Automation in finances, particularly within the banking sector, traditionally commenced with high-frequency processes and transactions. In banking, the most frequent activities involve transaction processing and retail lending.

These areas have been the primary focus of automation efforts, encompassing aspects such as application processing, risk assessment, and the transition from manual review of forms and documents to automated checks and model-based evaluations.

Mezzanine financing stands in stark contrast to these high-frequency processes. Characterized by its unique, tailor-made nature, mezzanine financing occupies a specific niche space within the financial landscape: it represents a financing solution with heightened risk levels, strategically positioned between standard corporate loans and equity investments.

Mezzanine financing either involves providing funding at the shareholder level (which is structural subordination) or through equity acquisition coupled with return instruments like put options (contractual subordination).

Given the one-off and highly individualized nature of mezzanine deals, automating processes in this area presents a significant challenge. The natural question would be the following: how can banks, especially major ones, approach the task of enhancing the profitability of their mezzanine business through automation and digital transformation?

As an expert with substantial experience in the areas of Private Equity, Risk Management, and Finance, I aim to provide an introductory exploration into the digital transformation in mezzanine lending which seeks to unravel the complexities and provide success stories in applying technological advancements to an area of banking traditionally reliant on bespoke, individualized deal-making.

The Traditional Landscape of Mezzanine Lending

Mezzanine financing is a distinctive and nuanced sector within the broader financial landscape. As was stated earlier, it occupies a middle ground between conventional corporate loans and equity investments and is characterized by an elevated risk level.

Uniquely, each mezzanine deal is tailor-made, and crafted to suit the specific needs and circumstances of each client, much like a custom-made suit.

Challenges in Traditional Mezzanine Lending

The nature of mezzanine financing inherently brings about significant challenges. Traditional methods rely mainly on manual processes and individualized deal-making. This approach demands a deep understanding of the unique aspects of each deal, a skill set that is often scarce and expensive.

In large banks with established corporate lending divisions, client and credit managers are well-versed in standard credit products. However, their encounter with mezzanine transactions is infrequent, which in turn limits their expertise in effectively selling or attracting such deals.

Establishing a specialized team of client managers exclusively for mezzanine products is not just expensive, but it also escalates the costs in comparison to the more standard lending procedures.

While it is possible to combine complex investment products into groups to reduce costs, digitalization in this regard emerges as a more economical and efficient alternative.

Digitalization as a Solution

The digital transformation in mezzanine lending primarily focuses on deal identification and attraction. Most credit and client specialists in banks use systems that record negotiations, deal ideas, and initial deal parameters.

Integrating mezzanine criteria into these existing systems could automate the identification of potential mezzanine deals.

When a transaction meets these criteria, it could automatically be forwarded to the mezzanine division for further processing. Further advancements might include AI models trained to differentiate between standard corporate loans and mezzanine deals based on a multitude of incoming deal parameters.

The scale of this transformation is significant: while a major bank might conduct thousands of corporate lending transactions annually, mezzanine financing deals are much rarer, often numbered in single digits. Implementing a system for identifying mezzanine deals could potentially lead to a tenfold increase in their volume.

Streamlining the Process: Automation and Standardization

Digital transformation can streamline execution by automating and standardizing the process. Instead of diving straight into full-scale automation and platform development, you could initially focus on simpler technologies like RPA, which automate data collection, verification, calculation, and reporting. This reduces manual work and errors and improves accounting and compliance.

Standardized mezzanine instruments and documents like term sheets and loan agreements can also be quickly customized for each deal without loss of quality. This speeds up processing and documentation, which further improves transparency and consistency.

Digital platforms and tools like databases and dashboards help track and manage increased deal volume and variety by organizing information. This enables monitoring deal status and progress, identifying and resolving issues.

Overall, automation and standardization simplify execution, reducing friction and costs. By streamlining the end-to-end process, digital transformation makes mezzanine lending more efficient, scalable, and profitable.

The Role of Reporting Tools

Mezzanine portfolio reporting is problematic without standardized data. These heterogeneous deals lack transparency, which makes it difficult to consistently evaluate key return and risk metrics.

