Getting granular: why banks need to be taking a sub-sector view when it comes to commercial lending

Sean Hunter, CIO at OakNorth

April 19, 2021

Banks have always relied on risk models to inform their commercial lending decisions. These models are based on historical data that’s built up over decades (and in some banks’ cases, centuries) of lending, across tens of thousands of loans.

As we saw over the past year, things can change dramatically within a matter of days and weeks – certain businesses may be forced to close for months at a time, relying on emergency funding and government support, whilst others may have found their business model is well-positioned for the new normal we find ourselves in. The COVID-19 pandemic has demonstrated the need for banks to take a bottom-up, forward-looking, sub-sector view instead of purely relying on past, historical data which does not accurately forecast future challenges businesses could face.

The value of sub-sectors on commercial lending

A great example of the importance of taking a sub-sector view is within retail. Retail can be split into dozens of sub-sectors – take automotive retail for example. During this crisis, specifically in its initial phases, sales of new cars at car dealerships decreased by almost 30% in 2020.[1] This was driven by the fact that car dealerships were forced to close, people couldn’t go for test-drives, and were perhaps weary of making such a big purchase given how much uncertainty there still was. However, while new car sales stayed fairly flat for several months, second-hand car sales rebounded fairly quickly.[2] One reason for this may be that a lot of white-collar workers who would typically be spending money on commuting to an office, socialising with friends and family, going on holiday, etc. are no longer doing so. This means many of them are saving more and therefore, have more disposable income. The pandemic, and the changes it’s catalysed in the way we work, have also seen a “flight to the country” with many city workers re-locating to the suburbs where they have more of a need for a car, but may not wish to make the hefty investment of purchasing one brand new.[3] In a way, one half of the sector has rebounded, and the other half hasn’t. This demonstrates the importance of knowing the value of each sub-sector instead of lumping it into one category.

Another COVID-19 winner in retail is boat makers and outdoor retailers. Given that some people have more disposable income, coupled with the fact that indoor leisure pursuits have been restricted by lockdown, some people have bought boats and similar outdoor recreational activities and equipment, such as bicycles. While a boat might not seem like an obvious choice it’s seen an incredible boom, with many boat manufacturers stating they can’t keep up with demand![4]

Home improvement retail has also seen a spike in demand. Whereas other retailers such as boutique dress makers or brick and mortar stores without an online offering have suffered, people are spending more time at home and taking up DIY projects or purchasing new office equipment.[5]

As evidenced by the above examples, it’s clear that commercial lenders can’t group all businesses within a particular sector such as retail together, and instead need to take a sub-sector view when it comes to commercial lending.

Lend Smarter. Lend Faster. Lend More.

This is where our specialty lies. We’ve created the ON Credit Intelligence Suite to enable banks to lend smarter, lend faster and lend more to businesses. We’ve split the economy into 262 different sub-sectors, so that lenders can obtain an incredibly granular, bottom-up view of every business in their portfolio.

The ON Credit Intelligence Suite is made up of three components:

  • ON Credit Analysis: a 360-degree view of borrowers with instant financial forecasting, sector insights and peer analysis. 
  • ON Portfolio Monitoring: easily track industry trends and set early warning alerts for potential covenant breaches.  
  • ON Portfolio Insights: instantly segment your portfolio and rate loans based on level of vulnerability.

[1] Motor1.com – UK new car sales down almost 30 percent in 2020 amid coronavirus carnage

[2] CarDealer Magazine – More research reveals used car buyers are out there during lockdown 3.0 and searching for their next car

[3] PropertyWire – Demand for homes in rural areas rises due to the pandemic

[4] Institutional Investor – The Managers Who Found Unlikely Covid-19 Winners

[5] Lovethesales – Consumer Demand For Home Office Equipment Skyrockets During COVID-19 Lockdown