Is Consumer Lending the New Model? with Mainstream Credit Cards Evolving, and CRE Still Smarting, Experts Say Community Banks May Return to Significant Personal Lending. Relationship Banking May Blossom Again
Cocheo, Steve, ABA Banking Journal
Cheap, frugal, and debt-free--or working towards it--got cool in a hurry for many American consumers. For others, it dropped on them like a ton of bricks.
Whether by design or necessity, consumer debt in the U.S. has shrunk as part of the ongoing deleveraging of the economy. Overall consumer debt outstanding fell by 5.75% in August, 10.5% in July, 5.25% in June, according to the Federal Reserve.
This comes at a time when credit availability, both in supply and form, is going through significant upheaval.
Major economic dislocation makes for a tough time to parse what shifts like this mean not only for the economy, but also the players in it--including community banks trying to determine "what's next." This is especially so when current problems dominate thinking. However, the trick to good driving is to focus on what's coming ahead, not just right in front of the windshield.
A range of bankers, consultants, and economists interviewed indicate that community bankers who understand what has changed in consumer finance--and how--may find fresh opportunities coming down the road. And many say that circumstances may even favor community banks as the industry takes the next curve.
No one is saying that community banks are going to have a "back to the future" revival. "I don't see community banking getting into personal loans like they used to make--making loans for refrigerators, for instance," says Jay Brew, chief bank strategist for m.rae resources, inc., Bethlehem, Pa.
But, clearly, for many, something is going to have to change, even if they aren't facing months or more of CRE cleanup.
It comes down to profitability, says veteran community banker W. Kirk Wycoff--chairman of the board and past CEO at Pennsylvania's $478 million-assets Continental Bank.
"We only make money when we take interest-rate risk or credit risk," says Wycoff, who is also partner in Patriot Financial Partners, L.P., a private equity firm specializing in banks. "This is a lousy time for credit risk--we're in a recession." Wycoff says many banks have so tweaked their gap that they are at "0," with less than half a year's duration. He sees consumer credit as an avenue for reasonable risk in both categories.
Mixed factors drove change
"It is an open question, in my mind, how much of the deleveraging is demand-driven and how much is supply-driven," says Jonathan Zinman, associate professor of economics at Dartmouth College, who specializes in household finance and retail financial issues. "On the demand side, it's unclear how much is a matter of psychology, and being more attuned to the the risk of job loss and other risks, or how much of the deleveraging could be a permanent shock for some people, feeling poorer, and being poorer, and feeling that they have less income to spread across their lives."
Meredith Whitney, CEO of Meredith Whitney Advisory Group, LLC, and an expert on debt, noted in a recent Wall Street Journal op-ed that credit-card lines have been cut by 25% since last year. That was prompted both by economic factors and by card issuers who began to shift policies and practices in the wake of passage this May of the Credit Card Accountability Responsibility and Disclosure Act of 2009. And Whitney predicted more than $1 trillion more in credit-card-line cuts by the end of 2010.
"For most Americans, credit card availability became their savings account," reflecting the financial enfranchisement of millions who had never had plastic before, says Walter Moeling, partner in the banking practice at Bryan, Cave LLP, Atlanta.
"People loved their credit cards," says Dartmouth's Zinman, "and the ability to get credit on demand."
Indeed, the shift in attitude shows in more than consumer credit outstanding. Ed Seifried, former professor of economics and business at Lafayette University, Easton, Pa., notes that total consumer spending came in at $343 billion for the month of September 2009. By contrast, in December of 2007, that spending had hit $382 billion for the month.
"We're $60 billion light," says Seifried, now executive director of the affiliation program at Sheshunoff Consulting & Solutions. "That's what I call the 'lite economy'."
Seifried believes the consumer's swing to savings carries potential harm, taken too far. "Overspending is as bad as over-saving and it will be a headwind for our economy for the next five to ten years," he says.
