With more borrowers making hard choices about the bills that are most important to pay, more collection shops are adopting a kid-gloves approach to recoveries.

Lenders are experimenting with changes to formulas to determine when they cut slack to late borrowers, and how much to give, says Vijay D’Silva, director and co-head of the payments practice at McKinsey & Co. Inc., New York.As a result, collections has evolved into a marketing game.

“The call-and-collect approach doesn’t work as well as it used to, especially if you’re competing against other lenders for the same dollar," D'Silva adds.

Consumers have a limited pot of money each month, says Liz Jordan, a senior manager at the governance, regulatory and risk strategies practice at Deloitte & Touche LLP, New York. Issuers know they are competing against other debts, including delinquencies on competitors’ cards. “They really want to be in line first,” she adds.

At American Express Co., the scale of expanded breaks given to borrowers has been significant enough to put a dent in interest income. At a meeting with investors and analysts late last year, Daniel Henry, AmEx’s chief financial officer, said the company is more inclined to pursue the minimum due rather than the full balance, turn to litigation against customers with high balances and forgo interest charges and fees on severely delinquent accounts.

AmEx would not say how many cardholders are getting a break under the new collection practices, or how big the breaks typically are. The company declined to say whether the strategies have helped delinquency rates – though it did say delinquencies would have fallen in the second quarter without them.

The reason for the shift in collection strategies is “to keep certain card members active and, over time, they turn out to be really good long-term customers,” according to Henry. “Another portion of those may eventually write off, but that will provide us the opportunity to have a higher level of collection from them.”

The new collections approach might explain a 1.3-percentage-point drop in the net interest yield on AmEx’s U.S. credit card portfolio from the previous quarter to 9.5% in the second quarter, Henry said at the time.

Bottom Of The Wallet

Jim Bramlett, a managing director at New York-based consulting firm Novantas LLC, describes the industry's move toward larger and more generous settlement offers as “a blunt instrument” that reflects “the degree of distress in the industry.

David Sisko, who runs the default management group at Deloitte, says that because of heavy losses, credit card lenders “need to try dramatic things to get dramatic results.”

And it appears many are following that advice. To wit: Bank of America Corp. said it expected the year-end numbers will show it modified approximately 1.2 million credit card loans in 2009.

Citigroup Inc. officials would not say whether the company has changed its approach to collections because of increases in delinquencies.

Samuel Wang, a spokesperson at Citigroup, says its programs to help troubled borrowers, including one that offers “matching payments which go toward reducing the customer’s outstanding balance,” are part of an “ongoing process.”

Discover Financial Services said it has “done some fine-tuning” to its collections practices “in the face of the challenging environment.”

Capital One Financial Corp. officials report that the lender now contacts borrowers sooner after they show signs of falling behind, among other changes it has made recently when dealing with consumers who appear to be in trouble. JPMorgan Chase & Co. declined to comment for this story.

Range Of Strategies

McKinsey & Co.’s D’Silva says the nature of unsecured debt has long made credit card lenders more sophisticated than other financial companies when it comes to collections. Without collateral, card issuers must rely more on models of consumer behavior, for example.

But amid a rise in credit losses and a multiplication of the potential sources of personal financial distress – including the strain of mortgage debt – the palette of forbearance strategies for late borrowers has increased dramatically, D’Silva says.

Lenders introduced five-year [term loan] plans, for example, that were not seen just two years ago, he says. One reason is that borrowers increasingly do not have the wherewithal to make big one-time payments.

Alan Mattei, another managing director at Novantas, says increases in “roll rates,” the percentages of late borrowers who proceed from being one month late to deeper stages of delinquency, prompted many lenders to step up settlement offers in an effort to secure some kind of payment before the borrower’s financial condition deteriorates beyond repair, or before another creditor claims whatever can be salvaged.

“You need to make some sort of appeal to the person in a way that’s going to say, ‘I’m trying to work with you here.’ If you can create a bit more affinity between the rep and the customer, you’re likelier to get through and likelier to get them to pay what little bit they can in your favor,” he says.

But it can be a struggle for large organizations to field efforts that successfully appeal to borrowers’ emotional needs, and lenders have been strained by the challenge, Bramlett says.

While lenders are willing to give more ground to troubled borrowers, operational obstacles to implementing wholesale changes to collections and queasiness over the economics of forbearance have hamstrung the industry.

“It’s hard for issuers to make a confident forecast as to whether or not they’re better off in making a major concession. It’s quite a bet,” Bramlett says. “It takes six or 12 months to judge whether bigger concessions produce a better outcome for a lender – for example, by measuring results against a control group not offered more generous terms.

As Mattei describes it, “Even if I decided to take the leap of faith, how do I now implement that and train that across 8,000 people on the phones? And my system changes take six to 12 months, and training cycles for that many people can take another month or two at a minimum.”

Moving early with large breaks also runs the risk of making needless concessions. People who lose their jobs can find new work, for example, and late borrowers can regain their footing.

Masking Future Problems

Moreover, as in the mortgage sector, where borrowers frequently fall behind again after receiving a modification, there also is much doubt about the effectiveness of concessions.

Some analysts attribute much of a recent improvement in delinquency rates to lender forbearance that is only masking credit problems that will emerge later.

A temporary reduction in the minimum monthly payment for a borrower who is trying to secure a mortgage modification, for example, may allow the borrower to stay current for a time, but without an improvement in the overall employment picture, any given borrower’s financial situation is unlikely to improve.

Rick Wittwer, who oversaw collections and recoveries while working as an executive at Washington Mutual Inc.’s cards unit and at Providian Financial Corp., says that because settlement installments can exceed the minimum payment amount under the original contracts, such stressed accounts can be classified as current.

Overall, Wittwer believes various forbearance strategies may have lowered delinquency rates by 20 to 30 basis points in recent months. A basis point is one-hundredth of a percentage point.

Though regulators require reserves reflecting exposure to customers who have been granted forbearance, Wittwer says, the forbearances still cloud the picture provided by delinquency rates and raise questions about the strength of the turn suggested by figures in recent months.

AmEx, for one, is cautious about how its new tactics will affect its credit performance. At that meeting held in the third quarter, Henry reported that the company had nearly doubled its reserve coverage of late U.S. card balances from the previous year, to 254% in the second quarter, in part because of uncertainty surrounding the changes in its approach to collections.

Sisko, with Deloitte, warns, “Until we see core improvement in the macroeconomic factors that are causing the high delinquencies, you’re going to see a higher than 50% redefault rate.”

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