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January 7, 2019

Auriemma 2018 Annual Letter: Payments and Lending Retrospective

January 7, 2019

As a kid, there were only three important events on my calendar each year. The last day of school, my birthday, and Christmas. Now, it seems there are three or more important events on my calendar every week! The staccato rhythm of the days, weeks, and months and the need to keep moving from event to event gives the impression that the pace of the treadmill has been turned up.

Given the rapid tempo of our lives, it becomes increasingly important to take a moment now and then to pause and reflect on some of the events and trends that took place over the last year and consider how they will influence the future. As many of you know, I’ve tried to do that by way of this annual letter, since 1992.

As our Firm has grown, our audience has become more diverse and it has gotten increasingly difficult to write a letter that captures everyone’s attention. While I suspect a few intrepid souls will bear with me for the next three thousand words, I suspect many others might choose to glance at the headlines and decide to read sections more selectively. For those who still can’t get enough, we’ve introduced hyperlinks throughout the letter to provide quick access to relevant examples of Auriemma research. Either way, I hope you enjoy this year’s annual recap.

Over the last several years, a big focus of our annual letter has been the challenging regulatory environment. For many of our clients, regulatory activities and compliance overshadowed almost everything else. It dampened innovation and, for many, the ability to grow or pursue new strategic paths. This year, that pressure seems to have been quelled a bit. That isn’t to say that there is less regulatory burden or pressure. We are told regularly by our clients that the bar is just as high as it’s been, despite the anticipated pullback given the new regime in DC and Brexit distractions in the UK. However, the pace of change has slowed. And that, in and of itself, feels like an improvement.

Lenders now understand the environment in which they are operating and how to navigate the complexities brought about by the heightened regulatory focus. So, for a change, we won’t be spending any more time on regulation in this letter. Instead, we’ll talk primarily about how lenders are preparing for the future, which seems to be the overwhelming focus for our clients.

According to key economic indicators, 2018 was terrific: strong GDP growth, record low unemployment, and confident consumers. On top of that, tax cuts bolstered corporate profits.

But despite all the good news, everyone keeps asking: “When is the next recession? And, how bad will it be?”  It’s no wonder everyone is worried: US consumer debt was slated to hit $4 trillion by year-end, according to CNBC. Because consumers have multiple financial obligations, the risk of contagion is also of concern. Auriemma’s consumer research finds that significant numbers of credit cardholders also have a mortgage, an auto loan, a student loan, and/or other personal loans. Will one of these products reach a tipping point that sets off the next credit cycle?

Certainly, it isn’t just the passage of time that concerns folks about the next inevitable downturn. Auriemma Roundtable data show that delinquencies for some products have been on the uptick. Early in 2018, for example, we reported that delinquencies for subprime auto loans reached recession-era levels, resulting in captive auto lenders pulling back on the subprime space. In card, absolute losses were anticipated to increase 30-40 basis points—although it’s important to remember that they remain near historic lows.

Despite a lack of consensus about when the cycle will turn, many agree that the next downturn won’t be as severe as 2008 – thanks, in part, to the lessons that organizations have learned, the vigilance executives are applying when developing strategies, and the protective measures being put into place, including higher levels of capital. Card issuers, for example, have developed early warning systems and increased scrutiny on underwriting, leading to lower approval rates and average credit lines. In short, there is a heightened sense of awareness today that didn’t exist a decade ago. However, there is also a high degree of sensitivity to any uptick in losses, with investors often reacting sharply to changes in loss performance.

It’s not just US lenders anticipating potentially rockier times ahead. In the UK, GDP growth has slowed, bankruptcies and insolvency figures have increased, and Brexit has perpetuated uncertainty. UK players are conducting stress tests and analyses to measure the impact of an economic downturn. The UK’s Financial Conduct Authority is focused on persistent debt, debuting a new set of rules meant to help cardholders who aren’t able to make headway on paying down their outstanding balances. In response, issuers are hiring and training agents to manage persistent debt-related calls, as well as crafting journey maps for affected customers.

While lenders are keeping a cautious eye on the economy and their delinquency and loss curves, they are also finding ways to bolster their profitability on the operational side of the house—an area where Auriemma Roundtables play a significant role.

After years of hiring armies of compliance and risk professionals, we’re seeing increased focus on the development of, and investment in, tools and technologies to work smarter, faster, and leaner.

It’s still early, but we are seeing more automation being deployed across many use cases. AI and robotics are being used to refine and automate processes in back office functions to improve efficiencies and workflows behind the scenes. AI is also being used to mitigate card fraud and to help increase the accuracy of real-time approvals and the reduction of false declines. Lenders are investing in predictive servicing within the IVR, which can better anticipate customer call reasons by identifying where they are within the customer journey. Chatbots are being deployed everywhere – some with intricate backstories and personalities.

