November 2009

From Cross-Sales to Cross-Defaults: Dealing with Multi-Account Credit Risk

Richard Tambor and Kenneth Alverson

Retail banks long have aspired to sell multiple products to each customer, hoping to boost relationship profitability and also strengthen ties with households. But many banks focused on the retailing aspects of cross-selling, including marketing, sales and product design.

Meanwhile, individual product divisions tended to focus on asset growth within their own silos. Seldom did banks look at the big picture of managing composite household credit risk.

Now this imbalance has come back to haunt the industry as the retail banking market is rocked by "once in a generation" losses. Nationally, hundreds of thousands of households are in arrears on multiple accounts with various banks.

It is a complicated problem, given that a single customer relationship can comprise credit exposure across all retail banking product lines, including the first mortgage, home equity loan, credit card account, auto loan and student loan.

With many billions of dollars of credit extended to multi-account households, banks urgently need comprehensive information and proactive strategies that will help them deal with a growing mountain of distressed loans and collections activities.

Conceptually, most banks would agree it is not ideal to have collections teams from several product areas each trying to negotiate with a single household. Yet this is exactly what happens today in most situations — product silos vigorously competing with each other as well as with other creditors.

Three Stages of Response

There are three major stages of management response, including: 1) building composite household information; 2) creating new risk analytics that look across multiple product areas; and 3) developing proactive treatments that will help to coordinate workout and collections activities in a balanced manner that works best for both lender and borrower.

Composite Information. A complete picture of household credit extension is needed, drawing on the various credit product silos within the retail bank. Though banks have been pursuing household cross-sell for several decades, many have not yet organized their internal customer information accordingly.

The reasons go beyond winning cooperation from the various credit product silos. Each area typically uses its own specialized technology platform. To compile customer information, the bank must build a centralized data warehouse and establish feeds from the product silos. A further challenge is to go beyond information on household members to building a picture of the total household relationship.

Perhaps the biggest impediment is a management perception that robust data integration is a lower priority than other uses of corporate resources. The current retail credit catastrophe should help settle this question, given the disadvantages of pursuing household workouts and collections on a product-by-product basis.

Risk Analytics. In pressurized situations, over-indebted households begin to make tradeoffs among various repayment obligations. Traditionally, for example, it was thought that families would almost always give mortgage payments priority over other obligations. More recently, the reverse has held true as sinking housing values eroded the motivation to "hang on" to the principal dwelling.

Either way, repayment tradeoffs affect the institution that faces delinquencies on multiple credit products sold to the same household.

It is crucial to identify this type of risk exposure, along with early signals of household distress. That is why banks need to broaden their understanding of composite household repayment patterns, leverage in-house transaction data (for example, with checking accounts) and monitor external changes in credit-related behaviors.

Proactive Outreach. The ultimate goal is coordinated customer management. Often today, various internal collection teams unknowingly compete with each other for recoveries from a single household. In addition to averting this counterproductive overlap, banks should devise workout arrangements that address the larger household credit picture.

In this more comprehensive approach to multi-account defaults, the borrower’s general circumstances must be assessed, including the situation’s root causes, overall ability to repay and continuing issues that must be considered.

Consolidated workout programs for distressed borrowers are fertile ground for innovation and continuous improvement. The goal is to test various arrangements, analyze the results and incorporate refinements into new offers that again can be tested.

Looking Beyond Crisis Mode

Unquestionably, banks need to follow up on their cross-selling successes with coordinated programs to manage multifaceted household credit relationships.

The immediate tactical payoff will be an improved collections operation. In the post-bubble world, where pressured households can easily have a dozen or more credit accounts to contend with, a nuanced collections process is needed to help the institution make its way to the front of the line for repayment.

Fortunately, an intrinsic advantage of cross-selling — relationship "stickiness" — plays to the advantage of the institution in loss mitigation. Customer loyalty can be a powerful factor in winning borrower cooperation. Moreover, in-depth customer relationships let the institution better assess household financial dynamics and respond to signals of impending distress.

In the next year or two, substantial opportunities will arise to enhance earnings by assessing risk and managing credit from a total customer relationship perspective.

Perhaps the biggest question is whether this will become a top priority. Within many banks today, credit product units are severely isolated.

In our view, this means that people such as the head of retail banking, the chief financial officer, the head of risk management and even the chief executive officer must step in — and quickly.

Richard Tambor and Kenneth Alverson are Partners in the New York office of Novantas LLC, a management consulting firm.