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Driving Growth in a Post-COVID World: Finding Success in the New Normal
By Suzanne Konstance
The events of 2020 have given commercial lenders the enormous opportunity of being the catalyst for helping to create greater economic stability. With the release of urgent stimulus programs, lenders must be nimble enough to make financing available to businesses that need it to keep their heads above water while they handle the COVID-19 effect on our economy. But at the same time, it is crucial for lenders to carefully mitigate risks and maintain strong lending practices to protect their organization so that they can continue to lend in a more uncertain world.
For astute lenders, it is possible to take steps to protect their business now and be poised for a bright future. To do this, what should lenders focus on to help them exceed expectations and achieve growth in a difficult time?
Learn from the past, prepare for the future
From 2016-2019, commercial lenders experienced a pre-pandemic “credit bonanza” of sorts. During that time, there was a flood of applications, a large percentage of approvals and high loan amounts. The average loan size was just under $200,000 and the loan approval rate was about 80 percent. And interest rates were among the lowest that we've seen in a long time.
The basis for competition among lenders consisted of who could provide borrowers with the most “frictionless” process to ensure the best customer experience possible. With so much focus on improving processes, there was less emphasis placed on onboarding and underwriting than there should have been, resulting in a tremendous amount of debt. Commercial and industrial loans nearly doubled from $1.2 million to just over $2.4 trillion in early 2020.
And then came the COVID-19 pandemic. During the first quarter of 2020, financial institutions increased their provision for loan losses by 280 percent, which means they anticipate that their non-current loans will soon be three time higher than they currently are. Sharp upturns in non-performing loans and leases are expected to rapidly follow. With so many outstanding loans to manage and borrowers struggling to make ends meet, commercial lenders find themselves in a precarious position.
COVID-19 challenges: The Paycheck Protection Program
The pandemic not only created issues for commercial lenders with existing loans, but stimulus programs have generated an enormous influx of work for lenders, many of whom were tremendously unprepared for this sort of undertaking. This distraction amidst COVID-19 has caused many lenders to lose sight of their lending best practices.
The Small Business Administration’s Paycheck Protection Program is an example of the massive scale lenders were tasked with managing – all with little to no preparation. 5,500 lenders originated 4.6 million loans in the amount of $512 billion. The PPP launched on a Friday, and by the following Friday there were still clarifications of guidelines being released. Lenders had an influx of loan applications to process, they were forced to troubleshoot them with evolving and constantly changing guidance, and then had to resubmit the applications through their loan origination systems not designed to handle the volume. Adding to the challenge was this all had to be done while lenders were working from home.
Community banking is an environment where borrowers and lenders have been slower to adopt digital technologies, so PPP caught many of these lenders unprepared. In fact, small banks originated 38 percent of the approved loans, so not only was PPP a distraction, it was particularly challenging because community bankers did not have time to scale to the volume or the resources to manage it.
But PPP is not the only source of distraction for lenders. COVID-19 has presented other challenges as well. Some financial institutions are trying to figure out how to reopen their drive-thru service, which they haven't used in years; others are challenged with shifting staff to branches with more small business loan activity than others. And perhaps the biggest adjustment is that it is now commonplace for people to walk into banks with handkerchiefs or masks covering their faces without anyone robbing it! Of course, that doesn’t mean that there aren’t those who are trying to manipulate the uncertainty and chaos for fraudulent activity. Fraud and cyberattacks are on the rise so lenders need to remain diligent.
The COVID conundrum
As the first state and city lockdowns began in mid-March 2020, financial institutions struggled to adapt to this new environment. Many financial institutions had no processes in place to accommodate social distancing or the ability to move operations out of their brick-and-mortar branches. Although financial institutions eventually moved to remote work, they experienced other unanticipated challenges. For example, some financial institutions couldn't all have their employees log in at the same time because the servers couldn’t handle that many external connections.
