American Banker/InsightExpress Executive Forum 4Q '06 (Consumer Finance)

American Banker   Friday, February 16, 2007
By Rob Garver

Despite rising interest rates, a weak housing market, and lawmakers pounding the table about increased regulation of home lending, financial companies are still looking at mortgages and home equity lines as their best hope for driving consumer lending growth this year.The latest Executive Forum — American Banker's quarterly online survey — also found that relatively few financial services firms are actively looking for new customers among the unbanked and underbanked.

The January survey of 318 senior financial services executives covered issues related to consumer finance. Among the other findings: Concern about data breaches that compromise customer information has subsided, while worries about increased competition from nonfinancial companies moving into financial services persist.

For the past several years the majority of companies large and small have predicted that they would expand their overall consumer lending efforts in the coming year, but the percentage has been sliding for small companies and climbing for large ones.

This year 51% of small-company respondents said they would increase consumer lending efforts, versus 56% a year earlier and 63% in the fourth quarter of 2004. By contrast, 83% of large-company respondents expect to increase consumer lending this year, versus 80% a year earlier and 72% the year before.

HOME LENDING

For the third year in a row home equity lines of credit and, to a lesser degree, mortgages were seen as the best opportunity for growth in the consumer market. Among small companies, 47% said HELOCs were their best chance to drive growth in that market, while 25% said mortgages offered the best opportunity. Among large companies, 45% cited HELOCs, and 14% cited mortgages. The percentages were nearly unchanged from a year earlier.

"The mortgage industry is always going to be a growth engine of some sort," said Joe Belew, the president of the Consumer Bankers Association. "If you don't take the view that the market is cratering - and I don't - it is reasonable to assume that mortgages and home equities are going to provide some growth."

David Olson, the president of Wholesale Access Mortgage Research and Consulting Inc. of Columbia, Md., agreed that it is no surprise consumer lenders are focusing on home loans, but he said they are doing so largely because they have few other options.

"You have to face reality. There aren't a lot of choices. There is certainly no better choice," he said.

For instance, credit card lending is so concentrated among the top players that growth in that sector is unattainable for most companies, Mr. Olson said.

(Of course, not all bankers see it that way: Wachovia Corp. returned to the card business last year after a six-year absence, and in November it said its growth was ahead of internal targets. Fifth Third Bancorp has said it aims to double the card loans it holds, the number of accounts overall, and the earnings it derives from the business in two years.)

THE UNBANKED

It appears that most bankers are taking a wait-and-see attitude when it comes to pursuing the unbanked and underbanked.

Asked to what degree their companies are pursuing that market, 71% of respondents from small companies said they were either not looking at all or were only studying it, 13.3% said they were testing products for that market, and 15.7% said they were marketing actively there.

Big companies seem slightly more inclined to pursue the unbanked; 48% of those respondents reported that they were either not pursuing that market or only studying it. By contrast, 24% said they were testing products in the market, and 29% said that they were actively pursuing customers there.

"From my standpoint," the number of respondents large and small that said they were pursuing the unbanked is "surprisingly low," Mr. Belew said. "Most of the banks we talk to are very interested in emerging markets; I think it is a very big part of the future of the franchise."

Respondents from both asset classes reported that prepaid cards appear to offer the best way to develop a relationship with unbanked and underbanked individuals, with check-cashing services running second.

Last week H&R Block Inc. said that it had achieved its goal of opening at least a million bank accounts, nearly three months ahead of schedule, and that it expected to add 1 million to 2 million more by mid-April.

The Kansas City, Mo., tax-preparation giant, which opened its bank last year, credited the popularity of its Emerald Card, a debit card that can store the value of a refund-anticipation loan.

Mark Ernst, H&R Block's chief executive, said last month that he expected to sign up 1 million to 3 million banking customers by the tax-filing deadline, which is April 17 this year.

CARDS

Interestingly, many respondents also cited different varieties of prepaid cards, such as reloadable debit and gift cards, as some of the top areas for potential growth.

When asked to identify the " biggest untapped growth opportunity" in the card business, 24% of respondents said marketing to small businesses, 19% said reloadable debit cards, 13% said health savings accounts, and 10% said gift cards.

Despite the buzz surrounding contactless payments and mobile payments, only 5% of respondents selected them as a major source of potential growth for card issuers.

The small-business card market "is underpenetrated compared to what it could be," said Avivah Litan, a vice president and research director for Gartner Inc. "Small businesses typically run things out of checkbooks. With credit cards, you do lose some of the controls - it is not a great control mechanism, like a checkbook is."

However, the increasing availability of "purchase cards," which provide the convenience of credit cards while allowing an employer to limit the amount an employee can spend, may help break down some of that resistance from small-business owners, she said. Purchase cards have typically been marketed to large corporations but are becoming increasingly available to small firms, Ms. Litan said.

Given that such a small percentage of respondents selected cards as the best growth opportunity ( 3% for credit and 8% for debit), it is perhaps unsurprising that MasterCard Inc.'s initial public offering in May and Visa International's impending transition to a public company have elicited mainly yawns. Asked to assess each company's going public, majorities in each case predicted little or no effect.

But Ms. Litan warns that to the extent bankers are committed to credit or debit cards, they might not want to be so blase.

"I think it is going to have a huge impact over time," she said. "Now Visa and MasterCard will answer to shareholders, instead of their issuing banks. It is a lot different when you are beholden to shareholders."