Meanwhile, voice analytics will be leveraged to identify customer sentiment and tag complaints. Lenders are looking to automate everything from fraud holds to decisioning counteroffer tools. And, robotics will be tested for more and more complex tasks to improve on—and eventually remove—human intervention, including in underwriting and decisioning.

Lenders are still working hard to convert customers from analog to digital platforms and are making strong headway. However, I had to laugh during a recent conversation with a senior exec who recently took over his bank’s digital migration strategy. He said, “Until now, our strategy was to treat people badly in traditional channels and hope they’d migrate to digital.” I don’t think his bank is alone! Whatever the driving force, after years of prodding, customers are availing themselves of a plethora of digital and virtual tools. According to Auriemma Roundtables benchmark data, the percentage of cardholders enrolled in digital servicing is increasing, with a 24% growth rate over the last three years.  And in the UK, e-mail topped the list as cardholders’ preferred method of communication with their issuers, according to Auriemma’s UK Cardbeat study.

Our auto lending clients are increasing their efforts in this area as well. Currently, just 43% of auto loan borrowers are enrolled in e-statements and only half of auto lenders offer online chat, according to Auriemma Roundtable data. However, things will change: The current best practices include automatically enrolling new customers in e-statements, digitizing account opening agreements, and making some features, like travel notifications, available exclusively online. A handful of auto lenders are providing self-service functionality for extensions and deferrals as well.

Despite all of this, the old maxim rings true: “Be careful what you wish for.” Digital servicing was supposed to be the holy grail of cost reduction. But while enrollment has grown tremendously, overall call volume is flat. It turns out, digital customers are more aware customers – and they are calling with complex questions or disputes, not simple balance inquiries.

2018 saw new product launches and growth from FinTechs continue at a rapid pace. Yet, many executives I speak with wish they could get odds in Vegas on the number of FinTechs that won’t survive the next credit cycle because they’ll either lose access to funding or stumble due to a lack of expertise in credit risk. Certainly, that will be the fate for some. But, increasingly, the FinTechs we talk to are savvy and chock-full of resources with deep expertise and executional experience.

In 2018, you likely received a deluge of mailers advertising unsecured personal loans. That’s because the product is now the fastest-growing consumer lending product, with unsecured personal loan originations increasing 15% between Q3 2017 and Q3 2018, according to Experian. The product’s popularity has been linked to the erosion of HELOCs as post-recession consumers grow increasingly reluctant to use their home as collateral.

In a September Auriemma Research study, we found that nearly 9-in-10 consumers are satisfied with their personal loans, driven primarily by the speed of funding, clear terms and conditions, easy application process, and lack of unexpected fees… all of which further elevate the product in the mind of the consumer relative to HELOCs.

Experian also reports that FinTechs are responsible for roughly one-third of total unsecured personal loans, while plenty of large and mid-sized banks have also joined the fray. Incumbency is a strength traditional banks can play to their advantage. When we asked consumers their reasons for choosing a lender, 19% said an existing relationship was a top driver. While that may sound low, it topped a list of 22 reasons about which we asked.

In 2019, FinTechs will have some strategic choices to make. With the OCC announcing it would accept applications for a new Special Purpose National Bank (SPNB) charter, FinTechs will have to decide if they will leverage the charter and become more traditionally regulated entities, comply with the various requirements of multiple states, or operate with the popular partnership model. Each strategy, of course, has significant consequences for their future viability, the pros and cons of which we’ve been spending a lot of time discussing recently.

In the UK, Open Banking regulation has cleared the way for third-party issuers, brands, and FinTechs to offer enhanced banking products to consumers. The potential use cases range from account aggregation to reward services, and major players in payments and retail are investing resources into developing services, including Amazon, John Lewis, HSBC, PayPal and Uber. As a result, we can expect a more level playing field for new entrants and greater competition that will extend beyond the UK, thanks to the PSD2 mandate that all EU payment account providers build APIs by July 2019.

Partnerships between incumbents and FinTechs will be crucial to success in the world of Open Banking. Any organization that opts not to partner could risk eventual disintermediation. These developments could have a major upside for co-brands to deliver innovative, money-saving rewards by using new spend data.

Regardless of whether you see FinTechs as competitors, disintermediators or potential partners to traditional institutions, your organization’s philosophy and ability to respond to a rapidly changing landscape will be critical.

In the co-brand arena, 2018 saw fewer splashy RFPs and renewals from large programs. But, in the US, several well-known brands have extended existing contracts (JCPenney, Lowe’s), changed partners (Walmart) or launched new programs or offerings (Ikea, Hyatt and American Airlines). In the UK, Virgin Atlantic Airways demonstrated that there is a strong future for co-brands, even in a post Interchange Fee Regulated environment, by launching a product with a market leading proposition.

Meanwhile, customer value propositions have continued to grow richer. This year, Hilton enhanced its sign-up bonuses for all its co-brands and Barclays announced it will refresh the value propositions for Frontier Airlines, Hawaiian Airlines, and Upromise cards. Starwood, Macy’s and LL Bean all have debuted new tiers and rewards. This heightened focus on rewards begs the question – at what point does the rewards war become too rich to sustain?

