Credit Risk and Bad Debt Management tn the UK Retail Lending Market

• Covers both the unsecured and secured lending markets including credit cards, unsecured personal loans and mortgages.
• Examines how consumer debt has increased over the years and how the IVA, bankruptcy and Debt Management Plan industries are growing.
• Analyses bad debt management strategies among retail lenders.
• Covers the debt collection sector.

• Learn about your competitors' strategies to curb bad debt in the future
• Learn about your competitors' strategies to recover bad debt
• Gain a thorough insight into the issue of increased consumer debt in the UK

CHAPTER 1 INTRODUCTION

Scope of the report

Who is the target reader?

How to use this report

CHAPTER 2 OVERVIEW OF CONSUMER DEBT IN THE UK

Introduction

Consumer debt has increased in recent years causing fears of overindebtedness

An increasing number of households are facing debt problems

The £1 trillion consumer debt figure is not as scary as it appears, said the Bank of England

The governor of the Bank of England recently announced that a 'potentially large social problem is materializing', as debt problems are mounting

The number of registered CCJs increased in 2005 after 15 years of continuous decline, thus stressing that debt troubles are on the rise

The average UK adult owed £4,122 in unsecured debt at the end of 2005, representing an increase of 5.0 per cent over 2004 levels

Debt-laden consumers are increasingly seeking solutions to their debt problems as personal debt reaches high levels

Many debt-troubled consumers are reaching a solution to their debt problems via DMPs, IVAs and bankruptcies

A debt management plan is a non-legally binding agreement that allows the borrower to benefit from reduced monthly repayments

Under an IVA, the debtor can generally clear their debt after five years

Bankruptcy is generally a solution of last resort

While no official data is available on the number of DMPs contracted, it is likely that DMPs have also increased in popularity

The fact that debt solutions companies are prospering has led to increasing investor interest

The top seven IVA providers accounted for roughly 60 per cent of the IVA market in Q3 2005

Due to prosperous business, debt management companies are attracting investor interest

A few issues have surfaced, as the number of consumers seeking debt solutions has increased significantly

Fears of mis-selling are surfacing, as the number of IVAs and DMPs has soared

The industry has raised concerns about graduates entering into IVAs to clear outstanding debts

Increased concerns about consumer overindebtedness have prompted the financial services industry to react

The FSA launched an online debt test to help borrowers assess whether they are likely to run into financial difficulties

The Banking Code Standards Board has strengthened their code of practice

However, there are signs that debt problems may get worse as households are now more vulnerable to economic upsets

While economic prospects for 2006 look less pessimistic, the overall picture remains sluggish

Unemployment has been rising steadily

The base rate may rise as the economy faces inflationary pressures

Conclusion

CHAPTER 3 CREDIT RISK AND BAD DEBT MANAGEMENT IN THE RETAIL LENDING INDUSTRY

Introduction

Lenders are feeling increased pressure on their business as bad debts are creeping up

Borrowers' difficulties in meeting repayments have started to feed through to lenders' secured books

Debts write-offs by UK banks on lending to individuals accelerated in 2005

Moreover, the ratio of debt write-offs to balances outstanding has also increased, albeit marginally

The majority of lenders have witnessed an increase in arrears levels and impairment charges

Lenders have had to increase their provisions for bad and doubtful debts, as a result of consumers defaulting on their repayments

Lenders are reconsidering their credit risk and bad debt management strategies in order to curb future bad debts

An increasing number of unsecured loan providers have now introduced more rigorous lending criteria

Lenders are adopting a more stringent lending policy by raising their cut-off points in their credit scoring models

Despite bad debts being far from being a major concern for the mortgage industry, some lenders are adopting a more precautionary approach to lending

Sector caps are being used on seven-year term unsecured loans by Lloyds TSB

Meanwhile, Lloyds TSB is one lender that has introduced sector caps on its seven-year unsecured loans

Credit card providers are putting less focus on mass-acquisition promotional offers

