societies and other specialist Chart Month Growth Rate of Secured Lending Approvals to Individuals (source: Bank of England 2007) Total UK Resident Banks Building Societies Other Specialist Lenders lenders positive rates (both around 15%) were enough to make the total rate positive (4%) as well. However, UK resident banks 12 month growth rate is also positive (3%) in September 2005, which shows an overall rising trend Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 However, this stabilized and has shown a steady downward trend up to July