Q&A: Signet Exec Takes Loan-by-Mail Losses in Stride

RICHMOND, Va. - Signet Banking Corp. is conducting one of the nation's boldest experiments in "branchless" banking. Using data base technology that it refined in its now-divested credit card operation, Signet is able to offer direct personal loans to customers thousands of miles from its home base in Richmond.

The so-called loan-by-check program uses data base marketing and direct mail to provide targeted customers with checks of as much as $10,000. All the customer has to do is cash the check at his local bank, since the credit has already been approved by Signet.

Such innovative techniques, when applied to the credit card operation - now an independent company known as Capital One Financial Corp. - made Signet a star on Wall Street.

But Signet took on some tarnish in the third quarter when the bank was forced to double its loan-loss provision from the previous quarter, to $8.7 million. The culprit: gross chargeoffs in the loan-by-check program surged to $9.3 million, from $5.7 million in the June quarter. Some analysts now worry Signet's fourth-quarter provision could climb as high as $18 million as a result of continuing losses in loan-by-check.

"Get used to it," is the response of president and chief operating officer Malcolm S. McDonald. In his first formal interview with American Banker since October, when he was designated heir apparent to chief executive Robert M. Freeman, Mr. McDonald, 57, insisted Signet would stay the course despite investor apprehension.

Weighing his words carefully, Mr. McDonald described the loan-by-check losses as an inevitable byproduct of Signet's methodology, which relies on test programs to build predictive consumer response models. Without losses, you can't build models, he said.

Mr. McDonald also said the $10 billion-asset company will likely eschew traditional bank acquisitions while remaining open to purchases of nonbank financial services companies.

Q.: What's been your experience with the loan-by-check program since the third quarter?

McDONALD: We had two mailings, one last September and one last November, which were deliberately made to higher-risk segments. In order to build effective models, we had to have some losses, and in order to get losses, we had to mail to higher risk segments.

There are only two mailings, out of maybe 10 test mailings since late 1993, from which we're taking any significant losses at all. Those losses will work through the system. They are certainly nothing that's going to cause any big impairment of Signet's earnings. And they're not indicative of the quality of the portfolio nor the quality of the product.

We dropped a mailing in late November, a broader mailing, to the segments where we've been successfully testing with very low losses since 1993. So we have confidence the losses from the loans made in this mailing will not look like those made in the test mailing because the way we measure the risk and the people is so entirely different.

We know what kind of response rates and delinquencies and losses we get out of the segments where we're currently mailing.

Q.: Was the test mailing loss rate worse than you anticipated or in line with your expectations?

McDONALD: The response rate was higher.

Q.: Which means more problems, right?

McDONALD: We were not surprised by the level of losses. But the response rate came in higher than we thought. And that means more bad credit picked up.

Those are the things we need to know in our models. It's exactly why we did the test, to find out these things so we can build solid, predictive economic models of who responds in what way and what the losses and delinquencies are.

Q.: So bottom line, the test mailing, for Signet, is simply the cost of doing business?

McDONALD: It is a cost of doing business. The early mailings we did in late 1993 and early 1994 did not produce enough losses for us to build statistically predictable models.

We will be testing continually. We test new products all the time. Let's imagine a year from now, when we have substantially larger outstandings and we send out another risk test. The losses won't even show up because they're part of a much larger portfolio of a much larger business.

This was a risk test done early on.

Q.: There's been a lot of talk in the press now about high debt levels and rising delinquencies for consumers nationwide. Given that background, may this be a bad time to expand a loan-by-check program?

McDONALD: The way we do our economic analysis for this mailing, and the way we do it for this product, we build in a margin for error on delinquencies. We could have delinquencies and losses substantially higher than we're predicting for ourselves and still have a "positive net present value" in these mailings. That's a positive return on capital after the hurdle rate.

So we agree there may be some trends that would indicate higher consumer delinquencies on a broad-scale basis, but we're mailing against economic models based on experience for us and have built-in substantial cushions.

Q.: We've talked mostly about retail banking. What's your strategy in the commercial area?

McDONALD: That's not a business that's going to grow rapidly when you're tied into a geographic boundary. So our strategy there is to develop niche specialties that we can take far beyond the Mid-Atlantic region.

We've built economic models for several different kinds of companies in media communications based on information that we've developed about companies in that business so we can predict cash flow.

For the specialties that we've chosen, we've gotten some fairly good growth. But some of that is covered by the fact that we're running down a large real estate portfolio. So when you look at aggregate growth, it looks like there's not much.

But we know, for the businesses that we've chosen to be in, that we've gotten good growth. Our leasing portfolio has grown 50% this year, from less than $500 million to more than $800 million. That's not modest growth.

Q.: PaineWebber analyst Thomas D. McCandless has suggested Signet might reexamine its need for a bank charter within five years as it evolves into a broader-based financial services company. Have you given that matter some thought?

McDONALD: The best way to answer that is to say we're currently making a lot of money with the bank charter. Our branches are profitable. They're not growing rapidly, but they're very profitable. The funding that we get from the branch system is very good funding for an awful lot of the loan programs that we do, although we securitize a lot too. When you're in the national asset market, you can't fund that with local deposits.

But to the extent that we're generating assets locally, we're funding them locally and that business is very profitable for us.

So, have we discussed the issue of giving up the bank charter? I'm sure that it's an issue that gets discussed in banking all the time. But are we likely to do it any time soon? (He shakes his head "no.")

Q.: While you've been expanding your loan-by-mail programs, a lot of your competitors have been buying branch systems in the traditional way to gain new customers. Have you ruled out branch acquisitions?

McDONALD: For us, we don't think buying branches will give us adequate growth in income with the equity we have to invest. We have chosen not to be aggressive buyers of branch systems.

We continue to look at acquisitions as they become available in Virginia and Maryland. We have even bid on some and not won any. But we wouldn't even look at branch systems outside Virginia or Maryland.

Q.: So investment bankers shouldn't come knocking on your door?

McDONALD: Not with banks to sell.

But we are open to nonbank acquisitions. We bought the Blanchard mutual fund group, which was the perfect strategy for us. They were a national marketer of mutual funds. We are a national marketer of financial services. They learned very well how to get people to respond positively to their ads and we have more information capability than they had. It's a perfect match.

We intend to use our information systems and their marketing capability and marry the two and be in the nationwide, direct response mutual funds business. Our strategy in buying Blanchard was to expand that acquisition through investment in direct marketing.

Q.: Would you buy another mutual fund company and layer it on top of that?

McDONALD: We would not be opposed to another acquisition if it fit with that strategy.

Q.: What other financial services companies would you consider buying?

McDONALD: We're interested in expanding our mortgage banking operation. We've looked at quite a few student loan portfolios and acquired some. We've acquired mortgage loan servicing.

So with the businesses that we're in, if there's a strategic acquisition that fits with our business strategies, that's fine.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER