Patrician Bank of Boston got blue-collar auto lender Fidelity Acceptance almost by accident -- and it's $30 million happier for it.
When Donald Davidson landed in Minneapolis one frigid day last December, the Southern California-born banker knew he was out of his element.
"They had to pry me off the plane," he jokes about his first day as president and chief executive officer of Fidelity Acceptance Corp.
The temperature wasn't the only reason Mr. Davidson suffered a bit of an identity crisis. He came to town six months ago to fulfill a mission that some in the industry might perceive as unusual for Bank of Boston Corp., which now owns Fidelity Acceptance.
The new acquisition provides car loans to customers with bad credit histories. Bank of Boston, better known for its fast-growing Latin American operations and commercial lending, has gotten into a business that isn't usually associated with the stodgy New England bank.
Low End of 'Food Chain'
"I always considered this to be the really low end of the financial food chain," Mr. Davidson confesses.
Is Bank of Boston out of its element? Not really, observers say.
Bank of Boston got into the business almost by accident. When it purchased Connecticut's Society for Savings Bancorp for a bargain $195 million last July, it also got the Minneapolis-based auto finance company, along with several other offbeat businesses. These included a credit insurance subsidiary, Admiral Life of America, and a letterhead stationery company.
Even though the odd mix of baggage seems a misfit for Bank of Boston, the deal has drawn no apologies. The reason is profits. Fidelity Acceptance raked in $30.1 million last year and earned a 5.61% return on assets -- about four times the average ROA of big banks.
Consumer Lending Experience
Before coming to Fidelity Acceptance, Mr. Davidson had headed credit policy for consumer finance at Bank of Boston for one year. He previously held a similar post at Los Angeles-based First Interstate Bancorp.
He went west to Minneapolis after the retirement of Nicholas Stang, who had been the president and CEO of Fidelity Acceptance for 40 years. Mr. Davidson's mission is to grow this profitable gold mine as Bank of Boston expands its own nascent retail banking business.
Both efforts are in consumer banking, but their clientele could not be more different. Bank of Boston is a patrician bank where executives sometimes seem as preoccupied with the bank's 210-year history as with its future. Analysts say that until recently, retail banking is something that was always left to other banks in New England, such as BayBanks Inc. and Shawmut National Corp.
Downscale Customer Base
The customer base of Fidelity Acceptance is a far cry from the Harvard Square crowd. The Minneapolis unit makes rich margins by lending to the unbankable, such as blue-collar workers with bruised credit histories.
But analysts are little worried that this portfolio will later hemorrhage losses. Instead, they see the niche of Fidelty Acceptance as a growing part of a $278 billion auto-lending business. Indeed, the Consumer Bankers Association said that banks saw their share of the market rise to $123 billion in 1993 from $109 billion in 1992.
Edward O'Neill, a vice chairman at Bank of Boston, sees Fidelity Acceptance as one piece of the bank's overall expansion into retail banking, which ranges from financing recreational vehicles to making home-equity and student loans.
"We want to have different origination channels and we want to have different products and we want to have different geographies," Mr. O'Neill says.
Meanwhile, Fidelity continues to grows.
Since Mr. Davidson started in December, he has added 15 offices and expanded Fidelity Acceptance into the states of Washington, Oregon, New Mexico, and Nevada. The company, which had $594 million in receivables last year, now has 127 offices in 26 states, mostly in the Northwest, Midwest, and South.
"By going out and opening new offices and reaching consumers, that's how we continue to grow this business. My growth rate target is 15% to 20%" annually, he says.
Fidelity Acceptance Corp. is a direct cash lender for buyers of new and used automobiles. It provides financing for the "credit challenged," Mr. Davidson says. That means Fidelity Acceptance gives loans to customers with "minor to serious past credit histories" including delinquencies so bad they caused repossessions, he says. Some customers have medical hardships while others are unemployed.
"Is it risky? Yes, it's risky. Absolutely," Mr. Davidson admits. In fact, 5% to 8% of Fidelity Acceptance's outstanding loans are written off. Mr. Davidson won't say what the exact number is because he doesn't want his competition to read it.
But Fidelity Acceptance is better off than finance companies which give loans only to those without credit histories, he insists. "At least I know how bad it's gotten," he quips.
The company does get rewarded for the chances it takes by charging customers more than twice the rate that Bank of Boston uses when it lends to customers in New England. Fidelity's loan rates average 20%-21% and are generally as high as state usury laws allow.
