New Zealand Credit Law Bulletin - Vol 9, No 6, September 2009
A free, plain English review of recent law and items of interest for creditors, produced by Hattaway & Associates Ltd, Credit Consultants. To subscribe, visit the New Zealand bulletin index and enter your details on the right
Plain language disclaimer:
This bulletin is not legal advice. Do not make decisions on legal matters based on a brief commentary. Instead, get professional legal advice.
In this issue:
- Debtors v creditors in the Global Financial Crisis
The Mercantile Gazette 2009 Annual Review of the Credit Industry - Just what is a credit risk strategy?
Every business has one, even if they don't know it - Which debt collection agency should we use?
How do you pick, and how can you judge performance?
1. Debtors v creditors in the Global Financial Crisis
We get our work based on relationships. We bend over backwards to look after clients who can’t pay. People have long memories. But there is a balance. You need to look after yourself as well.
Anonymous New Zealand financial controller, May 2009
Let me recap. Every May, the Mercantile Gazette gets me to write a feature article about the state of credit management in New Zealand. Last year, the most important issues seemed to be the fallout from the subprime mortgage collapse in the US (clearly a credit issue) and the likely consequences for New Zealand creditors if the world economy went haywire, as it subsequently did.
Since then, the world’s financial system has been put on life support, though our banks, and their Australian parents, appear (touch wood) to be among the most solid in the world. In recent years, some of our finance companies have turned out to be less solid, of course, and our banks did fuel the housing boom, but not as irresponsibly as the US banks did. Nor did our banks indulge in high risk derivative trading. Well done guys!
We deserve to have the shallow and short recession that the Reserve Bank predicted in December (when it claimed that we were no longer in recession!) but one thing that is clear is that no-one knows how long or how serious the global financial crisis is going to be. In an interconnected world, trouble elsewhere means trouble for us, and clearly there are lots of dominos still to fall. People and businesses are adjusting, but the adjustments often mean spending less, which means someone else makes less money, which means they lay off staff, which means they don’t pay their mortgages… and so on.
The big question this year is: how are creditors and debtors dealing with each other in practice, now that the crisis has hit?
Last year I wrote:
“Collecting debts in a recession is not the same as collecting in good times. If there is a recession, there will be more good customers who go bad, more stressed and angry customers, and more threats of violence or self-harm. … In these circumstances it’s even more important to treat debtors with respect. Bad things can happen to good people. … Businesses which can afford help customers through tough times should find that they build strong loyalty. … Credit staff who take a hard line early on will sometimes get paid where others miss out. Of course, in other cases they will upset customers who survive.”
Here’s an example of a business that was receptive to this idea. This business is a client of mine. It has strong competitors and a range of customers. For some of these customers, my client is its most important supplier.
Some of the senior management team of this business remember the early 1990s when New Zealand unemployment was 11% and many businesses in their industry struggled. My client supported some of those struggling businesses – obviously, only those they thought could survive – through that time. It got burnt by some, “but not too many.” In other cases, the business survived and the company won “customers for life”.
For the current recession it is tightening up its credit process, upskilling its credit staff, and putting the right resources in place to carry out more complex negotiations with distressed customers.
So this creditor is not intending to be a soft touch – any arrangement is likely to require guarantees from someone who is worth taking a guarantee over, and security over worthwhile assets – but it understands that it needs to support the end-users in its industry and it thinks it will be able to do this to some extent. I think it’s an example that other New Zealand businesses should see and learn from. When they are ready, I hope that they will go public about what they are doing, so they can get some good PR and win some new business.
Of course, there is another approach which is very much at the other end of the spectrum. Recently, I received an email from an overseas credit manager who I’ll call Veronica Veteran, who until recently worked for a business I’ll call Wellknownbrand. She was commenting on something I had written on a website about good credit managers being in demand. My argument was that because so many more debtors were in trouble, the discussions and negotiations over repayments were longer and more complex and required more skills. Veronica told me it was ironic to read this on the day she was made redundant from her role, along with several members of her credit team.
