Jonathan Rochford, portfolio manager at Narrow Road Capital, says the increasing bifurcation of the lending market – whereby banks focus almost exclusively on standard, straightforward prime lending and nonbanks deal with more complicated situations – has produced a marked difference in credit underwriting approaches.

Prime lending is a volume game, and Rochford says this means assumptions in credit decisioning. “Near enough is often good enough when it comes to banks’ assessment of, for instance, borrower expenses. This doesn’t pass muster for nonbanks. They typically examine borrowers’ bank statements, looking for things like exposure to buy-now, pay-later or payday loans.”

This detailed approach remains the case even as the larger nonbanks have increased the size of their books and diversified them. Rochford adds: “They have been able to scale up, adding staff – particularly credit analysts – and training them on how to look at what ‘Mr and Mrs Smith’ put across the table when they apply for a loan.”

Technology can help to some extent, Rochford continues, but the nonbank model still needs human skills on the credit side. He explains: “This is a fundamental difference: to some extent, the major banks have made the call that they don’t want to – or cannot – train thousands of people to assess loans in the same level of detail nonbanks do.”

The hands-on approach also applies to serviceability issues. James Donovan, portfolio manager at Challenger Investment Management, says: “Nonbank lenders are well prepared to manage distressed nonconforming borrowers. They are very capable, for instance, of taking a high-touch approach with borrowers in early-stage arrears or even ones that are at risk of getting into this situation. Some nonbanks take a proactive approach, getting in touch with them with a friendly call to say, in effect, ‘we are here if you need us’.”

This has always been a strength of the sector and if anything it was only enhanced by the pandemic period. Lenders describe a period in the early days of lockdowns when there was a deluge of requests for hardship arrangements – and the most common response was that granting hardship on request was the most compassionate approach.

It soon became apparent, however, that many borrowers requesting hardship did not actually need it – and that unnecessary hardship arrangements are actually a negative outcome for the lender and the borrower.

“The impression I get is certainly that nonbanks have further upped their game on engaging with borrowers about their circumstances, understanding them and responding appropriately,” says Tally Dewan, director, fixed income and rates desk strategy at Commonwealth Bank of Australia. “This has been an ongoing process over the years, but COVID-19 and the [banking sector] royal commission have certainly enhanced the focus on looking after borrowers.”

The incentive for nonbanks in particular to take a proactive approach to understanding and managing their loan books is clear. Donovan explains: “Nonbanks’ ability to fund themselves efficiently is directly related to their arrears: it is in their warehouse facilities and their securitisation transactions. They are hugely focused on arrears, because it directly affects their effective cost of funding.”