Human nature, need, and local banks
Are community bankers thinking in this direction? Many interviewed doubt it--they are too busy with cleanup. "Right now, most are out of the consumer finance market and I don't see it changing," says Don Musso, president, FinPro, Inc., Liberty Corner, N.J. "There's a certain level of 'duck and hide,' right now."
"We don't see any banks anywhere thinking about the future, right now," says Walt Moeling.
However, while pressing matters occupy many institutions' attention, other observers believe it is a given that community banks will return to the consumer market. (Some never left it, of course, but many deemphasized it due to competition.) One such believer is Brian Johnson, principal for Deloitte Consulting LLP's National Consulting Banking & Finance practice.
"To me," Johnson continues, "the question is, 'When?'"
Experts who see community banks moving seriously into consumer credit point to unmet consumer needs and desires. Americans haven't changed their list of necessities that much, they insist, nor have Americans changed their attitudes that drastically, either.
"There is a pent-up demand for consumer goods and eventually that is going to be released," argues Catherine Ghiglieri, former Texas Banking Commissioner and president of Ghiglieri & Co., Austin, Texas. She sees community banks meeting this need with credit, and considers this a return to their historic "bread and butter."
"Eventually people are going to want to buy cars again," says Ghiglieri.
"if things stabilize, that could provide a prime opportunity for community banks," agrees Richard Brunner, senior consultant at Sheshunoff Consulting & Solutions. "Depending on their markets, community banks could carve out a niche for themselves."
This may be so even though the nation remains somewhere in the midst of the worst recession since the Great Depression. "Human nature is such that if there's a bottom, and a little bit of optimism, I can see people being a little more willing to borrow," says Randy Marshall, managing director at consulting firm Protiviti, Inc. "But you won't see the excesses of the recent past."
The key driver to consumer willingness will be a leveling-off of unemployment, according to Protiviti's Michael Brauneis, director of regulatory risk consulting. Marshall believes some community banks have already begun to move in where larger banks have pulled back, out of need to shrink for capital's sake, or to re-trim the risk mix.
And there are some who stretch beyond this. Sheshunoff's Ed Seifried, for instance, hypothesizes a return to general deductibility of interest on consumer installment debt.
"If we could make it attractive for consumers to borrow again, it would be good for community banks and for the economy," says Seifried.
Making auto loan interest alone deductible for everyone, again, would have benefited consumers, Detroit, smaller banks, and the economy at large, he adds.
You already know your targets
Where will community banks find their consumer credit customers?
"You will find them in your own customer base," says Jay Brew of m.rae. He believes that the behavior of some very large banks in the recent period--changing credit card terms, cutting down unused lines, and more, while understandable in a bank management sense--has alienated their customers (or ex-customers).
"This is a big opportunity for community banks," says Brew, if they play it right. Customers with credit needs that large banks formerly met with plastic or other products may be quite willing to consolidate more of their business with their community bank.
Consumer lending for large players and the prospect of consumer lending for community banks, though similar in many ways, will be different creatures.
For instance, attorney Walt Moeling believes community bankers need to be realistic in pursuing consumer borrowers. He suggests that many AAA consumer borrowers will likely still borrow from larger players that don't need to know them to give them the credit they want. Such borrowers will likely continue qualifying for programmatic lending efforts. They'll continue to obtain credit cards without any trouble, they'll easily qualify for home equity credit, and more. They won't likely need more-traditional consumer loans.
"Community banks will serve the person who has to explain themselves, who doesn't look perfect," says Moeling. He's not talking about B or C credit, just people with credit records or circumstances that don't make it through the scoring models' filters. Some call these borrowers "dented credit."
"And there's good money there," says Moeling.
Clearly, for the foreseeable future, collateral is going to play a part in consumer borrowing. "Unsecured lending is pretty much gone right now," says Deloitte's Brian Johnson.
Experts predict that relationship banking, and local knowledge, will increasingly support community banks in their thrusts into consumer credit. The art of knowing people as more than numbers, spoken of almost until it is a cliche, really will mean something in this space.
