By Santhosh Shenoy Tonse, Associate Director of Commercial Lending at Acuity Knowledge Partners
Known for a “glass half empty” mindset, credit analysts shifted their perspectives and widened their roles outside of risk mitigation. Credit analysts spot key improving financial trends and identify new lending opportunities during the global economic recovery.
As the long-term implications of the COVID-19 pandemic reshape the financial services industry, credit analysts have been forced to reimagine their role. Historically, the organized form of credit analysis function originated on the principle of conservatism. The main function of the role entailed checking lending proposals prior to submitting them to a credit risk team. Therefore, analysts had primarily been extrapolating downside scenarios, operating in a ‘glass half empty’ mindset, placing restrictions on borrower actions to avoid cash leakage and ensuring stable performance for timely repayment.
Mitigating credit risk – the primary focus of a credit analyst
Banks aim to manage credit risk by laying out lending policies that provide the framework for lending across industries, sectors, geographies and borrower types. Credit analysts have always operated within this scope, and every credit analyst’s objective has been to mitigate risks when drafting the lending proposal and suggest measures if the financial performance were to deteriorate. The performance of credit analysts is measured by factors such as the number of early warning flags raised and the number of actual defaults, as they are the first line of defense, together with the origination team.
Given that the credit analysis function is an origination pay model, there is ever-increasing pressure on credit analysts to get deals approved. This is exacerbated by increasing competition and banks’ narrowing net interest margins. Credit analysts, therefore, are required to go the extra mile to get a deal approved. Measures include restructuring the deal, extending maturity, and monitoring the borrower more frequently. Analysts are also considering syndication vs. bilateral deal proposals and convincing the customer to offer additional collateral, cash cover or personal guarantee, and agree to covenants. Credit analysts, therefore, now represent the origination team on deal negotiation with credit risk teams.
Portfolio monitoring expands the credit analyst role
The role of the credit analyst has widened even further in recent years. Credit analysts raise early warning signals on worsening financials and also identify lending opportunities when the financials improve.
The first example of the new scope of analysts’ work is providing analysis on covenant headroom improvement. Trends like widening headroom and improving headroom are critical indicators of appetite for taking on debt. Now, credit analysts spot these improving trends and inform the origination team of new lending opportunities. Early identification of such opportunities helps the origination team engage with the borrower and convince them of the need for additional lending. Given the improving performance, it would be sensible to mark pre-approved limits for these borrowers, so that when the actual need arises, the bank is at an advantage to disburse the new money faster than the competition. In their traditional role, credit analysts would just report the data as improving credit metrics but would not perceive it as a lending opportunity.
Tightening liquidity is another trend analysts now observe, along with refinancing and takeover opportunities. For example, a traditional credit analyst would observe debt maturity as compared to liquidity. They would simply highlight the gap between the two factors as a possible default scenario and report this to the credit risk team, which would see this as an early warning signal of a likely default. The next steps would be perilous for the borrower.
An effective credit analyst in the current market, however, not only senses the early warning signal but would also come up with plans for the borrower to successfully navigate through this scenario, while generating additional business for the bank. This is a somewhat delicate situation, as the credit analyst would have to balance the objectives of the origination and credit risk teams. While the origination team would push to get a deal done, the credit risk team would push to recover monies lent and reduce exposure. In such a scenario, an effective credit analyst would come up with a restructuring/refinancing plan, working creatively within the scope of the bank’s lending policies to satisfy both the origination and credit risk teams, considering the competition in the market to take over these deals.
Pandemic driven changes in project plans and technology inspire further change
Credit analysts quickly had to adjust to lending amid an industry downturn as the world was thrust into the COVID-19 pandemic. While a traditional credit analyst would focus on reducing exposure and ensuring additional collateral amid an industry downturn, modern credit analysts also focus on identifying good credit customers with sound business models that find themselves facing headwinds due to industry-wide disruption but who could emerge stronger if provided lending support.
The COVID-19 pandemic also accelerated the adoption of technology and automation to spot lending opportunities. Cutting-edge automation tools, interactive dashboards and infographics complement the work of credit analysts, enabling them to conduct useful analysis and identify lending opportunities. The availability of statistical tools for predictive default and delinquency modelling helps credit analysts present balanced proposals to the credit risk team.
Finally, new projects have been initiated during this historic time, along with an increase in different lending styles. Unlike the traditional credit analyst, the pandemic era credit analyst tracks the portfolios of borrowers in the sector throughout the year, not only at the annual review. This includes keeping abreast of the borrowers’ strategies and acquisition and/or capex plans and relaying this information to the origination team.
Equity multiple-style lending has been on the rise, forcing traditional banks to rethink their apprehensions about lending to startups and fast-growing technology companies, as challenger banks are lending to them more confidently. By partnering with product and credit risk teams, credit analysts have developed hybrid lending products that assess the inherent strength of a business and focus on the future value of the business versus just the past performance. Default rates of such companies have been lower than those of companies in traditional sectors.
Increasing competition drives innovation amongst analysts
The intense competition brought on by the global pandemic has forced businesses to assess their inefficiencies. The role of third-party specialist firms in the evolution of business intelligence, and particularly the credit analyst role, has been significant. Given the increasing competition global banks face they have benefitted from partnering with third-party specialist firms that provide highly experienced, credit analysts trained to succeed in today’s landscape. As the pandemic continues to highlight increasing needs for innovation, trends toward hybrid job roles and partnerships with third party providers are bound to grow. Together these changes demand and are driving the development of next generation credit analysts who blend risk analysis with solution curation.