Desertification, the slow transformation of fertile land from farm to sand dunes, takes such a long time that it is almost imperceptible. Philip Knight, credit and risk director at Asset Advantage, notes some subtle – but significant – industry changes.
I do not think I am the only person in our industry to have identified some subtle but important changes in the world of credit risk.
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Before I get into the detail, I think it is worth observing that what we used to refer to as the ‘asset finance’ market has changed immeasurably over the past few years. The definition of an asset has been stretched almost to breaking point, with most – if not all – lenders in the sector expanding their lending into loans and short-term lending.
Only just today I read about a bridging loan company describing its product in the context of easily available cash-flow finance. The longstanding division between asset-based lending for plant and machinery and traditional bank lending seems to me to be fast disappearing.
So what has changed? And why does it matter? Perhaps the most significant change in the credit risk environment has been the huge increase in finance companies offering facilities to SMEs.
Go back at most a couple of years and brokers would probably have 10 to 15 funders on their panel. How the times have changed! One director of a broking group told me recently that it had 70 funders on its panel, and had actually paid out deals with 50 of them in the past quarter. So how has this adversely affected the credit risk environment?
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By GlobalDataFirstly, in the absence of a hugely increasing market, we have a larger number of funders chasing the same volume of transactions. In order to compete, a funder really only has two options: rates and credit appetite. With the former as low as they can reasonably be, the only alternative is to relax the credit criteria.
This has inevitably resulted in funders moving into higher-risk industry sectors and deal types such as new starts. The danger here is obvious, as those sectors were labelled as high-risk for a very good reason. Couple this with underwriting expertise that is inevitably more thinly spread across the industry, and the risk is amplified.
Moreover, the bountiful supply of funding sources has encouraged both brokers and customers to divide their borrowing requirement among this larger panel of funders. The impact of this is that lenders really have little visibility to the customer’s total borrowing intentions and many deals simply fly under the low radar of automated underwriting systems or more junior staff.
SPLITTING DEALS
While brokers ‘splitting’ deals is a longestablished practice – albeit one that Asset Advantage does not permit – the idea that customers might split their own deals is, I believe, another sign of the changing credit environment. They are doing this by either approaching different brokers or taking advantage of the fact that many of the alternative finance lenders encourage direct contact.
It is possible for businesses to raise hundreds of thousands of pounds of debt before it becomes disclosed in their financials, credit agency reports, or as a direct debit in their bank statements. Funders have little or no control over the customer, and if they default the recoveries process is compromised by the number of lenders involved.
It is also the case that customer expectations, with regard to finance have changed, and this has encouraged a far less forensic approach to underwriting. The ceaseless mantra of the lending industry at present is the speed with which a deal can be agreed, but this fast turnaround does not facilitate any sort of engagement with the deal, let alone the borrower.
It is a fact that the data that is used to make these swift judgements is no better than that used a decade or more ago. Despite my grey hairs I am no Luddite, and I acknowledge there are innovations such as the data provided by the Open Banking Initiative, shared lending data provided by credit agencies and fraud initiatives such as CIFAS.
But the reality is that so-called algorithmic underwriting is using barely any more or better data than we were using in the 1980s. Indeed, one could consider that the use of abbreviated accounts means there is probably less information. It seems almost certain to me that fraud or quasi-fraud will become an increasing feature of bad debt write-offs throughout the finance industry.
Of course, these changes are not universally a bad thing. It has been a fantastic opportunity for borrowers to break free of their banks, brokers have been able to leverage the huge demand for new business, and it has spawned many new entrants in the alternative finance market.
But at what cost? Thoughts of shifting sands bring to mind beaches and that Warren Buffet nugget of wisdom: “Only when the tide goes out do you discover who’s been swimming naked.” When did he say that? April 2009; note that date.
