Searching for new ways to generate income, community banks are slowly embracing the higher-risk-but potentially higher-reward-business of consumer finance.

Last week, Mason-Dixon Bancshares of Westminster, Md., announced it was acquiring Rose Shanis Cos., a Baltimore firm that specializes in financing purchases for consumers with less-than-perfect credit. With the deal, $1 billion-asset Mason-Dixon joins a growing number of banks and bank holding companies that have acquired or launched consumer finance operations with the hope of boosting their bottom lines.

"Bank margins are pretty thin these days, and we think the consumer finance business offers opportunities for wider margins that typical loan portfolios in a bank do not produce," said Thomas K. Ferguson, Mason- Dixon's president and chief executive officer.

It is unclear exactly how many community banks and bank holding companies operate consumer finance subsidiaries. But bank observers estimate that a few hundred of the nation's thousands of community banks have entered the consumer finance business in recent years.

"We're in this business to get a few more loans on our books and to make money, it's as simple as that," said David Flowers, president and chief executive officer of Commercial Bank and Trust Co. in Paris, Tenn. Commercial launched Money Tree Loan Co. with one branch in Paris in 1995 and has since added two more Money Tree branches.

Most bankers cite shrinking net interest margins as a reason for entering the consumer finance market. According to Sheshunoff Information Services, Austin, Tex., the average net interest margin for bank holding companies with less than $3 billion of assets was 4.462% as of June 30. That's about a 12% drop from yearend 1996.

The higher interest rates that come with typical consumer finance loans can help combat margin declines, bankers say. Because finance firms make loans on items less valuable than homes-such as cars, appliances, or furniture-or are lending to higher risk customers, they can charge interest rates as high as 36% in some states. And while the customers pose greater default risks than those at banks, bankers say losses are more than offset by higher yields.

"You get much better returns, on a risk-adjusted basis, on these loans than you do on mortgages," said Edward H. Sondker, president and chief executive officer of Bay View Capital Corp. in San Mateo, Calif. He noted that Bay View's consumer finance subsidiary-CTL Credit Inc. of Santa Barbara, Calif.-generates yields as high as 11.5% on automobile loans, compared to around 7.25% in traditional mortgages.

Tennessee banks are particularly active in the consumer finance business. At least 22 community banks in the state operate finance subsidiaries, according to state banking commissioner Bill C. Houston.

Among the most successful is Brownsville Bank, which opened Southern Financial Inc. with one office in 1989. Today, Southern Financial has 28 branches in five states, with a total of $150 million in loans outstanding.

"We took a rural west Tennessee bank that was struggling to make loans to one that is now struggling for capital," said Phil Clinton, senior vice president at Brownsville's holding company, Insouth Bancshares.

Most banking companies in the consumer finance business keep the identities of their banks and finance companies separate.

"We're looking to attract new customers, so we don't want them to think that this is just another branch of Commercial Bank and Trust," Mr. Flowers said.

That strategy is a good one, said William P. Johnson, a Denver banking attorney. "There's a segment of the American population that's still a little intimidated walking into a bank," he explained.

It is also important, bankers say, to hire a consumer finance expert-not a banker-to run the consumer finance division.

"When you're dealing with a marginal borrower, you've got to be a little more creative in your thinking," said John R. Wallace, chief executive officer at Farmers and Merchants Bank in Clarksville, Tenn., owner of the Finance and Mortgage Acceptance Corp. "Bankers tend to be too conservative."

Still, not all bank observers believe community banks should rush to launch consumer finance divisions. Christopher Hargrove, president of Professional Bank Services in Louisville, Ky., said that as competition for loans increases, consumer finance subsidiaries may not be able to sustain the volume needed to generate additional profits for a community bank.

John E. Lawson, president of Mount Sterling National Bank in Kentucky, said that with the current high level of consumer debt rates, "now is not the time" for banks to get into consumer finance.

"When we started our finance company in 1987, our customers didn't have credit cards," Mr. Lawson said, noting that Mount Sterling sold its finance subsidiary last year. "By 1996, they were all carrying tremendous amounts of credit card debt. We felt it was getting excessive and the risks were getting too large."

Nevertheless, bankers in the consumer finance business say those high- risk consumers are worth taking a chance on.

"If we didn't provide this service, many of these people would have nowhere to borrow money," said Farmers and Merchants' Mr. Wallace. Besides, he added, "maybe they can turn their credit situation around and someday come back and be bank customers."

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