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.