Managing loans amid COVID-19 is a big concern for middle market banks. They see the spike in non-performing loans coming—and the speed and scale at which it is happening. But there’s no playbook for the unprecedented.
To get some insights into this top-of-mind issue, I caught up with my colleague John Newlin. He leads banking for us in the Midwest and is a residential mortgage lending guru. We talked about how middle market banks can manage problem loans in ways that work for them—and for their customers.
Let’s start with how customers perceive banks. In the last financial crisis, people viewed banks as the villains. But in this crisis, banks are viewed as the heroes. Tell me about this dynamic.
John: During the pandemic, banks have been heroes. They provided instant relief through forbearance payments to people whose health or employment was impacted by the virus. That trend continued through government intervention, and with banks’ willingness to work with customers in a time of crisis.
Banks know that this trend has a shelf life. We don’t know when, but at some point, the intervention stops. What we do know is that there’s reputational risk for banks when it does. Banks will start to collect on loans that have been in forbearance. If they don’t do this well, they run the risk of “flipping the script” and once again assuming the role of the villain.
So that brings us to non-performing loans. What do you expect this landscape will look like for middle market banks in the coming months? How bad do you think it will get?
John: In forbearance programs, credit scores are muted. This makes it impossible to tell who has or hasn’t been impacted by COVID-19. Someone who is employed could have the same score as someone who is in financial distress. Forbearance programs mask the impact on the person in distress and create “visual equality” in terms of traditional metrics for two very different borrower types. The bottom line is that there will be a surge in non-performing loans, and leaders need to prepare for it.
Considering that traditional scoring measures don’t give them the full picture, how can middle market banks understand their exposure to non-performing loans?
John: Middle market banks have to rethink their data and analytics. This means using non-traditional data to supplement typical data. This way, banks can create new, external “signals” that predictively identify which segments of their customers are impacted. From there, they can develop highly effective outreach strategies based on what they know about these specific customer groups.
Can you offer some examples of this non-traditional data?
John: Think of it as the kind of data that digital marketers use every day. Take browsing history, for example. Banks can use what they know about who searches for unemployment benefits, who searches for COVID-19 health information, or who lives in an area with significant community spread of the virus. These insights supplement their existing data, helping banks understand trends and create predictive measures and outreach.
Once banks build a model like this to identify at-risk borrowers, what’s their next step to prevent loans from becoming non-performing loans?
John: Communication and outreach strategies become very important here. For at-risk segments, banks may want to reach out to borrowers earlier or work on different modification programs. The focus can be on helping these people ease back into a state of normalcy rather than fully jumping back to the financial position that worked for them before the pandemic.
Do you think middle market banks have an advantage as they pursue this type of strategy?
John: Absolutely. Their biggest advantage is their brand and their relationships. In middle market banks, relationships with customers tend to be more personal. That human connection is so important. These banks can and should draw on that connection when reaching out to their distressed borrowers.
Demand on operational teams will increase with more outreach. We’re seeing larger banks turn to digital assistants to relieve the pressure. Are these tools viable for the middle market?
John: Yes, they can be very effective. Since the pandemic began, banks’ customers and employees have become more comfortable using digital tools for banking. Banks can turn to AI-powered chat bots to resolve more “basic” borrower needs and direct human resources to more complex cases. These tools are cost-effective for this market, and they can be built and deployed in just days.
Do any of the takeaways or lessons learned from managing loans during this crisis translate to broader bank operations?
John: Banks were quick to redeploy the workforce as needed. For example, we saw teller helping to process PPP loans. Now they know they can flex resources if needed. And for banks that have developed digital tools, they now have the framework and infrastructure in place to be able to build them in other parts of the bank. The use cases exist. It’s just a matter of finding them. There’s a lot of future value to tap, and that’s exciting.