Given our comments earlier about a possible credit downturn, we believe co-brand issuers will likely hold fast or tighten existing credit criteria for co-brand programs. As a result, we expect an increased appetite for “second look” programs, which allow co-brand partners to approve more applicants, including underserved customers with lower credit scores or thin credit files. These programs are commonplace in certain types of private label programs – it will be interesting to see if they gain traction in more traditional co-brand programs.

Factors like richer rewards, credit concerns, and restrictive regulations add to the challenge of managing a successful co-brand program. At the same time, longer deal terms make “getting it right” even more important. As such, we are convinced you’ll see much more active management of relationships both by issuers and their partners. Both parties will be evaluating performance earlier and earlier in the deal cycle to ensure that the program is operating at its fullest potential. Everyone will be more conscious than ever about whether cardholders are attracted to the product and behaving in the way that was predicted. The Auriemma co-brand team is actively working with several clients to improve program performance and assist with ongoing management. This is a new area of focus for us, and one we think will become increasingly sought after by partners looking to maximize the success and longevity of their card programs.

Perhaps one of the most disappointing results of 2018 is that mobile payment usage in the US remained flat at 31% among eligible cardholders for the second consecutive year. Interestingly though, the number of mobile payment options has continued to expand, thanks to the continued launch of merchant wallets, bank wallets and other payment options. While two years ago, the dominant players were Apple Pay and Google Pay (formerly Android Pay), there are now a plethora of options, including Capital One Wallet, Kohls Wallet, ChasePay, Walmart Pay and others.

With all the new options, why is usage flat? According to Auriemma’s Mobile Pay Tracker, 55% of mobile pay users say there are too many payment options, and 53% say the options have become too complicated. Perhaps the industry is more enthusiastic about these products than are consumers.

So which wallets will be the eventual winners? Mobile pay users say they prefer open-loop wallets (55% compared to 23% who prefer closed-loop, and 22% who have no preference).

Another ingredient for success? Wallets that can be used for things other than payments – such as Apple Pay’s announcement that students can now use its wallet to carry digitized IDs that can open dorm rooms and function as library cards. Users are increasingly hungry to use wallets for non-payment purposes, with 40% of mobile payment users telling our Mobile Pay Tracker researchers they are interested in using mobile wallets for event tickets, membership cards, and boarding passes.

Meanwhile, Chase recently announced it would roll out contactless cards to its Visa and co-branded card portfolios by the first half of 2019. When combined with NYC’s debut of contactless MTA turnstiles, we are hopeful the US is on the cusp of widespread adoption, similar to what happened in the UK market when contactless debuted in 2007.

Although I admit that my experience using chip at the point of sale has improved dramatically from the initial roll out, I still find it to be a bit haphazard and less seamless than the old mag stripe used to be. And, I’m still stymied by trying to pay with my phone in the US. But after spending six weeks in the UK during 2018, I found the contactless card experience to be intuitive, easy and fast. As we look toward 2019 and beyond, what remains unknown is how quickly contactless will be embraced by consumers, and whether adoption will be stoked by merchant availability or organic cardholder enthusiasm.

As I wrap up this year’s letter, I wanted to share a few of the ways the Auriemma team is preparing for an exciting 2019.

In 2018, we partnered with noted behavioral economist Dan Ariely to develop a Behavioral Economics Initiative, which will produce exclusive, member-only research that can be applied to industry and commercial objectives, including product innovation and process design. This initiative will formally kick off in February.

This year, we will be developing new data initiatives in our Roundtable practice that will make it even easier for clients to leverage our benchmark studies to inform company strategy. These improvements will include new ways to auto-import data, resulting in an easier data submission process.  We’ll also be developing tools that offer more data visualization and are easier for executives to manipulate and interrogate.

As I noted in last year’s letter, our firm undertook a complete re-branding exercise in 2018. In the next few weeks, we will unveil an updated name and website. Our Roundtables practice now represents nearly 70% of our business. When combined with our M&A and research lines of business, traditional consulting comprises a smaller percentage of the work we perform for clients.

So, after 35 years, we are dropping the word “Consulting” from our moniker and will now be called Auriemma Group. In addition to an updated look and feel, our new website will make it easier to find and share the research and data we produce– such as the examples I have linked throughout this year’s letter.

Be on the lookout for an e-mailed announcement when our new site goes live.

In the meantime, I hope you had a happy and healthy holiday season and that 2018 treated you kindly. While none of us really know what 2019 holds in store, I’m confident that as an industry, we’ve put the right preparations and measures in place to safely navigate whatever comes to pass.

As always, if you have any questions or comments about our thoughts in this letter, or otherwise, please reach out. We’d love to hear from you!

Cheers!

Michael