SAN DIEGO -
Four veteran analysts shared their insights on those issues and others at Harland's Connections Conference here. Participating in the panel discussion were Terence Roche of Cornerstone Advisors, Rockwell Clancy of J.D. Power & Associates, Ruth Razook of RLR Management Consulting, and Craig Focardi of TowerGroup. The session was moderated by John O'Malley, president of Harland Financial Solutions.
Below is a look at some of what was said.
O'Malley: First, your general observations on the state of financial services:
Clancy: I come at this from a couple of perspectives, one of which is as a consumer advocate from my role at J.D. Power, but also from the industry, having previously been with Sheshunoff. There is pressure on margins. The things we are seeing is that there is increasingly, especially in some sectors, an imbalance between the value being provided, the fees being charged, and the willingness of the customer to take it.
My long-standing belief is that for a long time we made a lot of money from the inertia of people; there are going to be companies coming along who will take advantage of that.
Focusing on revenue growth and growing the top line is very important, as is managing your expenses and having a very clear value proposition.
Roche: If you want to oversimplify a trend pretty quickly, look at what has happened over the past five years with all the talk about fee income. The truth is the industry has offset that as a percentage of assets with reduction in non-interest expense. The efficiency ratio has improved. I think the industry has done a pretty good job. The bad news is, get ready for five years of the same thing. To the extent margin compresses, there is going to be continuous pressure to improve on expenses and overhead. I hear a lot of talk about where is the next big thing, the next big growth opportunity? I don't know that there is going to be a next big thing. It's going to be a lot of attention to efficiencies.
Focardi: In the lending industry you've got lending origination fees and lending servicing fees, many of which are tied to the loan amount. In recent years loan amounts went up and fees went up. Now a lot of loans are smaller due to what's happening in the home market. Another reason is information transparency; people tend to shop a little bit more now for fees. In terms of active margin growth, I do think there is a lot of cost take-out, at least on the lending side of the business. Those are the organizations that are going to be the ones that thrive. The others that can't make it up are going to see margins contract and become the subject of M&A.
Razook: Many of our clients are not charging the fees they could and should be charging. How about taking an opportunity today to look at what you're charging. I think if everyone just took a moment and looked at what fees you are assessing and what you aren't and try to take advantage of that, you could increase income automatically just by doing that.
O'Malley: What's going on in the mortgage market?
Focardi: I attended the first housing bubble conference in 2002, so we've been talking about inflated housing prices for a while. In 2007 Chicken Little was finally right, that housing prices just can't keep going up and up. What Alan Greenspan giveth, Alan Greenspan taketh away. The unprecedented drop in interest rates allowed everyone to have increased purchasing power, and everyone bid up the price of homes and also became speculators in the second home market. Where we are today is reverse leveraging; the Fed raised rates for 17 consecutive months and affordability worsened. Lenders who thought they could get bailed out of bad lending situations realized that rising home prices weren't going to bail them out. The subprime lending market is where it showed up first because they had teaser rates and rates that adjusted in one or two years. Where are we going? I think the (Fed) rate cut alleviates some of the pain and that the industry is resilient, but I do think we are in for a period of malaise. I think we'll eventually see some normalcy, even in the subprime market.
Clancy: At J.D. Power, we're obviously about customer satisfaction, but our goal as a company is to help clients strike a better balance between delivering a better experience to customers and a better return to shareholders. One of the things we find is we ask a question, "Does your company focus more on your bottom line or their own best interests?" The companies that finish very high on the 'focus on my best interests' are the ones that also finish very high with shareholder return.
One of the key characteristics between the good subprime lenders and the bad was the time and the education the lender provided in the process. You distinctly get the sense that those who were very unhappy were those who felt they were never educated. What it boils down to is greed at the customers' expense. A lesson going forward is that the focus should be on education. Some of our clients, such as BofA and BB&T, are having an outstanding quarter in the origination business as there has been a tremendous flight to quality.
It's not only the housing bubble, it was really sort of an exploitation bubble as well for people who counted on their lenders and their banks to serve them well.
O'Malley: Is this a good opportunity to become more active in portfolioing loans?
Focardi: I'm rather optimistic about future of mortgage industry; it's always darkest before dawn. Are delinquencies and foreclosures up? Yes. Will they be up over the next year? Yes. But community banks and credit unions have an excellent opportunity in their local markets to pick up share. It may be a little harder to go to your credit committee right now and say 'I want to improve our lending,' but why not? The majority of defaults are concentrated in seven or eight states, albeit large states, but unemployment is still under 5% and in many markets the economy doing well.
Razook: I think financial institutions need to make sure they have the right people with the right technology in place. If they plan to expand, they need to look at risk mitigation and right technology and people first. You could ask for trouble if you don't think through taking advantage of this opportunity.
