Learn to Love Consumer Lending

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We may be in the early stages of a seismic shift in the macroeconomics of banking. Consumer lending is back on the rise, while the commercial sector is getting less attractive.

Banks have spent the years since the financial crisis whittling down their consumer loan offerings, exiting categories from student loans to small-dollar personal loans, and even in some cases ceasing to offer new mortgages. Nearly every bank drastically tightened its underwriting, cutting off consumers deemed to be credit risks.

The retreat can be attributed to weak demand, credit concerns and regulatory pressures, but it also reflected a broad economic trend: U.S. households, under pressure from unemployment and stagnant wages, were deleveraging, trying to pay down the excessive borrowing of the pre-crisis years.

Even as households struggled, the post-crisis era was a boom time for U.S. businesses, which enjoyed record corporate profits and surging stock prices. Banks responded by shifting their focus to commercial credit and fighting hard for prime commercial-and-industrial and commercial real estate loans.

But some say the pendulum is swinging back, and it may be time to retire the notion, driven home from painful experience during the crisis, that consumer lending is best avoided. With the U.S. consumer borrowing again, loan categories banks have fled are poised to grow.

"The pivot toward consumer lending is happening," says Jason Ware, the chief investment officer at Albion Financial Group, an asset-management firm that invests in banks. "Banks are starting to look at it as more ripe for opportunity than in the few years after the financial crisis."

This changing attitude toward consumer loans is more apparent following a bad year for the corporate world. Profits in the third quarter, which nobody expected to be great, were even worse than forecast, forcing analysts to lower their projections.

Weak commercial revenue hasn't led to heavy loan losses so far, but regulators have begun ringing alarms about possible bubbles in C&I and commercial real estate, two categories that have been the cornerstones of banks' post-crisis strategies. The delinquency rate for C&I loans is still extraordinarily good by historical standards, but recently started moving in the wrong direction. After hitting a historical low at the end of 2014, it rose for two straight quarters, to 0.81%, according to the most recent data available.

That's by no means dire for C&I loans, but the market is slower, if still firm, says Ware. "We see a pretty firm commercial loan market, but with pockets of weakness, like oil and gas."

Meanwhile, U.S. consumers have enjoyed better-than-expected job and wage growth this year, and consumer confidence and unemployment have improved to levels not seen in a decade. There are also signs that the long deleveraging of American consumers appears to have finally run its course, with credit cards and other revolving loans starting to tick up after about five years of stagnation.

And consumer credit is better than ever before, even as Americans households have started levering up. The charge-off rate for consumer loans held by banks improved to 1.96% in the second quarter, the lowest level since the Federal Reserve began tracking it in 1987.

The question for banks looking to re-commit to consumer lending is how. Mortgage demand is still weak, and there are regulatory barriers to making small-dollar personal loans. It's a particular conundrum for small banks, which can't easily compete with the likes of JPMorgan Chase and Citigroup in basic offerings like credit card loans.

"Consumer is a hard niche, and you've got to find the right distribution channel if you're not a legacy provider," says Marty Mosby, an analyst at Vining Sparks.

One strategy is simply to expand the credit range downward to get higher-yielding consumer loans on the books.

Santander Consumer in Dallas and SunTrust in Atlanta are among those embracing this strategy. Santander recently began keeping more subprime auto loans on its books, and SunTrust is ramping up consumer lending through its LightStream unit, which is willing to finance just about any type of purchase, including new cars, hot tubs and jewelry.

The online-lending unit bases its underwriting decisions on automatically generated credit bureau data. This helps alleviate a thorny issue: the time and expense of underwriting small consumer loans.

"The loan file is presented very efficiently," says Randy Ellspermann, LightStream's chief financial officer. "They can make very fast decisions on the information they're provided."

Another tactic is to find niches that other banks shun or ignore. That's the strategy of Citizens Financial in Providence, R.I., which is looking to boost profitability after splitting from its former parent company, Royal Bank of Scotland. In the past year Citizens has started refinancing student loans, a niche in which it competes with just a few nonbank lenders.

Citizens is also pushing into unsecured consumer lending, and recently inked a partnership with Apple to finance iPhone upgrades.

Another promising field is online consumer lending, which has already drawn attention from Wall Street heavyweights Goldman Sachs and the Blackstone Group.

Both are preparing to start making personal loans online. For smaller banks, teaming up with marketplace lenders like Lending Club has become a popular alternative, allowing them to offer customers another product while letting the platform handle pricing and underwriting.

Banks can approach it many different ways, but the shift from commercial to consumer is gaining momentum. After years of shunning small-dollar consumer loans while piling into corporate credits, banks could find the growth potential is greater in financing washer-dryers sets rather than oil rigs.

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