"To the extent that large banks make credit cards less appealing, that opens the door to options," says Washington-based consultant Bert Ely. Exploiting local knowledge will be a boon.
Indeed, "there's great value in the local touch. There's great value to knowing the people that you are dealing with, as opposed to working through computerized models," says David Evans, vice-chairman of LECG Europe.
No monopoly in relationships
Indeed, the idea that consumer lending will increasingly be driven by relationship banking, rather than one-off product-based relationships, won't just be a game for community banks.
"The last 15 years of the credit card industry has been about specialization and consolidation," says Robert Hunt, assistant vice-president, and director of the Payment Cards Center at the Philadelphia Federal Reserve Bank. "There were evidently economies of scale which tended to favor the largest issuers (and acquirers). The technology has not changed and so perhaps that intuition is still correct." (He speaks for himself, and not the FRB of Philadelphia nor the Federal Reserve System.)
However, Hunt adds, with fewer options to reprice consumers, and possibly with a change in consumers' views about debt, "the credit card could become more of a relationship product than it has been in a very long time." His point, from the perspective of larger banks, goes beyond cross-selling. In order to make a profit on cards, large institutions may seek broader and stickier relationships with consumers, to keep them in the fold, and to know more about their overall finances.
Indeed, m.rae's president, Michelle Gula, says that Wells Fargo is contacting its card base in an effort to get them to consolidate their financial relationships with the megabank.
CFPA: Spoiler, savior, sinker?
A yellow light hanging over this discussion is the proposed Consumer Financial Protection Agency. The Obama concept remained in committee wrangling at this writing, on the House side, and much debate remained in the Senate.
Much hinges on who the main target of CFPA finally turns out to be, if it becomes reality.
Protiviti's Randy Marshall and Mike Brauneis see some potential advantages, under some scenarios, for community banks. For example, where large players might be forced into very standardized products to be able to handle compliance and large-scale operation, a smaller player could offer more innovative and customized options, especially if they only have to worry about one jurisdiction's legal requirements.
Likewise, Don Musso--while stressing he's no friend to CFPA as a concept--sees at least a leveling of the playing field for banks of all sizes if CFPA becomes more a regulator of nonbanks previously not overseen, or overseen seriously. But if they escape, and Washington targets banks alone, "it will kill the banks."
A carve-out for community banks has been entertained, and if that became law, and if it's truly a carve-out in more than words only, some say they could use that to their advantage, on the cost side.
But LECG's David Evans fears that the concept is going to put community banks at a disadvantage to larger players of all stripes, and may cut them off from consumer credit.
The old enemy keeps on going
Finally, there are credit unions, bane of banks for years in consumer credit, and more recently in business lending. To turn back to consumer credit, banks will be fighting credit unions on their traditional turf, with all the advantages, most notably their tax status, that ABA and others have worked against for years.
"Credit unions have a unique opportunity to pick up market share on the consumer side," say Protiviti's Brauneis.
Consultant Cathy Ghiglieri agrees that banks facing strong credit unions will have to bring their best game. "Credit unions are still going to be particularly competitive," she warns, "because they have never really lost focus on the consumer."
What's worse, the pricing advantage can upset many competitive balances. Ghiglieri helped start a website, RateGenius, for a client. The site helps consumers find car loans. She says tax-advantaged credit unions nearly always beat banks attempting to compete on that site.
Where is your bank's consumer credit niche?
As the main article notes, experts suspect community banks' opportunities in consumer lending lie in nichemanship. In discussing consumer lending's future among community banks with them, we asked about the adaptability of various types of credit. Here's a summary of what the experts said about three key aspects of consumer credit.
Is there a Ford (or Hyundai) in your future?
Auto lending, often seen as something surrendered by many banks to captive finance companies or credit unions years ago, has also been a niche play for some banks for years. Patriot Financial Partners' Kirk Wycoff serves on the board of $215.6 million-assets Franklin Security Bank, which carved out a specialty in dealer finance that accounts for about 60% of its business. The Plains, Pa., bank serves more than 50 dealers' customers in northeastern Pennsylvania. Experts say the margins are good in this business.