Wellknownbrand’s own success depends very directly on the success of its customers, much more so than is the case in a normal business. For this reason, Wellknownbrand has always supported these customers through any cashflow difficulties short of complete business failure. "The idea is to create a relationship which should be through good and bad,” says Veronica. It has pretty good security in respect of these customers – directors’ guarantees with assets behind them, and charges over the business (in some cases first ranked, in some cases behind a bank).
Now, however, Wellknownbrand is in dire financial straits. So dire that some trade insurers are saying they won’t insure suppliers who sell to Wellknownbrand. This means that for some products it is on 'cash on delivery' terms.
In respect of its own customers there is therefore a new approach and that new approach can be defined as, “pay up or you’re on stop credit and we’ll be suing in 7 days.” It's every man for himself. Of course, one consequence of this is that Wellknownbrand’s customers are likely to take a ruthless approach with their own customers, who will take a ruthless approach with their own customers … and so on.
“It’s all about cashflow,” Veronica says. She was instructed to develop a very rigid process. “Get the cash in the door. Take no prisoners. No scope for negotiation.” A good credit manager isn’t needed if the business decides on a policy of ruthlessness.
The thing that shocked me is not that Veronica lost her job – she’ll get another one – but that a business so dependent on its relationships with its customers would be so short-term in its credit management. The business knows it will lose customers (and it is; good customers are voting with their feet) and end up a much smaller organisation. But it believes it has to do this to survive.
Veronica is hearing the same take-no-prisoners story in respect of other credit roles she is now applying for, and hearing the same story from other credit managers in her country, from businesses with much less excuse.
Veronica, of course, understands that, “organisations have to do what they have to do in these times." But still, she’s in a good position to judge, and the bottom line is that Veronica thinks the approach to credit is wrong - unnecessarily brutal and foolishly short-term - even if the company is desperate for cash. Aside from the damage to the relationship with its customers, the creditor loses the chance of voluntary cooperation of distressed debtors. If debtors decide to be obstructive – to make things difficult for their creditors in order to punish them – they can slow down recovery of money, in some cases for years.
These are both trade credit examples. What about government and consumer creditors?
Well, on the government side, it’s good to see that the IRD, the New Zealand tax office, are actively encouraging struggling businesses to talk to them. “Please don’t bury your head in the sand… If a tax payment is coming up and you won’t be able to pay it, contact us as soon as possible – preferably before the due date. In most cases you’ll qualify for an instalment arrangement that allows you to repay your taxes over a period of time.” For some years they have been able to waive penalties and negotiate payment arrangements, but they’ve never gone as far as sending out flyers encouraging businesses to talk to them.
As for consumer creditors, I know of a couple of very large ones who have recently head-hunted experienced collection agency managers to sort out their credit management operations, and presumably make them more like those of debt collection agencies. Debt collection agencies, of course, don’t have the constraint that their clients have; they don’t want ongoing business from the debtors they are collecting from, so they tend to take a harder line. But unlike Wellknownbrand, most consumer creditors are happy to have a consumer debtor set up a steady drip-feed payment, so I don’t think we’re seeing a major change. Consumer creditors are trying to avoid driving debtors towards bankruptcy, because it’s here that the biggest change in the consumer debtor/creditor relationship has occurred.
Debtors who owe less than $40,000, have, since December 2007, had a new, easy way out of their financial difficulties – the “no asset procedure”, a form of insolvency which they come out of, free of their debts, after only 12 months. Australia tried a similar option, then quickly scrapped it because it was clearly a rort, but for some reason we’ve picked it up.
In the 12 months to the end of March 2008, bankruptcies and NAPs totalled 3318. Over the 12 months to the end of March 2009, bankruptcies and NAPs totalled 5108. Graph 1 shows that after a slow first few months, total insolvencies have been consistently well up on pre-December 07 figures.
GRAPH 1 – source data – Insolvency.govt.nz
The fundamental complaint of creditors is that the NAP option makes it attractive and easy for unscrupulous debtors to abuse the system. In many cases those entering the NAP are debtors who were paying off their debts without default and without any obvious change in circumstances. The perception is that what has changed is that they have realised that there is an easy way out of their debts.
