Host:
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The COVID-19 pandemic has ushered in a series of fundamental challenges to the US economy. Like the great financial crisis of 2007 to 2008, it has reshaped the landscape of consumer lending, but in a very different way. During the COVID-19 pandemic, individuals have curtailed their spending amid layoffs, while the federal government has injected billions of dollars back into the economy in the form of stimulus checks. E-commerce was a key beneficiary, and it looks like newly established purchase pathways are here to stay.
In this episode, we discuss COVID-19 recovery opportunities in consumer lending with our panel of expert consultants. We hear from Robert Haslehurst, managing director with a focus within L.E.K.'s retail and consumer products practices. Also Peter Ward, an L.E.K. partner focused on corporate strategy development, who has worked on a diverse set of consulting project across the technology, financial service, and consumer product industries. So to get started, considering government activity, access to credit, and the economy, what has been the impact of COVID-19 on consumer lending activity?
Robert Haslehurst:
Let's start with the impacts of COVID-19 on the economy and on consumer spending and the money in people's pockets. And then you can kind of flow that back through how the impact is on lending. I'm Rob Haslehurst. I lead L.E.K.'s Boston office and do a lot of our work in the consumer sector with a particular focus on financial services and how financial services providers meet consumer needs here in the US. I'll actually start with the US government and what they've been doing here to ensure that the US consumer still has money to spend and still has the ability to meet their own obligations. In the face of COVID-19, there were a number of actions that I think we all recall where through 2020, different government stimulus actions were put into place to put money into the pockets of consumers to give them some breathing room as you think about rental payments, or think about loan repayments, and ensuring that there was reduced forbearance on mortgages and student loans.
And those fiscal relief provisions, including enhanced unemployment, including direct stimulus, including sort of forgiven student loan debt and exclusion of forgiven student loan debt from taxation really ensured that throughout the pandemic so far, and particularly 2020 through early 2021, delinquency rates on loans were low relative to historical levels and relative to prior economic disruption that we've seen in other recessions, really a very different story as it related to the consumer lending environment. What that meant though was that the actual lending for unsecured loans went down as well. Although the access for credit was often there, the need and the driver for what drives a lot of loans historically was reduced.
Now, as we've seen 2021, you've seen the consumer already return to spending, to some extent services, but particularly goods. Access to credit cards, personal loans started to rebound as expected to continue. You've seen macroeconomic factors have improved. You've seen different ways of COVID certainly, but consumers having more confidence as to how they spend their time, how they spend their money, and in any wave like that, particularly where consumers have been used to having a backstop or maybe been less disciplined through the the last year and a half. You are also seeing some consumers at least kind of overextend and those government programs going away. And so we do expect that the consumer lending and the need for credit is and will continue to rebound as you think about that stimulus coming off, and so balances will go back up.
So COVID wave's not withstanding. Economic conditions have largely stabilized in 2021. And the outlook for the going forward is relatively positive. And that is prompted a good back job under good conditions. However, there's still a lot of uncertainty, a lot of unknown. Unemployment remains relatively high. A lot of people haven't reentered the job market. And so lenders have continued to implement restrictions on lending or to be more thoughtful around who they lend to. At the same time, a lot of the changes that have happened over the last 18 months, and particularly the forbearance programs that have happened and the implications on how consumers think about [inaudible 00:05:31], have changed the changed the landscape, have made it much harder to interpret credit scoring, have made it much harder to interpret the way that consumers have behaved recently as a predictor of go forward behavior.
And so there's understandably some reticence to rely on that data, and therefore question marks as you think about credit scoring, as you think about how to underwrite, and as you think about how to potentially collect on defaulted loans on a go forward basis, given how consumers have behaved. Now, we do expect that as vaccines continue to be administered, as businesses continue to reopen not withstanding the current environment, we do think that the consumers ability to manage the debt going forward will continue to increase and that quality will improve, but lenders are going to be cautious about stepping into that. They're going to be cautious about opening up from the low risk consumers that they're going to start lending to or have started lending to, whether it's very clear long term history on repayments, and extend into higher risk groups and ones where there is more risk.
