How coronavirus pivot helped this British fintech land PNC

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The British fintech OakNorth has been trying to sell its lending platform to U.S. banks for the past year. Its creation of a ratings system that predicts how borrowers will be affected by the pandemic has enabled it to win sales at Customers Bancorp and now PNC, which signed a commercial agreement with the company Thursday.

The draw for PNC Financial Services Group and for Customers Bancorp is twofold: OakNorth’s software automates lending to medium-sized businesses, a process that has been manual at many banks for years. And baked into the software is an ability to analyze and monitor each loan based on how it’s likely to be affected by the coronavirus.

Rishi Khosla, co-founder and CEO, OakNorth
“Banks don’t have the ability to run, on a data-driven basis, a forward-looking scenario down to the borrower level,” says Rishi Khosla, co-founder of OakNorth. “We’re giving them that."

For instance, OakNorth has created a scenario that predicts how a restaurant in a state that is reopening will perform as a borrower. Another scenario projects how a restaurant in a state that’s still under heavier restrictions will fare.

Two months ago, when the $12 billion-asset Customers Bancorp, of in Wyomissing, Pa., inked its deal with OakNorth, the startup had created about three dozen pandemic stress scenarios like its restaurant sector ones. Now it has more than 130.

The expanded COVID-related loan rating scheme helped OakNorth, which operates a nearly-five-year-old bank in the United Kingdom, land its agreement with the $444 billion-asset PNC. (Terms of the agreement with PNC were not disclosed and PNC declined to comment.)

It's a sign of the times, as banks brace themselves for continued economic repercussions from the COVID-19 pandemic.

A COVID-19 pivot

OakNorth has been marketing its underwriting platform in the U.S. more than a year, but when it started in spring 2019, no one had heard of COVID-19, or had any inkling a pandemic would upend the world economy in 2020.

OakNorth may have sensed the issue earlier than many. It began developing pandemic scenarios in January, co-founder and CEO Rishi Khosla said in an interview. From that starting point, it developed a rating framework Khosla said is capable of assessing individual loans and assigning each what it terms a COVID-19 vulnerability rating.

As with Camels ratings (the acronym is for capital adequacy, asset quality, management, earnings, liquidity and sensitivity), a COVID-19 vulnerability rating of 1 indicates solid performance, while a rating of 5 is unsatisfactory.

OakNorth's ambitions as a financial technology provider have attracted hundreds of millions of dollars in venture capital support from SoftBank and Clermont Group.

Steve McLaughlin said he believes the company's value as a technology provider will soon outstrip the value of its bank.

McLaughlin, who is managing partner at San Francisco-based FT Partners, a boutique investment bank focused on fintech, is serving as adviser in a secondary sale of OakNorth shares that is ongoing.

“We don’t see any new digital balance sheet-based fintech companies that are worth $5 billion to $10 billion, but the arms dealers, those that are supplying the technology to the big banks and the big insurance companies, they’re going to be worth huge amounts of money,” he said.

OakNorth has also worked with Customers and the $798 million-asset Modern Bank in New York to develop solutions for Paycheck Protection Program loans. The partnership has helped Customers originate more than 80,000 PPP loans, Vice Chairman and Chief Operating Officer Sam Sidhu said Wednesday in an interview.

“It wasn’t a moneymaker from their perspective. It just deepened the relationship with us,” Sidhu said. “It’s been a very positive experience.”

Predicting the impact of a pandemic

McLaughlin said OakNorth’s technology will give Pittsburgh-based PNC a 360-degree view of its portfolio, a goal the bank might struggle to achieve through its normal loan review process, despite its size and capacity.

PNC has thousands of middle-market loans in its portfolio, McLaughlin noted.

“How are you going to overnight analyze all those loans in hundreds of complex sectors and subsectors of the economy of different sizes, scales, geographies and individual firm performances?” McLaughlin said.

McLaughlin observed that signing up PNC as a customer is a big win for OakNorth.

“PNC is one of the most rigorous banks out there and one of the most prolific at getting ahead of technology and using it to its advantage,” he said.

OakNorth has built 126 domain models, which are further mapped to more than 1,600 subsectors of the U.S. economy consisting of a long list of business key performance indicators and financial metrics specific to those industries. The company has also developed hundreds of subsector-specific recessionary and COVID-related stress scenarios, adjustable by region, which are mapped onto those domain models to generate cash-flow projections. The result, according to Khosla, is an exceptionally granular treatment.

“Banks don’t have the ability to run, on a data-driven basis, a forward-looking scenario down to the borrower level,” Khosla said. “We’re giving them that. It gets done in the large-cap space all the time. In the middle market, no one does forward-look views.”

OakNorth’s platform and rating system are not meant to take the place of banks’ existing human underwriters, but to enhance their work and to deliver "a sense check against what are your provisioning levels based on your standard risk-rating model, and also, critically, identify those loans [bankers] need to spend time with,” Khosla said.

“Banks are at a crossroad in terms of how they think about risk,” Khosla said. “All the years of modeling, of developing scenarios, etc., clearly hasn’t prepared anyone for what’s happening today. The need to fundamentally re-underwrite your whole loan book based on a different rating scale is almost critical to really understand where your risk lies.”

Missing middle

Khosla defines middle-market loans as those of $1 million to $25 million. He refers to the sector as the “missing middle” because it doesn't typically have lending technology created for it.

“If you look at this market, the low-middle market and middle market, the way loans are processed internally, the way they’re underwritten, the way they’re monitored, hasn’t changed for decades,” Khosla said. “We just feel like there’s an opportunity to use superior technology and data to drive better insights, to make better decisions, to monitor loans in a much better manner than what’s currently being done.”

As a result, Khosla sees a substantial market opportunity to apply leading-edge technology solutions and shake up a sector that he claims has been operating on autopilot for years.

The market is huge, with the number of middle-market loans numbering in the millions globally, McLaughlin said.

OakNorth has been putting its lending technology to the test in Britain since opening its eponymous bank in September 2015. It has yet to record a credit loss, although it has seen a “handful of defaults,” Khosla said.

McLaughlin lauds OakNorth’s credit performance.

“No losses is no losses,” McLaughlin said. “It’s not easy to do that, no matter what geography or scale.”

Khosla added that OakNorth has built an approximately $4 billion loan book staffed with an average of eight relationship managers and four credit analysts over the past five years.

“This isn’t using brokers. Ninety percent of our volume is directly sourced,” Khosla said. OakNorth's technology lets the small staff originate and underwrite a fairly large book of loans, he said.

While OakNorth doesn’t license its technology to competing banks in the United Kingdom, it has forged 20 partnerships with international institutions. The going has been slower in the United States.

For its first North American customer, Customers Bancorp, the link to OakNorth “has become a very deep relationship in a matter of months,” Sidhu said Wednesday. “We talk to them on a daily basis from the Paycheck Protection Program to portfolio management to stress testing to credit underwriting.”

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