Unsecured lenders are encouraging their existing customers to consolidate high credit card balances into a personal loan with a view to turning unstructured debt into structured debt

Some credit card providers are using computer systems to automatically prevent deliquent customers from using their card

Slowly, lenders are partnering to share positive data on consumers in order to curb bad debts on their unsecured lending

Slowly, banks are moving to share more data

Abbey, Barclaycard, the Co-operative Bank and Egg agreed to share 'behavioral' data in early December 2005

Lloyds TSB, HBOS, HSBC and RBS have agreed to share current account data in March 2006

The move towards positive data sharing will slowly lead to a shift towards credit scoring models based on affordability

In the absence of better data sharing, lenders are concentrating on cross-selling unsecured lending products to their existing customer base

Some lenders are now using consumer indebtedness indices from credit agencies to make a better lending judgment

Callcredit introduced a postcode level consumer indebtedness index to combat overindebtedness

In a similar vein, mortgage lenders are moving towards an affordability approach rather than income multiples in order to prevent overindebtedness

A few lenders have increased their prices on some of their unsecured lending products in order to be in a better position to face higher risks of bad debt in the future

Abbey, Alliance & Leicester, Royal bank of Scotland and Nationwide have increased their rate on authorized overdrafts

Moreover, lenders are strengthening their collections function in a bid to limit impairment charges

Lenders are stepping up their debt collection activities by investing in technology

Some lenders are moving from the 'one-size' fits all approach by segmenting customers who have defaulted into separate groups

Lenders are increasingly making use of debt counsellors to help customers in financial trouble to sort out their finances

Third party debt collections agencies are increasingly being contracted by lenders

The debt collection industry is expanding significantly

Debt collections agencies are the subject of a review by the OFT

Conclusion

CHAPTER 4 CONCLUSIONS

Introduction

A few points can be concluded from analysis presented previously

Bad debt has definitely become a worrying issue and is likely to get worse

But what could be the worst case scenario?

Lenders do not have any control on past lending decisions...

...but most appear to be doing enough to prepare themselves against future deterioration

Going forward, lenders need to focus their efforts on a few areas

Lenders will gain by stepping up their collection processes

Co-operation with IVA agencies may assist in recouping some of the losses

Lenders should make data sharing a priority

CHAPTER 5 APPENDIX

Supplementary data

Tables relating to chapter 2: Overview of Consumer Debt in the UK

Tables relating to Chapter 3: Credit Risk and Bad Debt Management in the Retail Lending Industry

Definitions

Bank of England base rate

CAGR

CCJs

IVAs (Individual Voluntary Arrangements)

Loan-to-value (LTV)

Remortgaging

Research methodology

Relevant readings

Future readings

Datamonitor's custom research capabilities

The Retail Banking team

List of Tables

Table 1: Pros and cons of DMPs, IVAs and bankruptcies

Table 2: Provision for bad and doubtful debt for a sample of lenders, 2004-2005

Table 3: Typical APRs on unsecured loans of £5,000 for a sample of lenders, January 2005 and April 2006

Table 4: Interest rates on authorized overdrafts on current accounts for a sample of providers, January 2005 and April 2006

Table 5: Average unsecured debt and average debt to income ratio split by age group, 2006

Table 6: Average unsecured personal debt by region, 2006

Table 7: Number of bankruptcies and IVAs in Wales and England, 2001-2005

Table 8: Debt management plans arranged by the CCCS, 2001-2005

Table 9: Number of CCJs registered and on record, 1986-2005

Table 10: Number of bankruptcies in England and Wales, 1996-2005e

Table 11: ILO unemployed by age groups, indexed 1996=100, 1996-2005

Table 12: Number of arrears and repossession on record, 1995-2004

Table 13: Debt write-offs by UK banks, 2001-2005

Table 14: Debt write-offs of UK banks as a proportion of balances outstanding for lending to individuals, 2001-2005