GRAPH 2 – source data – Insolvency.govt.nz
GRAPH 3 – source data – Insolvency.govt.nz
Graph 2 shows that while numbers of NAPs have increase rapidly, the number of applications has gone up even faster. Graph 3 shows the increasing percentage of by the Insolvency & Trustee Service. I believe the Service is trying hard to retain the confidence of the business community by applying more and more rigorous standards to NAP applications. Essentially, staff are becoming better at spotting and turning down applications from debtors who have hidden assets, run up debts in order to profit, or in some other way tried to beat the system. But for this, the number of NAPs would be even worse.
However, as more people become familiar with the process, they will become more sophisticated in their applications. While most people are basically honest, giving them an easy opportunity to make or save a large amount of money will encourage dishonesty. If you give people this opportunity, they will learn to take advantage of it.
The global financial crisis is a result of lots of factors, but at its core is the issue of lending too much money to consumers. The ultimate trigger was high-risk “subprime” mortgages in the US, but it’s not hard to see that poor lending and borrowing decisions in New Zealand (on everything from investment property to credit cards) played its part in creating the situation we are now in, and the difficulties we face. Prosperity based on consumers buying things they don’t really need and can’t really afford doesn’t make good sense. In hindsight, it’s easy to see why it wasn’t a recipe for enduring prosperity.
The NAP is clearly aimed at dealing with just that problem – rampant consumerism and high risk lending. But giving people an easy way to go bankrupt and avoid their debts is only one possible way of dealing with these issues, and far from the smartest. Making finance companies less profitable, as the Credit Contracts and Consumer Finance Act 2003 did, was another attempt at dealing with the problem, but again, only a small corner of the problem.
But the global financial crisis and the numerous failures of New Zealand finance companies have largely dealt with rampant consumerism, at least for the moment. People are paying off debt rather than buying things that they don’t need. Government should take this opportunity to look at more sensible and more comprehensive ways to address consumerism, and while they are doing it, they should scrap the NAP. It may arguably have been justified as a short term fix, but now it should go.
The way debtors and creditors deal with each other affects people’s lives, and affects the society we live in. Hard times drain society's reservoir of mutual goodwill. It’s likely that the way debtors and creditors treat each other over the next two or three years is going to affect how people treat each other for the next few decades. It’s not just about creditors treating debtors well. If debtors have an easy option – the NAP – to rip off the local credit union, or the bank, or the plumber, it’s a bad thing for New Zealand society.
Peter Hattaway is a director of Hattaway & Associates, credit consultants – www.hattawaysconsulting.com. This article first appeared in the Mercantile Gazette, MG Business, in May 2009.
Back to top
Information on our current seminars
2. Just what is a credit risk strategy?
Here’s one of the things most people don’t understand about credit management. Every creditor business will have some sort of credit risk strategy, even if they don’t put it into words, and even if it’s not very good. Sometimes the strategy is common to an industry, sometimes it’s specific to a particular business. As a consultant coming into a business, one of my challenges is to work out the strategy for that industry and that business, and see whether it makes sense, then to work out whether my client should copy any of the elements I’ve seen from other strategies.
One of the traps for credit managers who move from one industry to another is that they assume that the strategy for the business they are moving to should be the same as that for the industry they are familiar with. So you might have, say, an ex-banker who knows that directors’ guarantees and security over the business-owner’s home is normal and works well for bank loans. He therefore tries unsuccessfully to impose these in a new industry where he has been appointed to a credit manager’s role, even though it’s not the norm there.
On the other hand, I see some situations where trade creditors don’t realise that they are in much the same position as a bank in respect of a particular customer. In those cases, it should therefore make sense to demand the same sort of security that a bank would get.
Let’s take the credit risk strategies for New Zealand electricity retailers in respect of their residential customers from say 1996 to 2005 as an example. I worked with most of them over this period. It was a simple strategy, so I’m giving away no trade secrets. Bear in mind that I’m generalising furiously, and that things changed significantly after the Muliaga tragedy.
