Lenders Think about Recession Readiness


Dave Kucera
Head of Financial Institutions Group at Capital One

This article first appeared in The Secured Lender in November 2019.

These are remarkable times. Back in 2008, few observers would have predicted that the economic recovery following one of the worst recessions would have lasted as long as it has or that the U.S. economy would be so resilient. Trade tensions, decelerating global growth, and geopolitical maneuvering are all contributing to exceptional global volatility and complexity, yet the U.S. economy has remained remarkably stable. Today, the United States is posting decent growth, stock markets are near all-time highs, we continue to experience record low unemployment, and wages are rising, albeit slowly.

In fact, the sheer length of our recovery—now exceeding any in U.S. history—is responsible for the note of uncertainty that invariably intrudes into any discussion about the economy. It is well accepted that a recession at some point in the future is inevitable, but its timing, duration, and depth are at best matters for speculation. As a result, U.S. businesses by and large are taking a cautiously optimistic view of the immediate future but, at the same time, are more guarded about the middle-to-long-term outlook.

A similar picture emerges on the consumer side. The Conference Board Consumer Confidence Index, even after declining marginally in August, is still at its highest level in 19 years. Nonetheless, there is evidence that consumers are less optimistic about the future, seeing moderate downturns in business conditions and jobs in coming months.

Given this sentiment, non-bank financial institutions (“NBFI’s”) should engage in strategic evaluation, borrowing and capital raising to improve their balance sheets and expand their businesses, invest in technology, and strengthen their lending and capital partner relationships. In this way, they will be able to confront the recession—when it comes—from a position of strength.

Engage in strategic capital raising

Many of Capital One’s commercial and consumer finance clients have already begun to use this grace period to become more recession ready. Their efforts are being facilitated by the abundance of capital available to U.S. borrowers. Although borrowing rates in the United States have come down, they are still in positive territory, making them relatively attractive to global investors looking for a better return or a safe haven.

The resulting low cost of capital in U.S. markets and the enthusiasm for U.S. debt instruments is one reason that our team has had one of its busiest years ever. The NBFI market, and in particular the consumer and commercial finance companies that we support, are taking advantage of low rates to refinance their existing debt, expand their businesses, and in some cases make strategic acquisitions.

In doing so, our clients are not only preparing for an uncertain future but also positioning themselves to more efficiently meet the capital requirements of their commercial and consumer customers. On the commercial side, the lending environment for companies that provide equipment finance, factoring, small business finance, floorplan and asset-based lending is still reasonably well balanced, though larger EBITDA add-backs and higher leverage have become more common in cashflow-based lending. There has been less growth in companies exploring secured financing because the cash flow markets are still available to most companies, but we expect this situation will change when and if a downturn occurs.

We have seen moderate growth opportunities for lenders serving consumer markets like mortgage and auto, although we saw a downturn in August in the growth of the student loans. We are also seeing moderate growth in unsecured consumer debt. Our clients are continuing to meet the needs of their customers even as they put their financial house in order.

Invest in technology

In addition to strengthening their balance sheets and growing their businesses, our clients are also viewing the favorable lending environment as an opportunity to invest in technology, which they see as an essential bulwark to economic headwinds. In virtually every sector, they are turning to data analytics, artificial intelligence, and machine learning to better serve their clients, streamline their financial processes, lower regulatory compliance costs, develop new products, and better assess risk.

For instance, in consumer finance, lenders are considering integrating alternative data into credit decisions, and in a number of sectors like home mortgages, they are digitizing the approval process to significantly shorten the time to close. In commercial finance, non-banks are beginning to use modeling and advanced analytics to validate borrowing companies and accelerate loan decisions.

Strengthen lending and capital relationships

Regardless of their goal, the favorable lending market as this long recovery progresses has put companies in an ideal position to evaluate their financing alternatives, diversify their financing, and potentially elongate it. For companies interested in locking in low fixed-rate terms for the long run, we recommend they not waste time waiting for the perfect execution, but act on one that is attractive. Hedging options have also become attractive for many companies to take advantage of the currently low fixed rates available to many. When a recession strikes, those few extra basis points they might have gained will likely not matter materially.

It also makes sense to build a relationship with a financial partner who offers a broad array of products and services, providing the added flexibility and speed that so often are important under rigorous economic conditions.

Non-bank lenders need a financial partner who understands the business they are in and has been through the entire business cycle. Because we are careful about the companies we partner with, we believe in their ability to achieve their goals and are committed to working with them for the long term.

Although no one can predict the future, we can all do our best to prepare for it. And for non-bank lenders, a critical part of that preparation is finding a financial partner that you can trust.