Digital analytics tools for data visualization and Business Intelligence can help by integrating fragmented data for consolidated visibility: it enables interactive dashboards that visualize portfolio performance sliced by the borrower, industry, geography, and other dimensions — this empowers holistic monitoring.

Qlik also enables advanced analytics like predictive modeling, scenario analysis, and stress testing. Lenders can simulate future portfolio performance under various assumptions and conditions — these data-driven insights help optimize strategy and risk mitigation.

Qlik Sense and data analytics in this regard are the best to provide the transparency and insights needed to actively manage mezzanine portfolios. By enabling comprehensive reporting and predictive analytics on these complex deals, digital transformation gives lenders the visibility required to maximize returns and minimize risk. It's a powerful lever for optimizing results in mezzanine lending.

Case Studies

In this section, we'll explore instances of credit process automation. Notably, there are limited prominent cases of optimizing mezzanine transactions beyond our work at Sberbank.

However, I'll present some examples that demonstrate how similar approaches can be applied to mezzanine business, akin to what we achieved at Sberbank between 2018 and 2021, and what I’ll unveil later in the text.

Case Study 1: Major European Bank Implements End-to-End Digital Lending Platform

Background: A large European bank sought to reposition its SME lending business amid competition from agile fintech rivals. It aimed to create a digital ecosystem with seamless customer journeys. The first step was reinventing its commercial lending with streamlined applications, mobile access, and real-time approvals.

Approach: The bank partnered with Deloitte to define customer and technology requirements for a new cloud-based Digital Lending System. Deloitte's OpenDATA platform on AWS enabled flexible, scalable, modular development. This allowed the adoption of Agile methodologies, delivering the first version in just 13 weeks.

The system uses advanced analytics including AI and ML to integrate and analyze data from internal systems, external databases, social media, and other sources to create comprehensive, up-to-date borrower profiles.

It applies predetermined rules to filter and rank suitability for mezzanine financing. RPA, blockchain, and smart contracts automate manual tasks like documentation, calculations, and reporting.

Qlik Sense enables interactive data visualization, predictive modeling, scenarios, and stress testing to optimize mezzanine strategies and risk management.

As a result, the loan application time was reduced from 20 days to 15 minutes, the approval rate increased from 50% to 90%, and processing costs decreased by 70%. Lead flow, quality, and conversion also improved, whereas transparency and consistency of mezzanine offerings were enhanced. Analytics and simulations optimized strategies and decisions.

Case Study 2: Private Lending Company Leverages GoDocs to Modernize Lending

Background: theLender is a private lending company that specializes in providing bridge loans to real estate investors. theLender sought to differentiate itself from other lenders by offering a faster, simpler, and more transparent lending process.

Approach: The company partnered with GoDocs, a leading provider of commercial loan document generation software, to implement a digital lending platform that automates the entire loan origination and closing process.

The platform leverages cloud computing, artificial intelligence, and blockchain technology to streamline workflows, reduce errors, and enhance security.

Further, theLender’s digital lending platform enabled it to reduce the time to generate loan documents from hours to minutes, eliminate manual data entry and human errors, provide real-time visibility and collaboration among all parties involved in the loan transaction, securely store and share loan documents on a distributed ledger, and finally integrate with third-party services such as credit bureaus, title companies, and escrow agents.

As a result, the company’s digital lending platform helped it increase its loan volume and revenue by 300% in one year, improve its customer satisfaction and retention rates, reduce its operational costs and risks, as well as gain a competitive edge in the private lending market.

Conclusion

Digital transformation presents a compelling opportunity for mezzanine lenders to innovate and create value. Advanced technologies including automation, AI, and data analytics can address current pain points around deal sourcing, process efficiency, and portfolio management.

The potential benefits are multifaceted — improved customer experience, employee productivity, risk management, and strategic agility. The main benefit is an increase in the number of transactions, and therefore in income.

Drawing on my experience working at Sberbank from 2018 to 2021, it's clear that implementing such changes in the mezzanine business can significantly boost both the volume of business and the number of deals. Initially, Sberbank managed around 10 mezzanine deals per year.

However, by 2022, following the adoption of effective automation strategies, the bank's capacity surged to over 100 deals annually.

This remarkable growth highlights the substantial influence of digital innovations on enhancing both the scale and efficiency of operations in mezzanine lending.