Some consumers might see such rates as gouging, but analysts say Fidelity Acceptance is often the only source of loans for its customers.
High Price or No Credit
"Do you want credit at a high price or no credit at a low price," asks Brent Erensel, an analyst at UBS Securities. A fan of Fidelity Acceptance, he says that it has been successful because it manages the unbankable customer just as well as General Motors Acceptance Corp. handles its middle-class borrowers.
"It takes a unique expertise to size up these kinds of credits," Mr. Erensel said.
Fidelity not only builds a credit file on its customers, but it also requires at least $1,000 in cash or the equivalent value in a used car trade-in before it will make a loan. This equity is a strong incentive for borrowers to keep making payments.
A bigger risk than delinquencies are higher interest rates, which squeeze profit margins.
Mr. Davidson said Fidelity Acceptance is funded by its parent at a 4% to 6% interest rate. As the Federal Reserve Bank raises its rates, Bank of Boston, boosts what it charges Fidelity. To remain profitable, the auto lender jacks up what it charges customers.
Already Near Ceiling
But that has two risks. First, Fidelity may have little room to raise rates which are already near the limits of usury laws. More significantly, competitors could undercut Fidelity with lower rates, forcing the company to match them or lose market share.
That scenario doesn't seem to phase Mr. O'Neill, who sees a diverse consumer finance business as the best guard against such events. If times get tough, he reasons, he can always shrink the business while other Bank of Boston subsidiaries generate profits.
Of course, competition is already stiff in the consumer finance arena with new entrants -- often mom-and-pop operations in specific cities -- starting up. The newcomers are so plentiful that executives at industry leader Mercury Finance Co. know little about Fidelity Acceptance.
"I'm really not up to speed on them," said James Doyle, senior vice president and controller at Mercury, which boasts an incredible 8.51% return on assets.
Like Fidelity Acceptance, Mercury got its start as a unit of a commercial bank, but was spun off in 1989 in a public offering by First Illinois Bancorp Inc.
Bank of Boston says it is not interested in spinning off Fidelity and Mr. Davidson doesn't see independence in the future, calling Fidelity "an annuity stream for the shareholders."
UBS' Mr. Erensel agrees, saying that it's sometimes hard to determine if Fidelity Acceptance was a hidden treasure. Considering that Bank of Boston paid so little for Fidelity's former Connecticut savings bank parent, he jokes, "Bank of Boston bought Society and got Fidelity for nothing or vice versa."AMERICAN BANKER/Bank Rate Monitor's[TM]Consumer Money Index Retail Yields 6-month 1-year 5-yearNew York 3.36% 4.04% 5.61%Los Angeles 3.24 3.85 5.39Chicago 3.79 4.23 5.90 San Francisco 3.13 3.79 5.26Philadelphia 2.81 3.19 4.88Detroit 3.17 3.84 5.42Boston 3.38 4.04 4.77Houston 3.61 4.12 5.27Dallas 3.50 4.07 5.16Washington 3.25 3.60 5.45BRM NATIONAL AVERAGE 3.32 3.88 5.31 8-Week High(*1) 3.32 3.88 5.31 8-Week Low(*2) 2.99 3.39 4.96 Retail and Jumbo CDs Jumbo Rates 6-month 1-year 5-yearNew York 3.56% 4.22% 5.59%Los Angeles 3.61 4.28 5.91Chicago 4.13 4.63 6.08San Francisco 3.65 4.39 5.81Philadelphia 4.23 4.55 N.A.Detroit 4.28 4.46 5.37Boston 4.13 4.50 5.29Houston 3.98 4.43 5.95Dallas 3.91 4.37 5.79Washington 3.63 3.99 5.43BRM NATIONAL AVERAGE 3.91 4.38 5.69 8-Week High(*1) 3.91 4.38 5.69 8-Week Low(*2) 3.47 3.87 5.28Here are the market-by-market averages being paid on jumbo andretail certificates of deposit by the 10 largest banks andthrifts in each ofthe nation's 10 largest markets on June 15. The eight-week ratetrend is the average being paid on one-year maturities by thesame 100institutions on the dates indicated.(*1) Range of the BRM National Average over the latesteight-week period.Source: [C] Bank Rate Monitor, North Palm Beach, Fla. 33408.All inquiries: (407) 627-7330