An important feature of power companies, as with most utility companies, is that they have very, very large customer-bases which they regularly bill relatively small amounts. The sheer numbers tended to determine what was believed to be feasible in terms of credit strategy. The profit margins on electricity are low, but there is an awful lot of it sold, and most customers are honest and pay on time. Unlike many other businesses, power companies don’t grant credit as a marketing strategy to encourage customers to buy more. It’s simply that they don’t know in advance how much a customer will want, so they let them use it, then they bill them monthly for the amount they’ve used. (In Australia, some power companies still bill – or did until recently – on a two or three monthly cycle, which, from a cashflow perspective, is an appalling system for both customer and power company).
So how did our power companies try to judge and reduce the risk? Unlike most consumer creditors, many utility companies had no application form and no identification check for residential customers. Instead, most applications were done over the phone, on the assumption that most people are honest. This was a cost-saving measure which has probably lost them much more money than they realise over the years. People are less likely to worry about leaving a bad debt if they know they gave a false name when they applied.
Of course, as time goes on, more systems are put in place to stop the cheats, but traditionally, most power companies didn’t carry out a credit check on a database like Veda. Instead of a credit check, they looked for a reference from the customer’s previous power supplier. For customers with no previous power company history, they might have just charged a bond, though bonds are messy to administer and hard to extract from hard-up customers. In some cases they judged risk based on whether the customer was renting or owned their home, a home owner being seen as a good risk. Most power companies also had a prepaid option where customers would pay in advance for a certain amount of power, but the cost of setting up this type of meter almost certainly meant that they would lose money on these customers.
An important piece of the puzzle for most power companies was (and still is) a substantial prompt payment discount. Disconnection and reconnection fees also provided an incentive for customers to do the right thing.
When customers defaulted, power companies would send a letter (because the numbers of defaulters were thought to be too high to phone) then cut off the power. As that was the norm and as each power company was a monopoly in its own area for most of the period we’re talking about, they could get away with this. Close to 100% of customers would quickly pay to get the power turned back on, so losses were relatively low. The greater proportion of residential bad debts was probably from people who were up to date when they moved house but, by oversight or design, never paid their final bill.
Increased use of direct debit and automated credit card payments reduced the “whoops, I forgot” defaults over the years, but on the other hand, the Muliaga tragedy, increasing competition from other power companies, and the constraints of the Electricity Commission have created new challenges.
So in summary, the risk strategy for power companies in respect of non-business customers until recent times could be summarised as: try to get bonds from the riskiest customers, set up automated payments if possible, give an incentive to pay on time, and cut off the power quickly when people default. That’s a credit risk strategy at its most basic, and, for most power companies (and most customers) it worked well.
Interestingly, some power companies have had another credit risk strategy that they offer for a relatively small number of fixed income customers. Each month those customers paid an estimated monthly average by automatic payment, evening out the low bills of summer and the high bills of winter. This suited low-income people with little disposable income to meet peak costs.
Once a year there was a wash-up; the power company adjusted the regular payment to reflect the actual usage, and might refund any overpayment or ask for cash to meet an underpayment. In theory, a more fine-tuned version of this could work for the entire residential customer-base, especially if combined with new meters which report power usage to head office every 15 minutes.
Credit strategies don’t have to be fixed in concrete. They can change to reflect new ideas, new technology, and, at the moment, the global recession. The first step, however, is to understand what your current strategy is.
Peter Hattaway is a director of Hattaway & Associates Ltd, Credit Consultants – www.hattawaysconsulting.com and can be contacted at peter@hattaways.com. This article first appeared in the Mercantile Gazette in May 2009.
Back to top
Information on our current seminars
3. Which debt collection agency should we use?
Tough times encourage people to set up debt collection businesses – I know of at least three New Zealand finance companies which are now also advertising collection services, and no doubt there are many other newcomers to the game. The barriers to entry are almost non-existent. Crimes of violence or dishonesty may bar you from being a repo agent, but they don’t stop you collecting debts. I’m often asked: which collection agency should we use? This seems like a good time to put down some thoughts on the subject.
