In his first months as HSBC Finance Corp.'s chief executive, Brendan McDonagh has been occupied primarily with fixing its subprime mortgage business.
The HSBC Holdings PLC unit has tightened underwriting, modified internal controls, eliminated its correspondent channel, and centralized the servicing of problem loans to a site in Florida. The unit also has modified more than $500 million of loans, mostly adjustable-rate ones, and it expects to modify $3 billion to $4 billion this year as the loans' rates reset.
In an interview last week, Mr. McDonagh said that "rationality" has returned to the market, and that the industry shakeout had eliminated a "material" amount of capacity. He also gave high marks to what he called a coordinated and rational response by regulators, politicians, and lenders.
But Mr. McDonagh, a 28-year veteran of the London parent company, said he would "counsel against people declaring victory at too early a stage," even though he is confident in the consumer lending outfit he took over in February.
"We feel today as we did three months ago," he said. "This is no easy fix." Still, the $1.4 billion profit that HSBC Finance turned last year — despite a 44.5% increase in its credit provision, to $6.6 billion — "holds up the theory of diversification."
The Prospect Heights, Ill., unit remains a blueprint for HSBC's plan to build consumer finance businesses around the globe, particularly in emerging markets.
Mr. McDonagh, who recently completed 100 days in his new post, was chief operating officer of HSBC's traditional U.S. banking operations from 2004 to 2006. In his current post, he succeeded Siddharth N. Mehta, a holdover from Household International Inc., which HSBC bought in 2003 and renamed HSBC Finance. (Mr. Mehta resigned in February, after HSBC revealed the 2006 credit provision would be higher than expected.)
The unit stopped buying loans from correspondents May 31, implementing a decision announced in March. It still makes subprime loans through brokers.
The retail network of 1,300 to 1,400 branches in 46 states produce a high proportion of fixed-rate loans and were not the source of unusual delinquencies, Mr. McDonagh said.
If HSBC Finance had not closed its correspondent channel, which bought loans in bulk, originations in that channel "would be at a fraction of previous levels, because we just wouldn't be selling the mortgage products that we had been," Mr. McDonagh said. Most so-called affordability products became untenable when home prices stopped rising.
But reputational risk was another reason the correspondent channel was closed.
"One of the things that makes us different" from most mortgage companies is "that we keep a lot of the mortgages on our books, and we see these things as a one-to-one relationship," he said. With retail offices, "you're in control of the complete sales experience, so from the point of view of 'know your customer,' broader compliance issues, customer service standards, appropriateness of the product to the individual, you're in charge."
Also, "you can do that to a pretty large extent with the broker channel, because you're individually underwriting each mortgage," he said. But with correspondents, "there's always a risk that you're buying something … within that pool [that] could be problematic in the future."
For HSBC, "it was much better just to walk away" from the correspondent business, he said. "If that means leaving money on the table, that was OK with us, because the brand was more important."
The unit's retail branches, where originations have been "a little above plan," have another "inherent control mechanism": The typical manager stays at a branch for two to four years, increasing accountability. Mr. McDonagh singled out the branch network as HSBC Finance's strongest asset.
At the Florida site, HSBC Finance "cleared out a bunch of files" with more typical performance characteristics "and moved them outward" to make room for the problem loans, he said.
The centralized approach to problem loans lets HSBC Finance apply effective collections practices quickly and broadly, he said. Instead of "having to teach nine centers, you do it immediately that day or the next day or the next week" at one. "You can give a lot more autonomy to the management to get on with it."
It's too early to say how successful the loan modifications will be, Mr. McDonagh said. "But we wouldn't be doing this if we didn't think it had a good chance of working, and it's the right thing to do."
The level-headed response to the subprime mortgage meltdown by regulators, legislators, and lenders went "a long way to calming the market," he said. "Very quickly, a lot of cool heads got together and made decisions about what had to be done. Obviously, there was a certain amount of heightened interest and posturing. But at the end of the day the views of the key political public officials and the key regulators are pretty much aligned with the key financial players."
And though there have been a number "of bailouts or takeovers, there has been quite a material contraction in the market," Mr. McDonagh said. "We're already seeing a rationality in the secondary market."
He pointed to past interventions at his unit and elsewhere as a result of "third-party inspection, whether it's political or regulator or consumer" — including Household's settlement five years ago with state prosecutors over predatory lending — as cushioning the industry's pain in this cycle. "Rather than saying, 'We will now start thinking about home preservation policies,' we had them in place for five years," he said. "Yes, for the first few weeks you had to scramble around, but you've got the base. … It's just a case to gear that up."
Most of HSBC Finance's operations — which include credit cards, car loans, insurance, and tax services — have not been affected by problems in the subprime mortgage market, Mr. McDonagh said, and he is optimistic that the rising U.S. population will propel growth at the business, which is serving as the blueprint for expansion elsewhere.
"We have a lot of executives currently posted outside the United States working with the local teams to help build those up, particularly in the emerging markets, where there is going to be an increased need for that type of credit," he said.
In the United States, Mr. McDonagh sees big opportunities in Internet lending as other industries move to online distribution models. He cited HSBC's traditional U.S. bank's success in building and running an online deposit platform.
"There's got to be a way to replicate that in part on the lending side," he said. "It may be that for the moment the lending product side is more complex," due to documentation issues, "but you've got to keep working at it."