Rather than skewing their decision-making toward the interests of owner-banks, the two companies will begin to weigh the concerns of merchants and consumers more than they have in the past, resulting in less favorable (read: more expensive) treatment for issuers, Ms. Litan said.

WALL STREET

Considering their hopes for growth in home lending, respondents seemed surprisingly unconcerned about recent deals by Wall Street firms to acquire mortgage originators.

Half the respondents said they expect the trend to have little or no effect on their business, while 31% said they were unsure. One in five respondents from large companies said they expect the trend to be a positive one for their companies, compared with just 5% of respondents from small companies. Among small companies, 11% said they expect a negative effect, as did 10% of large companies.

Echoing comments by many participants, one respondent wrote: "I believe that entrance of the investment banks will most impact the existing large mortgage originators. Smaller or community bank originators can still sell on service and local knowledge."

Others warned that investment banks may be sailing into unfamiliar waters.

"I expect the cyclical nature of the mortgage business will have a greater impact on the investment bankers than the other way around," a respondent wrote. "They are buying in late in the cycle. The slowdown in originations will strain the cost structures. … I expect some of those same originators will be sold at fire sale prices further down the cycle."

The rise of investment bankers as a force in mortgage originations had one respondent worried about potential regulatory disparities.

"It could create an unbalanced playing field if the investment banks are able to originate loans outside of the recent issued regulatory guidelines, especially depending on the regulators' interpretation of the guidance," the respondent wrote. "It is clearly a threat to the mortgage businesses of OCC and Fed-regulated institutions."

However, Lehman Brothers, which began vertically integrating its mortgage operations well before most of its Wall Street rivals, houses its origination arm in a federal savings bank. And UBS AG, which began funding loans through brokers last year, does so through a bank regulated by the Office of the Comptroller of the Currency.

The acquisition of mortgage originators has been seen largely as an effort by investment banks to create their own supply of loans to package as securities, rather than having to buy loans from banks and mortgage companies. Having an in-house production arm also gives a securities firm more control over the quality of the loans it securitizes.

Mr. Olson said he did not expect such deals to have a significant effect on originators' ability to sell mortgages into the secondary market, even to firms with their own originating affiliates. "They seem to have an insatiable appetite."

But some players in the secondary market have either lost some of their appetite or begun to chew more slowly. Last week Michael McQuiggan, the chief executive of Lenders Direct Capital Corp. of Lake Forest, Calif., told American Banker that it had shut down its wholesale division because "buyers stopped bidding on our loans, or if they did give a market price, they wanted to hold a percentage of the premium as a reserve."

And for some time now Wall Street firms have been sending back what they cannot stomach. Forced repurchases of loans that had early-payment defaults played a role in several widely publicized blowups of recent months in the subprime sector, such as those of Ownit Mortgage Solutions Inc. and Mortgage Lenders Network USA Inc. Margin calls on Street-provided warehouse lines helped seal both companies' fates.

NONFINANCIALS

If Lehman or Bear Stearns Cos. is not giving most bankers heartburn, Wal-Mart Stores Inc. apparently still is.

For the second year in a row the notion of nonfinancial companies' getting into the business of providing financial services was a major concern for bankers.

"Incursions by retailers will have the potential of diluting the already lean market for financial services," one respondent wrote.

Unlike last year, though, it is no longer the top concern of banks in both asset classes.

Asked to choose, from a menu of options, the one that would have the " biggest impact on your business in 2007," a third of respondents selected the incursion of retailers and other nonfinancial firms into their markets. The percentage of small companies choosing that option increased 7 points from a year earlier, to 35%, but the percentage of large companies choosing it dropped by nearly half, to 17%.

Respondents from companies with under $10 billion of assets expressed worries that disparities in regulation will make it difficult to compete with nonfinancial firms.

"Competition from unregulated, nonfinancial companies and large retailers will continue to eat away at business segments now served by banks," one respondent predicted.

Others worried about the effect on their cost of funds.

"Banking is under intense pressure by nonfinancial companies for the deposit side of the business, but they provide little by way of loans that our customers want," one respondent wrote. "Therefore, we will be on the short side of the available funds to provide those loans."

(It should be noted that the survey was taken before the Federal Deposit Insurance Corp. announced it would extend by one year its moratorium on approving industrial loan company charter applications by nonfinancial companies. Also, the survey was conducted before the introduction of a House bill that would create an outright ban on ILC charter approvals for nonfinancial firms.)

For large companies, the continuing growth of e-commerce was the top choice among concerns for this year, chosen by 19% of respondents. But the worry was not limited to large firms - 19% of small companies made the same choice.

"Although banks are building branches at an unprecedented rate, consumers are demanding increased e-commerce opportunities," one respondent wrote. "With the current margin squeeze, there is not the capital available to effectively attack both delivery channels. In the short run it appears that brick and mortar is paying the bills, but I believe in the long run those financial institutions that have robust e-commerce offerings will be the winners."

Nineteen percent of respondents said changing payment technologies would have the biggest effect on their business this year.

One respondent from a small company said the introduction of new payment technology is a particular challenge in some markets.

"Our rural-market consumers are typical in that they are slow to accept innovation," the respondent wrote. "Many are just joining the debit card bandwagon. They have discovered the ease of use and the protection afforded by technology embraced long ago by their city cousins. The Internet has spread word of newer technologies that are even more helpful, and the positive experience of the debit card has primed them to take the next steps."

Mr. Garver, who covered regulatory issues as an American Banker reporter from 1999 to 2003, is a freelance writer in Springfield, Va.