Navigating Through the Haze: A Return to Old School Credit Fundamentals
by Rita E. Garwood Monitor 100 2021
What can a credit manager do when reliable methods to measure risk fall short in an anomaly economy? Monitor checks in with three credit leaders who underscore the importance of tried-and-true fundamentals such as truly knowing a customer, diversifying equipment types and effectively managing the credit quality of your portfolio.
Matt Akins, Director, Credit Products, Regions Equipment Finance
For many in the U.S., the COVID-19 pandemic began as distant headlines from China and early supply chain disruptions before the virus was suddenly spreading so rapidly that the World Health Organization declared it a global pandemic. Lenders were left in a fog. Suddenly, reliable methods of measuring risk — such as prior credit metrics, time in business and guarantor credit scores — failed to be predictive.
Credit leaders were experiencing a new type of event. “One of the big things for us was making sure that we took as much time as possible, looked at the facts and didn’t make a knee jerk reaction,” Chris Maudlin, CLFP, SVP, chief credit officer at Wintrust Specialty Finance, says.
“The economic disruption from COVID was progressing at a speed that was really outpacing the ability of historical financial statements, even recent company prepared projections to accurately reflect what the risk drivers for particular businesses was going to be,” Matt Akins, who primarily focuses on the buy side in his role as director, credit products, Regions Equipment Finance, says. “So our attention turned quickly to having a deeper understanding of our customers.”
“For us, it was really taking a step back on the leadership side and trying to identify where did we see the biggest potential impacts from what we knew about COVID. Then trying to manage future risk through this new lens,” Maudlin says.
Maudlin’s team identified “highly impacted industries” such as limousine or motor coach companies that required close personal interaction between people. His team examined why these companies needed equipment and what they were doing to manage the impacts of the pandemic. Ultimately, they witnessed a natural pullback from the market happening in these impacted industries as the need for equipment decreased.
Both Maudlin and Akins employed what Maudlin calls “old school credit” or a return to fundamentals.
“We developed what we called a COVID questionnaire,” Akins says. “It was an initial launch
point in discussions with our clients to help us gauge how the outbreak was directly or indirectly affecting their businesses.”
From there, Akins’ team learned to check in with customers during the underwriting process to talk about their projections and expectations. “It helped us evaluate two things: ongoing liquidity and management’s ability to articulate their plan,” Akins says. “We wanted to know if management was focused appropriately on cashflow and the sources that were available to them.”
“What was important is that during the pandemic, we were still able to create and foster relationships, despite the fact that we were doing it from our home,” says Cecile Latouche, who began the pandemic as the equipment finance credit risk officer at Sterling National Bank before entering her current role as director at Atalaya Leasing in September 2020. “We powered through the awkwardness of virtual meetings and managed to close transactions without being face to face.”
When it came to existing customers, many in the equipment finance space spent the early days of the pandemic wading through deferral requests. Maudlin says Wintrust took a “less aggressive approach” when it came to granting deferrals. Initial requests were granted for 90 days, and his team prioritized staying in touch with the customers.
“We’ve had some customers who we’ve continued to help through deferrals over the last year and a half,” Maudlin says. “It came down to what was actually happening with the customer, what their challenges were, and just making sure it made sense to grant the deferral at that point in time.”
Similarly, in Latouche’s prior role, the bank’s small-ticket customers were hit first because they had to shut down. The bank adopted a policy of granting three-month deferrals with no questions asked. When companies began to request a second wave of deferrals, it was time to start asking harder questions.
“You start looking more closely at what’s going on with the company and you ask yourself ’is this company going to make it?’” Latouche says. “The second wave of deferrals really required more direct conversations.”
As second wave requests came in at Wintrust, Maudlin’s team focused on truly understanding each customer’s situation and partnering with them. “We wanted to make sure that we were giving them opportunities to get back on their feet where we could,” Maudlin says. “The vast majority of our relief requests got back to paying their regular payments and have been paying since their initial relief requests, which helps us feel that things are stabilizing and normalizing.”
The buy side portfolio Akins manages experienced minimal deferments that were granted for 90 days with interest only while the larger Regions Equipment Finance portfolio processed 384 COVID-19 related deferrals with payments tacked on to the end of contracts. Despite an initial flurry of activity throughout the organization, Akins says deferrals did not make a huge impact at REFCO and most customers are now back on track.
Maudlin believes granting deferrals led to fewer trips down the path of repossession. Since Wintrust prioritized working with customers, when a business owner felt they had “reached the end,” they were more likely to surrender the equipment. As a result, repossessions did not make a major impact on Wintrust’s portfolio.
According to the Equipment Leasing and Finance Foundation’s first quarterly COVID-19 Impact and Recovery Survey, default rates in 2020 increased very slightly to 92 bps from 73 bps in 2019.1
“That illustrates the fact that portfolios overall have been very resilient given all the stimulus money injected into the economy,” Latouche says. “In 2021 we’re expecting to see default rates to be even lower than the pre-pandemic ones.”
When it comes to collections, Akins, Maudlin and Latouche agree conditions are returning to normal. Maudlin points out an overhang from deferrals still exists in certain impacted industries. Akins notes the collections team at his company has noticed a dramatic shift toward the use of email versus phone calls in their interactions with customers.
Since she primarily deals with large-ticket equipment, Latouche says her focus has shifted to dealing with pent-up demand: “Investments in equipment and software are expected to grow twice as fast as the GDP this year. The post-pandemic leasing space has been booming and the market presents a diversified opportunity set. We are very much focusing on what’s next and making sure we are building on that momentum.”
Maudlin and Akins both reported a slight increase in losses in 2020. While losses are normalizing, Maudlin says more severely impacted businesses could take the balance of this year to return to full levels of recovery.
Latouche views the pandemic environment more as an anomaly as opposed to a true downturn. “The pandemic only slightly disrupted the industry, mostly in Q2 due to the statewide lockdowns, but with all of the government support, demand for goods remained especially strong and so did equipment investments. This is a trend that has accelerated and will likely continue throughout 2021.”
Before 2020, Maudlin and his peers spent a great deal of time trying to identify when the longest economic expansion in U.S. history would reach its tipping point. None of them predicted a pandemic.
This wild card event underlined the importance of managing credit quality for Maudlin. “Have good credit fundamentals on the files that are going into your portfolio because they’re more likely to be able to weather a storm,” Maudlin says.
Another eye opener for Maudlin was the fragility of industries that were typically rock solid. “As a credit person, it’s important to understand that while an industry or an asset class may not have hit that downturn or had a challenge, there’s always a possibility that there is going to be a challenge down the road in that asset class or industry that you weren’t anticipating.”
Latouche agrees: “If you didn’t have a diversified portfolio, it was probably difficult to navigate the pandemic.”
For Akins, the pandemic magnified the importance of truly knowing your customer: “It was a really strong reminder that credit risk managers have to keep on having a deep understanding of management’s plans of actions in these short-term periods where there’s potential extreme distress. The foundational tenant of knowing your customer, it’s always been critical, right? But I think it’s even more so in events like a pandemic.”
“The lesson learned is that clients that demonstrate flexibility [and] strong management are really worth their weight in gold. And that flexibility starts with [a] sound balance sheet. Do you have manageable debt maturities? Do you have diversified liquidity sources? And I think those things are going to be evaluated more in depth as we move forward, as really important mitigation strategies for these short-term distress situations.”
1“COVID-19 Impact and Recovery Survey,” Equipment Leasing and Finance Foundation, May 2021.