Minimize Losses or Maximize Profits?

The efficacy of every creditor’s recovery operation is most often measured at the end of the accounts receivable lifecycle, long after customers have been selected or credit has been used. To monitor the credit crisis, reporters largely rely on net charge-off rates and bad debt allocations to measure how issuers are performing financially. These metrics only tell part of the story.

For a more comprehensive view of a credit issuer’s recovery performance, take a look further back. The ultimate performance of every company’s bad debt operation begins with a decision about who receives credit in the first place. Even after a borrower is approved, every credit issuer has a number of tools at its disposal to manage how borrowers use credit. By monitoring a borrower’s transactions for unusual activity or monitoring how his credit score changes over time, credit issuers bring their collection efforts back, not only to the period before charge-off, but to the period before a transaction even takes place.

This way of thinking about the extension of credit and subsequent collection efforts leads to a question that is infrequently asked in recovery circles: is a credit issuer approaching recoveries with the goal of minimizing losses or maximizing profits? From a post-charge-off perspective, we tend to think of the two as one in the same: as we recover more receivables, more money drops to the bottom line.

By thinking of collections in the entirety of the customer experience, something else follows: it is entirely reasonable for a credit issuer to accept a higher net charge rate if cash flow follows. Here’s an example involving an issuer’s selection of two different customers – which would you rather have?

	Customer 1	Customer 2
Credit Extended	$10,000	$50,000
Chargeoff Rate	5%	10%
Chargeoffs	$500	$5,000
Cash Collected	$9,500	$45,000

All other things being equal, every credit issuer should choose Customer 2 over Customer 1, despite a charge-off rate that is twice as high. Even post-charge-off, an issuer is likely to recovery more from Customer 2, either through its own efforts or through the efforts of a service provider.

Better profits can follow from more liberal extensions of credit, and an issuer’s net charge-off rate is not the only metric that should be followed as credit issuers improve their financial performance in difficult market conditions.

Paul Legrady is a Director at Kaulkin Ginsberg Company, a leading strategic advisory firm to the credit and collection industry. He can be reached by email.