What in the World Do We Do with Consumer Lending?

One of the most profoundly changed parts of the banking business going forward will be how the industry views and delivers consumer lending. Because the Great Recession was substantially a consumer-driven recession (predicted by GonzoBanker in 2004), many are wondering what those “green shoots” are that might get consumers back on their feet in the current economy, and how banks will respond from a lending point of view.

For banks, the consumer lending landscape is one that takes careful study and will require many improved capabilities internally to ever manage this line of business profitably again.

First, let me provide Gonzo readers a quick status report on the consumer credit markets.

Update #1: There has been an ever-so-slight decline in delinquencies depending on geographic region

Several major banks happily reported slight declines in credit card and consumer loan delinquencies these past two weeks, but the chart below from Horwitz and Co. keeps this “good news” in perspective. The dip has been miniscule. and the trend line in the past three years has been horrific.

Update #2: Charge-offs remain at their worst levels ever

While it is hopeful that delinquencies are starting to peak, the charge-off picture remains at more than twice historic levels. Here’s what the major credit card lenders reported for last month:

Clearly these levels demonstrate the immense pain still working its way through the consumer economy – this is more than just credit flakes. This is the result of the jolting the Great Recession has done to average household finances. Any type of consumer lending at these charge-off levels is purely an unprofitable destruction of capital.

Update #3: Consumers are beginning to reduce their debt loads

One piece of good news: for the first time in a long time, consumers are starting to pare back their debt levels, especially in the revolving credit card side. The Federal Reserve just reported an annualized 7.5% drop in revolving consumer credit for November 2009. The chart below shows how $111 billion of consumer debt has gone away since the October crisis hit in late 2008. However, the $2.4 trillion of consumer outstanding recently is still higher than debt levels as recently as 2006. We still have a bit more to go in reducing consumer debt exposure.

Update #4: Unemployment trends give little indication of near-term improvement

Clearly, the greatest systemic risk concerning both consumer credit quality and future origination capacity is the still bleak unemployment picture. Faith in any stimulus plan creating jobs has disappeared from even the most liberal mind, especially as surprises pop up like last week when initial jobless claims came in much higher than expected. Signals coming from Washington regarding heavy regulation, taxation, health care costs and high government spending are hardly inspiring the private sector to put capital at risk toward creating new jobs. It seems that political upheaval or a Clinton-like move to the center from the current administration are the only scenarios where the mood concerning private sector job growth may change.

Update #5: Low rates have helped debt service capacity, but this could change

The mortgage refinance boom of 2009 helped American consumers get out of risky ARM loans or free up some needed household cash flow. This, coupled with a heavy market adjustment on housing, is helping to build a stronger base for consumer credit quality in the future. However, this progress could all be tanked if inflation were to get out of hand and short-term credit card, HELOC and auto loans became much more expensive. We have to hope for some renewed fiscal credibility from Washington to allow this debt relief process to slowly work its way out.

Update #6: The regulatory burden around consumer lending will increase

It almost goes without saying, but all consumer lenders in the future are going to pay a price brought on by the worst actors in the consumer credit boom of the past 20 years. As banks works to manage the profitability of their consumer lending operations, they must be realistic that operating costs around compliance will go up.

The Gonzo Consumer Lending Action Plan

So, GonzoBankers, getting the consumer lending business revving again is going to take some time, but in times of fear like these, it’s also wise to have a long-term game plan. Here’s my quick advice:

1. Keep your resource focus on collections – it’s far from over
Most banks were caught short-staffed and weak in process/reporting on the consumer collections side. As we finally get better process up and running, it’s time to stay focused on these efforts well into 2011. No expense reduction opportunities here yet.

2. Be modest with goals – it’s too early to go “contrarian” and lend aggressively
There is just no interesting trend arising yet that makes ambitious consumer lending goals worth their while. It will be a less active time of only high quality borrowers getting an audience and volumes being modest no matter how much cajoling Washington gives banks.

3. Improve data analytics and internal “learning” capabilities inside your organization
The next wave of consumer lending will not be for the half-awake staffer running a FICO and printing out a closing doc on the HP printer. The new era will only award profitability to those who use credit information and insight that lurks within it to drive their business. Most banks do a pitiful job of capturing and learning from origination and ongoing servicing data to make better decisions and pricing policies in the future.

4. Build your underwriting 2.0 capabilities for the future
The breaking of the FICO-driven underwriting model of the growth era has caused consumer underwriters to rethink their overall approaches to approving deals. Lenders will be building more debt analysis and collateral analysis into their own internal scorecards and underwriting rules, and they will need to train underwriters to better recognize the nuance of successful consumer lending. It will be a return to old school thinking while still using streamlined processes and rich information of the new school.

5. Be ready and have the stomach for contrarian lending as opportunities arise
Despite the fairly tattered landscape of consumer lending today, there will be growth opportunities in the future for those who don’t think like the crowd. As an example, the whole industry will be trying to “risk rate” a borrower who did a home mortgage modification during the Great Recession. It will take the credit reporting agencies several years to build behavioral histories on these types of households, and some lenders may take contrarian sooner. Also, there could be the chance to take market share from retail store credit cards, as these companies now have to play by the same underwriting standards and compliance under the recently passed credit card bill. Finally, with a portion of consumers sincerely trying to reduce debt, there could be packaged lines of credits and term loans that steal share from the high-cost large credit card issuers.

GonzoBankers should keep the hatches battened down pretty tight when it comes to consumer lending in 2010. However, major changes in this landscape are taking shape, and smart, creative bankers will leverage these changes to build more sophisticated and profit-disciplined consumer lending businesses in 2011 and beyond.
-sw