However, as lenders look to grow, as lenders look for their own revenue, they're going to need to step into that slightly higher risk consumer. They're going to need to reassess their lending criteria and ensure that their risk appetite is increased to ensure that fundamentally their books aren't run off and that their incomes don't fall to unsustainable levels, given their organization. So we do expect that lender risk appetite will largely rebound and be in a position where lenders want to lend, consumers will need the money, and the industry will have to find ways to make the two meet that will look a bit different to how they did before the pandemic.
Host:
Thanks, Rob. Let's talk innovation for a moment. What has been the impact of COVID-19 on consumer lending innovation?
Robert Haslehurst:
The consumer lending market was innovative before COVID-19, and I think it's worth remembering that context. So consumer borrowing options were already on the rise when COVID-19 hit, but the pandemic threw that really into overdrive, as it did across a lot of the consumer landscape. It really opened the opportunity for technological innovation. It opened up the ability for FinTech lending platforms to access both new, small businesses and new consumers. And that need for change and the appetite for interacting with businesses in different ways has absolutely increased as it has across the economy. As an example, mobile apps are offering easier and faster ways to borrow money. The user experience has been streamlined and really in line with what consumers are experiencing in other parts of their lives and of their commercial life that the consumer lending market has had to meet that, has had to catch up, has had to ensure that they can meet the needs of emerging demographics and consumer expectations.
Many big banks and legacy loaners are looking at their FinTech rivals, are learning from those. Some of the best practices that you are seeing, that the successes and the failures are being observed widely by the market. And that's really causing the legacy industry to say, "Okay, what can we adapt? How do we think about what innovation works for us? What are the things we need to fast swallow?" And so there are a range of things that are really emerging as best practices and not just confined to those FinTech innovators. So starting with data, using data, using psychometrics around the consumer, using our lot richer set of information in order to assess credit worthiness. Secondly, really deploying accounting integration to provide financing for short term needs. Tied to the data piece, harnessing artificial intelligence to really transform the relationship in a scalable way to being a long term partnership, rather than just the transactional lending, being able to understand where the consumer is in their life cycle and potentially meet their needs in different places and have that lifetime value element that is harder to do on a transactional basis.
And then building ongoing relationships, not just through that marketing and AI driven piece, but membership models, thinking about how to really incent the consumer to stay with a lender and to use them through different parts of their needs and life cycle.
Peter Ward:
I'm Peter Ward, partner of L.E.K, co-lead of our global financial services practice. And in particular, I spend a lot of time around consumer finance, whether that's banks of large or small types, specialist lenders, including complex and subprime lending. So COVID has also acted as a catalyst for lenders to adopt new technologies to stay competitive and actually just to respond to the initial emergency in the first place. So where everyone immediately had to work at home, office environments were closed and bank branches were closed. There was no option but to use remote and online channels. And that's done two things. One is to cause a step change of adoption from those people who weren't really using those channels much before, and the other is to accelerate adoption and the progress of those institutions already using those channels.
And those things are supported by market level statistics as well. So you can look at, for example, how much consumers use online channels and digital platforms. So 40% of US consumers say they use digital channels significant more frequently than before and well over half of consumers say they now do most of their financial transactions on mobile, both of which are significant advances on what was happening prior to the pandemic. And you get as many as two out of three consumers using digital platforms at least weekly, and that's rather changed the landscape in terms of what are the market positions of financial institutions using digital innovations so the become a much more natural port of call for people who are now accustomed to behaving and interacting with their banks this way. And those who were best prepared and perhaps frustrated with rather slow rates of digital adoption should be pretty well positioned to take advantage of what's happened as a result of what is effectively a sort of mass forced experiment in using online channels and tech.
So that that's more driven by the emergency and downside, but of course, the fact that these institutions are using online and digital more, it offers positive opportunities as well, so you can study consumer journeys in a lot more detail and consumers can be a lot more receptive to new offers of credit, for example, that you can tailor to their needs instantly online in response to how they're behaving. And it means that that all the type of service and smooth engagement, omnichannel, all those types of things that people have been talking about for years, they become central to competition. And those lenders that have already been working on that have an advantage now, and they're likely to win going forward. It's probably also worth mentioning specifically point of sale lending.
So this is where lending is offered alongside a purchase at the point of sale, so traditionally in a physical retail store, but in the pandemic a lot more adoption in online channels. So that has become a lot more common just as online spending has increased. And e-commerce merchants there, they're great places to do this. And you can observe what consumers are doing during the purchase process and promote those things to the consumers whilst they're doing the purchase, which is a lot smoother than it would be in a physical retail store where you show up at the checkout and someone's offering you a lending option, the queue builds behind you, all that sort of stuff.
