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Commercial lending in 2021 – what do we know so far?
After the unexpected events of 2020, certain knowledge is in especially short supply for commercial lenders.
Forget everything you thought you knew about the financial health of your customers. In the wake of an ongoing pandemic, credit risk has resurged and the safe bets of 12 or 18 months ago could now be failing business models.
First came the immediate economic impact of COVID-19, as many industries shut down, financial markets plunged and GDP growth slowed around the world. In turn, transport restrictions and interruptions to production have reduced inventories, while travel, leisure, tourism and hospitality have seen revenues fall to record lows.
And the bad news keeps coming, as new waves and strains of the virus continue to ravage economies. Rising unemployment has reduced consumer spending. Equity and bond markets remain volatile; rental decline is hitting real-estate investments; both consumer and investor confidence are on the decline.
On the face of it, what you know about your customers may not look good. But in 2021, you need to look harder.
Is your knowledge out of date?
For the past two decades, banks and other lenders have looked backward to assess the creditworthiness of commercial customers. Mainly, they’ve based their lending decisions, risk models and credit ratings on historic financials and past business performance, typically using data gathered at the end of a customer’s fiscal year.
So, what happens when the next year looks nothing like the last?
For many retail firms, 2019 financial statements may have indicated a healthy business with sound growth prospects. With no missed payments, their impeccable credit history would also have demonstrated a low probability of default.
Fast-forward a year and the same firms could have seen their sales plummet—or their supply chains dry up—in repeated lockdowns. Some have defaulted on loans or have even gone into administration.
Others have been buoyed, so far, by government-backed business bailout schemes, such as the U.S. Paycheck Protection Program (PPP) and the U.K.’s Bounce Back Loan Scheme (BBLS), which held many non-performing loans or late payments at bay. But for most firms, this support is now starting to expire.
It’s no longer enough for commercial lenders to look backward at financials. In the pandemic and its aftershocks, predictive analytics are the future—and only a dynamic view of data will do.
Understanding credit quality in a crisis
The more forward-looking knowledge you can gather, the better you can support both your customers and your business. In these uncertain times for lenders, the urgent priorities are to predict the performance of your portfolio, monitor your existing customers and loans, and use what you know to plan your next move.
That means both constantly updating your insights into commercial customers and casting your net wider, beyond historic financials into industry trends, portfolio analysis, borrower behavior and even sentiment analysis.
Early warning signs of credit risk come in many forms; the key is getting all the information you need to take the right action at the right time. That action could be as simple as calling a customer to check their 12-week cash flow or to ask intelligent questions about a worrying report in your news feed.
Regulators want more knowledge, too
New regulatory recommendations for globally significant banks underline the importance of keeping on top of credit quality with better data. In its Draft Guidelines on Loan Origination and Monitoring, the European Banking Authority (EBA) is encouraging lenders to establish more robust and prudent standards for credit risk taking, management and monitoring.
As well as setting out new requirements for credit assessment, risk-based pricing and internal governance, the EBA has stipulated the ongoing monitoring of credit risk and credit exposures, throughout the life cycle of lending facilities. This should include regular credit reviews of borrowers, monitoring of covenants, stress testing and use of early warning indicators.
With a framework for continuous credit risk monitoring, lenders will be in a stronger position to prevent defaults and reduce non-performing loans. It all comes down to building—and maintaining—broader and deeper knowledge of the commercial customer base and loan portfolio.
The power of proactive monitoring
Essentially, the EBA is driving the world’s lenders to proactively monitor both the financial health of their customers and the health of their business with those customers.
Think of it as a turbo-charged version of Know Your Customer, built for the real, fast-changing world of today. Now, the aim is to not only understand your customers better but also to better know your deals.
Are customers fulfilling their obligations or showing the early warning signs of a default? And more to the point, what can you do right now to help reverse the impact?
Turning data into action
In the drive to know customers and deals better, there’s no shortage of data to mine, with key credit risk indicators lurking at every level.
- Financial trends may show a decline in cash flow, suboptimal regulatory ratios, falling inventory levels and revenue or heavier use of credit lines.