The lockdown not only enforced a disruption of the lending workflow, but when combined with the need to move lending staff to process PPP loans, it resulted in a total gridlock. As lenders navigate their new normal, it’s important to examine what the current environment means for their existing portfolio, as well as make a game plan to handle loan origination going forward. Lenders continue to face high operational challenges during the pandemic because work capacity is still less than 100 percent, the high influx of customer queries, and the inability to survey collateral in person.
When lenders reach the other side of the pandemic, one thing we know for sure is that remote work is going to be a bigger part of a financial institution’s existence and automation is going to be required as a result.
Rigorous lien management is critical
Since COVID-19, there is more credit risk. It’s important for lenders to strengthen their defenses against the economic downturn by initiating better ways to assess the borrower’s situation over time and their evolving risks. As lenders learn to identify these underlying risks to their lien portfolio and adjust their liens to safeguard their interests, they’ll be able to pivot more quickly when new challenges emerge. To do this, it’s important to understand the five components of successful lien management program, including:
1) Lien analytics
Healthy liens are not “set and forget it.” Is your lien portfolio free from debtor name mismatches or jurisdictional mismatches? Changes can happen with the debtor over time, and no matter how small they are, they can impact whether the liens are secure, as well as affect your ability to collect on the debt. Lien analytics provides visibility into your entire lien portfolio to find issues and fix them.
2) Debtor monitoring
How can lenders keep track of all the borrowers in their lien portfolio? With over 16 percent of borrowers having a change event every year, debtor monitoring is critical to alert lenders to these triggers. Getting name and address changes correct ensure good standing when it comes to managing your liens.
3) Portfolio Synchronization
Most lenders don't file all their liens in one place, and therefore, do not have complete visibility into their portfolio. For example, with so many mergers and acquisitions in the commercial lending space, there are often many different portfolios to keep track of that are kept separate.
Liens expire every five years. Lenders are responsible for extending, managing and releasing the liens, making it critical to have the capability to view your entire portfolio in one centralized location to effectively and efficiently manage this complex process.
4) Automation and integration
How do lenders streamline and automate lien filing in a remote work environment? Banking system integration is speeding up, making Application Programming Interfaces (APIs) valuable right now. With an API, lenders can integrate their loan origination systems with the UCC filing and search services for a seamless commercial lending process.
5) Vetting borrowers
There is currently a surge in unsecured government loans, which makes it very difficult to determine if borrowers have received multiple loans. On top of that, each Secretary of State office has a different update schedule, so it can be challenging to manually gather the most current information. Automation helps lenders vet their borrowers by ensuring that their searches are accurate, complete and current.
Lower thresholds for securing collateral
One of the questions that commercial lenders often ask is under what circumstances should they file liens on secured loans. The decision is often made informally, and typically there is some type of value threshold set. If the loan goes above it, then the lien is filed at the time of origination. But if the loan size is below the threshold, then lenders often wait until a negative event occurs, whether it's a missed payment, a default or a bankruptcy, before filing a lien.
The danger in the second approach is that the longer lenders wait to file the lien, they could find themselves removed from the first lien position. They could land in a second lien position or even lower depending on the borrower. Given the current environment, a lot of the factors that went into setting loan thresholds pre-COVID are now being reevaluated and new thresholds are being established.
Moody’s corporate default and recovery rates lists 65% recovery on the first lien and only 23% recovery on the second lien. Now is the perfect time to go back and reevaluate lien thresholds ahead of what could potentially be a relatively significant surge in bankruptcies.
Lenders are on a bit of a roller coaster right now. Many were quite free with their lending over the past few years but severe risk to their portfolios was hiding just out of sight. There was a real need for better risk management, and it seems that the COVID-19 crisis, and the resulting unprecedented default, might be the catalyst to move that need to the forefront.
Despite our best hopes, liens have never been a “set it and forget it” proposition. There's a lot of work that still needs to be done to truly secure a portfolio, and if lenders didn't consider these things before we were faced with the grim realities of COVID-19, then it’s time to start paying attention now. After all, a riskier environment necessitates extra attention. The end result is we become nimbler in the face of sudden shifts in the lending landscape while at the same time maintaining solid practices, which protect the lender, borrowers and other key stakeholders.