Managing Originations in Turbulent Times, Part 2

Introduction

Last month, I set the scene and described this highly challenging time we all find ourselves in right now.

In this second part of the blog I provide some practical tips as to what a lender should do to manage originations during a turbulent period such as 2022.

Tips for Turbulent Times:

Make sure you have the right team

‘A rising tide floats all boats’ is a phrase that is often quoted when conducting economic post mortems.

The credit risk team that you may have accumulated during the ‘good old days’ may not be applicable for a recession, especially if it is a young team that has no experience of what is required during an economic downturn.

In order to be best prepared for turbulent times, the risk manager needs to ensure that their risk team that will be implementing all of the new measures is:

  • Right size
  • Right skills
  • Right experience
  • Right attitude

The good news is that recessions typically result in an increase in the head count of a risk team and so a good risk manager has the opportunity to address any perceived weaknesses with new hires.

However, also be aware that most other sensible companies will also be hiring additional staff and so unless the salaries and benefits that are on offer are competitive, the company will be at risk from attrition.

Make sure you have the right tools

‘Never take a knife to a gun fight’

Good economic times often breed complacency and a lack of available budget for the credit risk team.With the wheel turning, smart organisations re-allocate  available budget from the marketing and sales departments to ensure that the risk team is armed with the best tools to take on a recession.

Examples of tools that are often over-looked during good times and so require investing in during lean
times are:

  • Scorecards – have they been aligned on a regular basis and do any require re-development?
  • Decision Engine – is the software version of your system up to date?
  • Decision Engine – is your system fit for purpose, or does it need to be replaced?
  • Policies review – when was the last time you completed an end-to-end policies review?

Companies that have under-invested in the risk function will need to make large and swift investments, rather than waiting for the tsunami of write-offs to arrive and then start making changes.

Make sure you have the right information

A recession is the perfect time to do a bottom up evaluation of everything that the risk management team has in place. This is a wonderful opportunity to address any “but we have always done it this way” discussions.

An economic downturn means that there has been a significant shift in the economy. Based on this, it makes sense for risk managers to examine whether there are additional sources of information that can be accessed which will improve their risk decisions in the new status quo? For example:

  • Credit Bureaux – are you using the optimal mix of bureaux to mitigate your risk? (Some credit
    bureaux may be stronger for specific products or regions and so this is well worth testing on a
    regular basis).
  • Alternative data – are there any types of alternative data sources that you have not
    considered before which may be beneficial in a recession?
  • Alternative scores – are there any types of new scores that you have not considered before,
    but they may provide a lift in an economic downturn?

Make sure you have a clearly defined strategy

Just as you wouldn’t consider going on a long journey without a map or GPS, it is vital that all companies entering a changing economic environment develop a clearly defined strategy.

One of the most interesting strategies that I have observed in this recession is the focus by agile companies on changing the product mix.

Gulf Business, describes this phenomenon in an article released on 27 September 2022, titled “Buy-now-pay-later firms switch from Gen Z shoppers to businesses.”

Start-ups such as Billie, Mondu, Tranch and Tillit are offering buy-now-pay-later solutions to companies in an attempt to secure a slice of this $700bn industry.

Fresh from their shake-up of Gen Z’s shopping habits, buy-now-pay-later (BNPL) firms are now targeting business payments as the next sector ripe for disruption. Start-ups such as Billie, Mondu, Tranch and Tillit are all offering BNPL solutions – which allow buyers to split their payments into instalments – to companies in an attempt to secure a slice of a $700bn industry that gives companies short-term loans to help them manage their daily business.

The use of short-term credit, most notably via supply chain finance, has become a lifeblood to companies dealing with a range of issues from Covid 19-related lockdowns to rising input costs in an inflationary environment. With few tech entrants into the sector – and the spectacular failure of Greensill Capital – the industry remains dominated by established lenders such as Barclays and HSBC Holdings in the United Kingdom and Deutsche Bank AG in Germany.

Pure-play BNPL firms have seen their valuations crash this year as rate rises across the world challenge the viability of their business models. But plenty say the ease of use such upstarts can bring to age-old credit products will prove a winning formula in this part of the market. “These B2B BNPL companies can easily win over market share from slow-moving traditional banks,” said Lily Shaw, an early-stage investor at North American venture capital firm Omers Ventures, which is not currently invested in the sector but is actively looking at the space. “Banks’ risk profiles are set up in such a way that they can’t move fast enough.”

Berlin base

Billie and Mondu are approaching the model through a BNPL lens – offering small businesspeople a similar experience when buying office equipment as a fashionista would when buying a Gucci handbag using Klarna or Afterpay. “If a typical transaction on business-to-consumer BNPL is about 80 to 90 euros, our typical transactions are about 10 times that size,” said Aiga Senftleben, co-founder of Sequoia-backed Billie. The Berlin-based firm, which was valued at $640m in its last funding round, works with banks as financing partners and operates currently in Germany, Austria and Sweden.

Mondu co-founder Malte Huffman said that it is hoping to make inroads into the trade finance space, especially given that more and more business transactions are being conducted online. “We believe there’s a $200bn market opportunity for B2B BNPL just in Europe and the US,” he said.

In Germany alone, for example, there were EUR200bn ($204bn) of e-commerce business transactions completed in 2021, compared with EUR86.7bn of business-to-consumer e-commerce, according to data by Statista, a research firm.

Growing pains

Despite their stark valuation declines, BNPL companies such as Klarna, Afterpay and Affirm Holdings have shaken up the e-commerce sector with customer-friendly apps and popularity with 18-24 year olds, forcing many traditional banks such as Natwest Group to launch competing offers. The advantage these B2B BNPL start-ups have is that traditional banks may step back from this sector amid the deteriorating economic outlook, thereby reducing the competition, according to Jeff Tijssen, head of global fintech at consultancy Bain & Company. “It does solve some important cashflow issues for businesses, and you have some big investors such as Sequoia and Klarna involved,” he said. “The slowdown in the economy will give them opportunities but could also have a negative impact. It’s still early days.”

Summary

The purpose of this article is to provide some practical tips as to what a lender should do to manage originations during a time of turbulence.

What is most interesting is that over the economic life cycle, a risk manager will be confronted by multiple crises and challenges. However, the approach that is taken to address each economic challenge will vary and a ‘one size fits all’ solution rarely ever works.