In addition to the devastation the COVID-19 crisis has caused throughout the world, the shock to the equipment leasing & finance industry from sweeping preventive measures taken by the government has been immense. The credit markets, especially for small and mid-sized businesses, have not so rapidly eroded in generations. The U.S. economy came close to a complete screeching halt.
With restrictions now being gradually lifted to varying degrees throughout the country and businesses restarting, equipment leasing and finance companies are faced with a very unfamiliar and challenging mandate: Quickly learn to evaluate and monitor credit risk in new ways as most of the old methods lack real-time visibility and fail to adequately address the current environment.
The path forward requires the ability to understand the impact COVID-19 countermeasures have had, as varied, based on the intersection of industry, geography and resiliency of each unique business. Additionally, new ways of quickly assessing and verifying the pre-COVID-19 and post-COVID-19 financial trends for borrowers relative to one another must be established.
Even more than before, robust data and analytics are at the center of the discussion. Accelerating digital transformation to facilitate the ingestion and synthesis of ever-growing amounts of data and feeding it into today’s more mature decision and monitoring models is the only prudent path forward for the majority of equipment leasing and finance companies.
The following are actionable recommendations to help equipment leasing and finance companies rethink SMB credit risk analysis post-COVID-19.
Beware of personal credit reporting blind spots and adjust.
Many struggling business owners have fallen behind on repayment of personal debts. Unlike in a pre-COVID-19 reality, as a result of a provision in the CARES Act, missed or delinquent payments are not necessarily reflected in FICO scores or on personal credit report narratives. Under the new law, if a lender allows a borrower to defer their debt payments due to COVID-19 hardships, that lender is disallowed from reporting these payments as late to consumer credit-reporting agencies. It is imperative for equipment leasing and finance companies to be aware that scoring models overly reliant on FICO scores and personal credit report data will, in effect, cause them to run blind.
Apply heavier weighting to industry-specific risk models for both expected COVID-19 impact on P&Ls and expected time to recover.
At the industry level, economic shocks from COVID-19 are certainly not equally distributed. An example of this dynamic is the relative effects of COVID-19 on brick and mortar retail versus automotive services industries. While both may have experienced similarly intense initial adverse economic impacts, it will likely be the case that automotive services businesses will recover much more quickly as the U.S. economy continues on its reopening path. Consumers inevitably will need to get their cars inspected and serviced, but they can generally buy most of their goods online. A great place to start is to get a handle on what businesses are generally considered essential (all states have lists and they are quite similar), particularly those whose services are easily provided with physical distancing (e.g., arborists, last-mile parcel delivery contractors) and take a look at how those businesses have performed for you so far.
Organize your portfolio into geographical clusters stratified by delinquency and default performance statistics and monitor/adjust over time.
Organizing your current portfolio this way and creating a matrix combining results from your industry-specific risk models mentioned above, will allow you to identify your greatest current portfolio risk areas. Use this process to inform your response strategy and go-forward credit decisions for similar borrowers. Monitoring portfolio performance and adjusting your scorecard as the recovery story evolves will help you spot and respond quickly to trends, protecting your portfolio from preventable deterioration.
Consider doubling down on your existing Paying as Agreed customers.
Your existing borrowers who have weathered the storm well enough to continue paying on their obligations are excellent candidates to consider for follow-on financing. This is a great opportunity to consider strategies focused on build lasting relationships and improving the average lifetime value of your customers.
Pick up the phone.
Sometimes a call with a prospective borrower changes everything. There’s just something different about having a good old-fashioned business conversation with a business owner to understand the context of a borrowing request. There was a time that transactions wouldn’t have even been considered without talking to the human being behind a financing request. Try it; especially if you are on the fence about approving a transaction. You’ll learn a ton!
Use transaction data for real-time assessment of how a prospective borrower has weathered the COVID-19 storm.
Operating account bank data is a treasure trove of data. Looking at inflows, outflows, daily balances, number of NSFs, overdraft credit line usage, rent, utilities, payroll (etc.) payment inconsistencies, and evidence of additional borrowing activity with an eye for trends and material changes can often tell you most of what you need to know about the actual current financial health of a borrower. Compare that to looking at a tax return from 2019 as a proxy for a business’s current financial health or interim financial statements, which can be dubious. Both tell you something, but certainly not nearly enough in this environment.
Expand the number of personal and business credit reporting and fraud check data points you are assessing.
There are myriad tools that are readily available that, when taken together, can provide key, nuanced insights when it comes to creditworthiness, current financial condition and fraud prevention. Get up to speed on what tools others are using and how they are using them to generate a more complete borrower picture. The amount of data available today to help equipment leasing and finance companies assess credit risk and fraud is vast and easily integrated digitally to risk platforms, especially if they are “in the cloud.”
Consider alternative data sources to develop a more comprehensive real-time understanding of SMBs applying for credit or currently in your loan portfolio.
Alternative data sources to the standard go-to sources are helping credit analysts paint a more complete and current picture of SMBs and personal guarantors’ financial health and creditworthiness. In addition to the aforementioned business operating account transaction data analysis, cloud-based lending technology stacks have enabled modern equipment leasing and finance companies to crunch mountains of data from a vast number of sources quickly to establish baseline proprietary PD and fraud risk scoring and monitoring. This includes data such as social media and online sentiment analysis, comparative macroeconomic data, credit card processing data, and even virtual site inspections.
Test and learn.
Lending technology has advanced significantly in the last decade. With the right technology, it should be very easy to answer questions such as this: “Had we adjusted our credit model in x way, would the result (y) have been lower losses during COVID?” Then do it again and again until statistically meaningful results emerge. With a few keystrokes, the technology exists today to allow equipment leasing and finance companies to run scenarios and rescore existing portfolios to gain deep insights as to what might have been. These same insights help astute analysts make valuable presumptions about whom to lend to, not only now during the COVID recovery period, but also as part of the normal course of business.
Look closely at your lending technology and if any of the above seems like too heavy a lift, change now.
The above should arguably be the general practice for equipment leasing and finance companies in 2020. Technology has made all of this easy and intuitive, and it does not have to be expensive and time-consuming to implement a highly powerful solution. The borrower, analyst, underwriter, processor and chief risk officer’s user experience should be frictionless and enable valuable risk management insights and tools in this day and age.
With the right technology, equipment leasing and finance companies can seamlessly integrate “in the cloud” with credit bureaus, alternative data sources, online banking data and risk mitigation services. Additionally, more data can be ingested and synthesized faster, and portfolio performance can be measured and risk models can be calibrated in real time, including advanced warning systems to give equipment leasing and finance companies a chance to take mitigating action and avoid being blindsided.
If anything positive comes out of the COVID-19 pandemic for equipment leasing and finance companies, it will be that they were forced to accelerate their digital transformation plans. If implemented properly, the benefits as we come out of this crisis will be truly transformative.
Richard Henderson is an equipment leasing & finance industry veteran and fintech expert leading growth for Capiform, a SaaS-based, comprehensive, fully configurable digital lending application enabling financial institutions to embrace the digital lending age at their own pace.