"This is an opportunity for community banks," says Richard Apicella, executive with Benchmark Consulting International, which specializes in auto lending programs. "White the credit unions have been pushing up share, the big national lenders have been pulling back."
"It's good business, if you know what you are doing," says Apicella. "You have to know how to price for it and you have to know how to collect it."
Note that Apicella adds: "We've come into a number of institutions where that hasn't been the case."
Dismissing banker fears, Wycoff says "it's not a high-barrier-to-entry business. You have to hire somebody who is experienced." Wycoff believes many bankers feel leery of indirect auto finance because their institutions didn't approach it properly, years ago. In addition, he says, the technology available decades ago, when some bankers' attitudes solidified, was primitive compared to what is now available for auto-loan operations.
Apicella believes that community banks have an advantage over other lenders, because they know their markets more intimately. "And they are better connected than some of the larger players," he adds.
What about the captive finance companies? Apicella says they are still out there and still active, though the asset-based securities market has only recently started to come back, thanks, he says, to the Fed's TALF program. But he adds that bankers need to recall that captives continue to be a marketing mechanism for manufacturers, and so serve different priorities than traditional credit-oriented lenders.
Not just for boom times anymore. Among some, the very idea brings laughter, along the lines of "What equity?" But a handful of experts suggest four counter-arguments: 1. Community banks don't lend in the other guy's market; 2. Equity hasn't taken the same hit all over; 3. Banks don't lend on average prices or levels--they lend deal by deal; and 4. There are people in your market who still have equity, still have good credit, and may want to borrow; think selectively.
Regarding the last point, m.rae's Brew points out that a bank he started, and serves with as director, Embassy Bank for the Lehigh Valley, continues to make home equity loans. A special program enables the bank to make Loans that are both first and second mortgages, using a home equity template that permits faster amortization for the customer.
Even if a bank's locale doesn't favor home equity lending currently, some experts say banks can tool up now for the return of better price levels.
"This is not one that comes into play early in 2010," says Geri Forehand, director of strategic services at Brintech Management Solutions, Austin, Texas. But further on, he believes, entry, or reentry, could be attractive.
Still viable for big players. The consensus among experts is that, except for community banks that join a program specifically for them, this continues to be prohibitive for banks in their league.
Sheshunoff's Richard Brunner says experience indicates that it is hard for community banks to penetrate their own customer bases beyond the 10% mark, so growth then means going to strangers. Nowadays, this is rife with fraud and related risks. When even megabanks face huge costs on that front, the advisability of getting into it directly is debatable, he adds.
"Long term, I'd be pretty bullish on the prospects for the credit card business as it stands," says Dartmouth professor Jonathan Zinman. "It took them decades to come up with the business model that works, and in the long-run, it's on the right side of IT trends." Existing megaplayers have a sophisticated understanding of typical consumer behavior that factors into their risk-pricing models, he adds.
(ABA offers two card programs specialized for community banks, that promise a risk-free approach, through its Total Business Solutions operation. One works through First Bankcard, the other through TIB-The Independent BankersBank. Go to www.aba.com/BusinessSolutions/default.htm)
EXPERTS' TIPS ON CONSUMER CREDIT
"If you were a bank executive considering a renewed push into consumer lending, how would you go about it?"
We asked many of the experts interviewed for this article this question. You can find an online companion to this article at www.ababj.com with their answers.
By Steve Cocheo, executive editor…
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: Is Consumer Lending the New Model? with Mainstream Credit Cards Evolving, and CRE Still Smarting, Experts Say Community Banks May Return to Significant Personal Lending. Relationship Banking May Blossom Again. Contributors: Cocheo, Steve - Author. Journal title: ABA Banking Journal. Volume: 101. Issue: 11 Publication date: November 2009. Page number: 18+. © 2009 Simmons-Boardman Publishing Corporation. COPYRIGHT 2009 Gale Group.
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