So it's much smoother online. And this has really grown. And the retailers like it, because they can lend money alongside and increase the spend that consumers are making, and the lenders themselves benefits as well. So [inaudible 00:14:13] a firm after pay for example are good... They're good instances of third party lenders who have partnerships with retailers that are really well integrated into the checkout process. And the pandemic has accelerated the sort of smoothing out of that process, which had already been going on, and it's just become quicker, more accessible, easier to do. So around the world, but specifically in the US, there's been really rapid growth in that particular, fairly new product line.
Host:
Peter, we expect some challenges in lending due to COVID-19, so how would you categorize them? And will they be short term or long term challenges?
Peter Ward:
So there are two sets of challenges really associated with COVID-19. So the first set are conventional macroeconomic challenges that would go alongside any financial recession or macro problem. So increased unemployment, for example, somewhat lower incomes, and so on, reducing repayment rates. But there are some specific one-off behavioral changes that we think probably have changed the way that lending will work permanently, at least in part. It's also true that at this stage, many consumers, given the macro environment since the end of the GFC, have never faced these types of unemployment conditions or interest rates at anything very far above zero. So I would argue that consumers are uniquely unprepared for the situation in macroeconomic terms versus any previous recession over the last 30 years.
And that means that lenders also face corresponding challenges associated with that. As consumer behaviors are different for the reasons we talked about above, consumers are less well prepared for this type of situation they than they have been in previous recessions. And also, emerging technology, data sources, all those things mean that it's a slightly different environment to try and address these challenges as well. So there are some short term challenges, many of which are largely overcome now. So for example, the operational challenge, just the volume of forbearance requests from distressed customers through a lot of 2020, which is now largely processed, but that did challenge the resourcing levels, the working methods of banks and lenders in ways that they have had to adapt to, and now largely have adapted to.
The forbearance measures themselves have also been a challenge in the sense that you wanted to go and collect money from people who were in arrears. But lots of those forbearance measures meant you simply were not allowed to collect in the same way that you normally would, and that has an impact on recovery rates, on lending. And thirdly, just because of the remote working, the requirement to do that, it's been pretty difficult to use what we regard as normal working methods. People aren't accustomed to having to do remotely and having to invent on the fly operational plans and methods, which are well beyond what the contingency plans that the banks and lenders had in place, had ever envisaged. So, well beyond any reasonable expectations.
So those things were big challenges, and elements of that continue and will continue if there are repeated resurgences of COVID. Beyond that, into the long term, some of the changes we were talking about above... So the way in which credit [inaudible 00:18:13] needs to be assessed will be quite different, I think, in two respects. So the one is the standard credit scoring information that people would've had isn't of that much use at the moment, because it's confused by forbearance and whether forbearance is actually recorded as missed payments or not, for example, how much people have benefited from government measures to give them cash to get them through the pandemic, that sort of thing. So that makes underwriting more difficult. And also, I think fundamentally, if pandemic, and potentially, hopefully not, but potentially other pandemics in due course, I mean, we just expect a more volatile environment. Perhaps lenders just have to make allowance for the fact that there will be more volatility and repayment than there has been historically.
So it's worth noting, actually, delinquencies on loans. So, failure to repay actually haven't been so bad during this period, and certainly compared to compared to the GFC where defaults were much, much higher. It has been okay, but most institutions initially responded pretty negatively in terms of their willingness to write loans and... The largest retail banks, so JP Morgan, US bank, Wells Fargo, for example, all tightened their lending standards around mortgages, and there's extremely heavy competition for the very lowest risks, but less willingness to lend outside that. And outside the banks, it was a substantial challenge for those businesses, some of whom had had funding challenges related to higher delinquency rates. And many of those had to cease lending altogether. But now, as perhaps Rob was mentioning earlier on, realizing they have to resume lending to keep their operational cost bases covered and so on. So they will come back, but it will be a challenging environment with a number of simultaneous new things to deal with.
Host:
So finally, Robert and Peter, are there any particular bank types or classes of lenders that will see opportunities more so than others? And if so, what are the key strategies they can take to successfully navigate the post COVID 19 era?