Note that I’m talking here about debt collection as it is usually understood: where a creditor collects its easier debts with a reasonable degree of effectiveness, but hands on the debts it considers largely uncollectible, and often writes them off at this point. If you’ve written them off, then anything an agency recovers is a bonus, so in one sense, there is not too much point in agonising over which agency to use.
How can we expect the newcomers to go?
I’m sure some will prove to have what it takes, and others will find that it’s much harder than it looked from a distance. Collecting hard debt is a hard way to make money, and creditors will get smarter about collecting in-house as the recession continues. The debt that they pass on in a year’s time will be worse.
Bear in mind that working on a commission which might be, say, 25% of money collected, a collection agency has to be a lot better at debt collection than its clients – who gave up trying even though they got 100% of the money collected. Of course, debtors sometimes pay simply because they fear a collection agency more than they fear an ordinary creditor.
What should you expect of a debt collection agency?
You should expect an agency to have more familiarity with and a better understanding of the practicalities of the civil litigation process than most creditors possess. Many creditors pass debts on because they want to go legal, but don’t want to manage that process in-house. Things have changed in this area, however. Twenty years ago, credit managers tended to give agencies a free hand to initiate legal action, and some of the major debt collection agencies made more money from legal documents than from commission. When creditors wised up, legal action dropped to a fraction of its former volumes.
Another thing some creditors look for in an agency is superior tracing, perhaps based on sources of information that they don’t have themselves. Some unscrupulous collection agencies may have illicit sources of information that help it track down consumer debtors, and some of their clients will be well aware of this. Note that there was a case in Australia some years ago where a bank was badly embarrassed by its use of agents who were bribing civil servants for information.
At what age should you give debts to an agency?
Debt is at its most collectable when young. One of the main thrusts of collection agency marketing used to be to try to persuade creditors to hand debt over earlier. That’s when the agency is most likely to succeed and therefore earn its commission. And, to be fair, if the creditor isn’t doing anything useful to collect the debt in-house, then it should be handed over to someone who can do the job better.
Is bigger better in debt collection agencies? Is longer-established better?
The track record of the people behind the business is always worth looking at. The longer they’ve been around, the more people will have an opinion about them. I’d be looking for “substance”, which may come from longevity. It may also come from a newcomer to the industry putting in significant capital, or from a finance company building on its existing infrastructure (although the phrase “finance company” does have a slightly uncertain ring to it at the moment).
Software and telephony are important factors for agencies, so I’d be looking at those, particularly for agencies specializing in consumer debt. Other factors which may influence your view might include geographic location and local knowledge, or nationwide coverage.
You’d want to be confident of the accounting of any new business. This is not a good business in which to get the books in a muddle.
Another thing to think about – does the agency want your business? Are you their ideal client? Are you important to them, or do they just want big banks and telcos?
How do you judge agency performance?
I talk to a lot of creditors who appear dissatisfied with their debt collectors. I think this is often unfair. Remember, it’s hard debt to collect and the commission structure usually means that they can’t justify hours of effort on a particular debt, which may turn out to be wasted when the debt proves uncollectible.
The problem is: it’s very hard to judge performance. If an agency collects 10% of the debt you give it, is that outstandingly good or shockingly poor? Who knows? Would another agency have done better? Who knows? The only creditors who can tell are very large businesses which can give a comparable load of debt to two different agencies, then see who collects the most.
So in practice, how do you decide if an agency is doing a good job? Many creditors assess performance on quality of communications from the agency – essentially, does the agency keep them informed, do they like their account manager and can they understand the reports they get? That’s probably as good a basis for selection as any other. Some agencies are particularly knowledgeable about particular industries, and provide add-on services like industry groups.
Creditors should be aware that if an agency goes bust, it’s not unheard of for clients’ money to be grabbed by the agency’s bank. Get confirmation of the status of any so-called “trust account”, and keep an ear to the industry grapevine.
And one last point: if your agency is collecting significant amounts of money, you should be asking why you’re not collecting it yourself, in-house.
Peter Hattaway is a director of Hattaway & Associates Ltd, Credit Consultants – www.hattawaysconsulting.com and can be contacted at peter@hattaways.com. This article first appeared in the Mercantile Gazette in March 2009.