- Behavioral indicators might include more frequent covenant violations, delays providing information or a complete lack of management communication.
- Other transactions with a bank could be just as revealing, from increased use of overdraft facilities and credit cards to reduced inflow to current accounts.
- News feeds and social media can provide a rich source of data on sentiment for obligors, loan principals or even their suppliers or parent company, or shed light on financial or operating performance.
- Market and economic data will give you the bigger picture of adverse industry or regional reactions to events or a sharp decline in market fundamentals.
- Credit bureau information can be used to complement other early warning signs and confirm credit deterioration.
The real challenge, however, is to synthesize the vast amounts of data at your disposal and translate it into actionable intelligence. In line with the EBA standards, you need to show that you have processes in place to measure and monitor your customers—and how you’re using information to manage a given customer business and your deals with that business.
Put on the spot, many lenders couldn’t tell you how they deal with a covenant breach or what measures they take when credit starts to deteriorate. In 2021, it’s time to take process more seriously than ever.
Advanced analytics are critical, but it’s how you act on the data that counts. Today’s lenders need systems that keep relationship teams informed of and alert to late payments and other warning signs—and prompt them to take action.
It’s also important to act fast. When a loan is in distress, can you get in there quickly and restructure it ahead of your competitors? That way, you’re more likely to secure the best terms.
Recognizing good credit – before it’s too late
As well as enabling you to respond faster to credit issues, proactive monitoring will help you take early advantage of credit opportunities. Even in 2021, good credit still exists; the more you can pre-approve at the start of the year, the less risky business you’ll need to chase later to meet sales and revenue targets.
Again, knowledge is power—and it pays to look more closely and constantly at changes within industry segments. While the pandemic has hit hotels badly in business travel destinations, some tourist destinations may be less affected. Although the events industry as a whole faced a year of revenue-crushing cancellations, the digital events subsector boomed in 2020.
Another reason to better know your customers and your deals is the growing focus on environmental, social and governance (ESG) issues. More and more commercial lenders will no longer approve deals in unsustainable markets, putting new hurdles in the way of their lending decisions. With this changing dynamic, good data, total transparency and detailed insight are more important than ever.
Nurturing relationships with knowledge
Whatever good credit opportunities arise, bad debt management is likely to be a defining feature of 2021. To cover their losses, the new generation of online-only lenders will need to raise their interest rates, putting their business models under enormous pressure.
By contrast, most traditional banks will have already made provision for bad debts and added significantly to their write-off books. With their deep market knowledge and focus on relationship banking, these larger lenders are now ideally placed to steer commercial customers through the coming storm.
Loan workout specialists will be in high demand to stay in close contact with businesses, understand their requirements and make sure they don’t become non-performing loans. To facilitate this human intervention and keep interactions efficient, banks will also need a strong, standardized framework for credit risk monitoring and management.
In recognition of this fact—and of the growing need to provide more services online—many halted digitization programs are now restarting in earnest.
Protecting the base
With a single technology solution for commercial lending, banks can not only help future-proof their revenue but also protect their existing income.
When you’re capturing data only once and making it available throughout the lending life cycle, you remove opportunities for error, increase efficiency and reduce costs. In turn, a more efficient, transparent framework will also help you reconcile repayments more quickly and identify gaps or leakage in non-interest income, whether staff have booked fees incorrectly or waived them because they lack the right information.
So, are you on top of credit quality?
From the origination of credit to the day-to-day servicing of debt, there’s never been a greater need to understand what your commercial customers’ past, present and future look like, fast.
With continuous, active monitoring of your portfolio, your deals and the wider market, you’ll have the actionable information you need to plan ahead and protect both your customers and your profits.
What more powerful reasons to stay in the know?
Let’s solve change in lending faster.
Get in touch and find out how FIS® can help you take digital transformation beyond business as usual. See the early signs of defaults, understand your customers better and get more insight into every deal. And stay ahead of the game by focusing on what you do best—customer acquisition, account management and risk control.