Robert Haslehurst:
So there are a variety of strategies that can create success going forward. They differ though by bank type, by lending class. And I think we see particularly strong opportunities as you think about either specialist lenders or those who have really access and capabilities around complex data driven underwriting capabilities. So if we kind of take each class one by one. We'll show you what that means. As we think about big banks, they really need to make sure that they sustain their position and really capture the now 7 out of 10 Americans who say that they would switch to a financial institution with more inclusive lending practices. They do have the capabilities and the technology team, so to really build out and use machine learning, to use big data, to use the information that they have about their customers and those who approach them to augment the credit reports that Pete talked about earlier, to really use realtime income, realtime cash flow data to make better decisions. And the banks can do that.
They also need to accelerate their shift to online channels. As we talked about before, COVID has been a catalyst towards that in a direction they were heading in any case, but the consumer is really demanding seamless engagement throughout the process, seamless underwriting, a servicing experience that is in line with what they see across the broader consumer landscape. And large financial institutions that prioritize that, prioritize digital innovation and doing something a bit different are better for their consumers, are, we believe, the ones that are going to win and be most competitive over the long term. Small banks obviously are going to be less well positioned to write those large checks and to make that investment in the behind the scenes experience. But there is a big segment of the consumer group that is really looking for trustworthy lenders.
There is that local element is still going to appeal to a segment of the consumer base. And as long as the small bank can meet that with an appropriately frictionless consumer experience, so an intuitive digital application process, personal loans for new [inaudible 00:22:51], some degree of self-serve and sort of omnichannel experience that maybe off the shelf, or maybe working with third party software, as opposed to something they develop, but certainly a necessity in order to compete and to sit alongside both the large banks and the specialist lenders in terms of meeting what consumers and small businesses are looking for.
Peter Ward:
So, as Rob was mentioning that the opportunity at this stage of the macroeconomic cycle is best for specialist lenders and subprime lenders. So it may feel counterintuitive to say that in a recessionary or economically challenged situation, what you want to do is to take more risk. But actually, what happens is, the mainstream institutions contract their credit appetite, as we've discussed earlier on. And that means that a bunch of customers who were previously addressed by mainstream banks are now rejected by them, and those quite good credit risks become available to address for the specialists and subprime lenders. So at this stage of the cycle, both specialists and subprime lenders, first and foremost, need to position themselves market appropriately to make those consumers who are newly turned away or have received significant higher rates from mainstream institutions, to make those people aware of their existence to take advantage of that opportunity.
And particularly, those who have access a good data, sophisticated underwriting skills, and so on, continue to reinvest in those strengths. So, make the use of the tech solutions we mentioned above, make the use of the data, continue to streamline processes, and so on, and really make hay while the sun shines in this industry over the next few years and try and position themselves, continue to hold those customer relationships beyond the end of the crisis, of course, because customers never like to be turned away. So there's an opportunity to double down on these customer relationships and retain them beyond the end of the crisis. And there are some specific things to do. So we talked earlier on about the opportunity to offer point of sale financing. That's a particular area which is fairly complex to underwrite for people who are not the most prime.
So that's a particular product line that should be positively received at this point. And lastly, to keep investing in automation, rules based. So, subprime is typically associated with sort of complex whites of the eyes underwriting where you get to know the individual, understand their circumstances, and so on. And you still need to do that, but to try and do that in a way which is efficient and keep your rates competitive. But really overall, there's opportunity for lenders of all types in this situation. It's just a... It's a complex situation. It's one where being absolutely informed of current tech, current working methods, and so on is essential. But for people who do that and can consider risk appropriately, there's very substantial opportunity at this time, but most particularly in the specialist and subprime areas.
Host:
Economic shocks and the downturns they yield also create opportunity. And COVID-19 is no different. And unlike in the great financial crisis, the federal government has provided a significant amount of fiscal relief to help consumers meet their loan obligations. Banks, and specialist lenders, and their investors need to embrace strategies that make the most of their capabilities while directly addressing the needs and evolving behaviors of their target customers. To download the detailed executive insights from this conversation, locate the link in the show notes or visit lek.com. Thank you, our listeners, for joining us today at the Inside Exchange, presented by L.E.K. Consulting. Links to resources mentioned in this podcast can be found in the show notes. Please subscribe or follow for future episodes wherever you listen to your podcasts. Also, we encourage you to submit your suggestions for future insights online at lek.com.