Clancy: If you subtract out the influx of subprime borrowing over the past five years, you're still at healthy rates. There have been some dramatic declarations that have whip lashed the market, but in the longer term I would underscore I do think there is a role for banks that are not huge mortgage originator or purchasers through brokers to play the role.
Roche: Let's not overlook the fact banks and credit unions have been doing that. In terms of real dollars the biggest increase has been in residential mortgages.
Focardi: The last Fed report found that 56% of lenders tightened guidelines on subprime loans. It will be interesting to see how that has changed by the next report. On conforming loan side only about 14% have tightened up their guidelines.
O'Malley: What about trend toward outsourcing?
Roche: Any internal function at your bank needs to show it can beat the (outsource) price or you outsource. But a second trend is with core systems: when you change you either are in-house staying in-house, outsource and staying outsource, or in-house moving to outsource. No one ever goes from outsource to in-house.
I think with the risk management area the sheer sophistication of the systems that have to deal with (risk management) is such that no individual bank wants to make that investment. Who's going to replace Falcon? The risk factor has hugely played into outsourcing. I think people want to get behind the vendors' walls. If you can outsource to a player who just has scale to go after this, you do. Having had my (credit) card compromised just two weeks ago, and it was Chase, I can tell you their response was phenomenal. I had a call in an hour and a half. It's just hard to hire talent, particularly if you're not in a big city. Where the line (with outsourcing) still gets drawn is in managing that relationship with the customer, and that's not going to change.
Razook: When you are in-house, the capital investments are just so high to stay abreast. We see larger and larger institutions actually gong from an in-house to an outsource environment because it's just costing them too much and they can't keep up with the changing pace of technology and they just can't hire people.
Clancy: We're seeing some of the early adopters of putting contact centers offshore rethinking that. If you're an especially high-value customer we see the contact coming back domestically, because they don't want to exacerbate the issues that might arise from an off-shore contact.
Roche: The economic factor very important here. In-house becomes way cheaper once the initial investment is off the books.
O'Malley: What about small business? Larger players seem to be moving more downstream. What your perspective?
Razook: I probably have an atypical answer. I think every credit union and every bank needs to look at their target market and understand the needs of the customers. There is no one size fits all here. Too often we see institutions in a reactionary mode; we see some very successful institutions now doing focus groups with small businesses to understand exactly what the needs are. We even see this with the de novo banks going into new markets and exploring what they expect from their financial institution. I do not believe overall financial institutions do a good job of completely understanding what those small businesses' needs are in their market. They sit in meetings and may or may not do a survey and try to come up with what they think might work based on the competition, but not on asking the business. This must be individual for an financial institution to be successful.
Clancy: On the small business side from the strategy standpoint, you see the larger banks going into that space. There are more deposits there and there are friends and families. On the credit side the smaller institutions have the ability to deal with more obtuse information than a large bank can. There is stuff you can load into a solution and score a small business app, but it doesn't necessarily capture that I've known this person since I was a kid and see him at church. The ability to make those types of credit calls and take on what for a larger bank would be more risk because they don't have that kind of information is a key advantage smaller banks and credit unions have.
When you spend money on one thing, you're not spending money on something else. What is the cost of that is something you should spend time on?
When you talk about segmenting small business, there are a lot of ways to do that. The fundamental point of separation is that when the owner of the business is making the decisions it behaves a lot like a retail customers. When the decisions are being made by a set of executives, it takes on a different method of operating. It's not sales size.
Roche: At the end of the day if you say 'We have a four-person small business where the owner makes all the decisions,' you can probably use the model you have for making retail decisions. You can use your Internet-based model or scoring model.
If you're going to change the model you have to ask if you're going to see an increase in business to justify the cost, because there are places like Wells Fargo that are pretty good at that already.
Clancy: And the pricing on the loan side can start to get brutal at that point. They know they can get credit.
Roche: Statistics show you don't have to dramatically change your model to serve that customer or member. But you don't have that breakout opportunity to capture that larger customer. There is a lot of talk about going after small business, but what piece of small business? Is there a niche in the market that is overlooked? Absolutely. But you have to get focused before you move forward.
Quickbooks dominates in this marketplace. Understand when you go to service this customer you're not competing with another bank and their solution. You're competing with a bunch of paper in a box in the back. That's why QuickBooks is so successful. These small business don't give a hoot about your system except for the two weeks a year between April 5 and April 20.
Clancy: It's about shooting a bear, it's about shooting a whole bunch of squirrels and stringing a coat together from that. It's a tedious process-particularly for the squirrel.
For instance you may ask, 'Should I be open on Sunday?' Well, what is it you do? What's your pitch? If convenience in all its forms is what you do, then absolutely. But if not, then it's a waste of time.
How To Get The Expanded Story
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