Why You Should Care about Greece

Dwight Johnston
March 10, 2010

The sovereign debt woes of Greece dominated the headlines for a week and drove a major flight into the dollar and U.S. treasuries. But the immediacy of the Greek problems faded when the EU ministers came out of a meeting and mumbled a few vague sentences of support for Greece. That seemed to satisfy stock traders, although currency traders are less convinced. Some of you might be wondering why we should care or be concerned about Greece's debt at all. The U.S. economy is at least showing some improvement, although employers still seem reluctant to add jobs. But, if you believe in the economic theory that depleted business inventory restocking will boost hiring and the well-timed hiring of 1.2 million census workers will lead to other economic benefits, you could make a strong case for ignoring Greece altogether.

A quick look at the numbers supports the argument to ignore Greece. The population of Greece is about one-third the population of California. Even more striking, the GDP of Greece is roughly $300 billion compared to California's $1.85 trillion.

So, why Greece?

The reason is that Greece represents tip of the iceberg of a bigger trade. The global leverage trade. The leveraged trade comes in many shape forms and fashions. But for those of you not familiar with these trades, here is a quick and simple example.

If investors owned these Greek debt securities outright, this wouldn't be a huge problem. But, the problem mirrors the mortgage-backed securities problem. These bonds are owned through leverage. As short-term borrowing rates plunged, hedge funds and others borrowed near zero to buy the higher-yielding sovereign securities like Greece. This is a global trade. Those speculators sought the cheapest countries in which to borrow. Those countries would be the U.S. and Japan. As an example, a big euro fund would borrow from a U.S. bank. The fund would then sell the borrowed dollars to buy euros for purchase of the Greek bonds, for instance. What happens is that the fall in the value of the bonds triggers margin calls from the U.S. bank. Now the hedge fund is in the position of liquidating the bonds in an illiquid market or selling other more liquid assets. Additionally, a sharply-rising dollar could mean additional large losses as the funds have to convert euros into dollars to meet margin calls or pay off the borrowing.

Take that one example and multiply the impact around the globe in almost any asset class you can think of. The problems with Greek debt should be taken as seriously as the early warning signs or mortgage-related problems should have been taken here. The contagion threat is not to be likely regarded. As liquidity dries up in bonds like the Greek notes, some funds are forced to liquidate more liquid assets to meet margin calls. As those assets start falling in value, other sales are triggered. Again, this is exactly the way the subprime debacle morphed into the great liquidity squeeze and financial meltdown. Just for good measure, you can also add multiple layers of more complex trades involving derivatives on the various assets like Greek bonds. Remember AIG.

Could “Financial Meltdown Part II” become a reality? Unfortunately, the answer is yes. After the first meltdown, credit spreads soared and margin borrowing of any sort was difficult at best. But as global stock markets rallied, credit spreads contracted again and margin requirements (or haircuts on bonds) fell. The levels aren't quite back to the pre-2008 levels, but they are moving in that direction. How could that happen so soon? Two things enabled this. First, something I call “the power of 0%.” With short-term rates so low and funds more available, leveraged players of all ilks could not resist the siren call of free money and poured into any and all assets. Second, absolutely nothing was done on the regulatory side to prevent this. Yes, some leverage was reduced at U.S. banks, but no firm capital requirements were mandated. Just as important, after all the ranting about consolidating and regulating in some fashion the $600-trillion dollar derivatives market, not one initiative has made it out of the starting gates.

If it weren't for the potential of Financial Meltdown II, we could afford ourselves the luxury of assuming the economic recovery will continue, albeit at a moderate pace. Perhaps we will avoid Financial Meltdown II. But as financial managers we can't lose sight of the reality that problems far from our shores and in markets and esoteric instruments not in our purview have the potential to threaten our economy yet again. This is not to suggest you should make your priority a plan for disaster. But, it would be wise to have in your back pocket a Plan B for just that occurrence.

Dwight Johnston is vice president of economic and market research for WesCorp.

Collection Strategies Adjust to Economy

CU360
March 5, 2010

With more borrowers facing hard choices about which bills are most important to them, friendly overtures from collectors can be more effective. More collection agencies are adopting the kid-gloves approach, according to McKinsey & Co.

As a result, collections has evolved into a marketing game, notes Collections & Credit Risk magazine. Consumers have a limited pot of money each month, and issuers know they're competing against other debts, including delinquencies on competitors' cards. “They really want to be in line first,” says Liz Jordan, senior manager at Deloitte & Touche consultancy.

CU360 is an online portal for benchmarking tools, market insights, industry data, and analytical information. This article was orginally published online by CU360 at cu360.cuna.org. Reprinted with permission.

Lenders are experimenting with changes to formulas to determine when they cut some slack to late borrowers, and how lenient to be. “The call-and-collect approach doesn't work as well as it used to, especially if you're competing against other lenders,” says Vijay D'Silva, director of payment practices at McKinsey.

The shift in collection strategies is an attempt to keep certain card members active, in hopes they become profitable long-term customers. Another segment of customers might eventually be written off but still provide the opportunity for a higher level of collection.

The industry-wide move toward settlement offers is “a blunt instrument that reflects the degree of distress in the industry,” says Jim Bramlett, managing director at consulting firm Novantas. And the scale of expanded breaks given to borrowers has been significant enough to put a dent in interest income.

Range of strategies

The nature of unsecured debt has made credit card lenders more sophisticated than other financial companies when it comes to collections. Without collateral, card issuers must rely, for example, on models of consumer behavior.

The number of forbearance strategies for late borrowers has increased dramatically, D'Silva says. Lenders introduced five-year term loan plans, for example, that were not seen just two years ago. One reason is that borrowers increasingly do not have the ability to make large one-time payments.

Increases in “roll rates”—the percentages of late borrowers who proceed from being one month late to deeper stages of delinquency—have prompted many lenders to step up settlement offers. It's an effort to secure some kind of payment before the borrower's financial condition deteriorates beyond repair, or before another creditor claims whatever can be salvaged.

“You need to make some sort of appeal to the person in a way that's going to say, ‘I'm trying to work with you here',” says Allan Mattei, Novantas managing director. “If you can create a bit more affinity between the rep and the customer, you're likelier to get through and likelier to get them to pay what little bit they can in your favor,” he adds.

How far to go?

While lenders are willing to give more ground to troubled borrowers, operational obstacles to implementing wholesale changes to collections—and queasiness over the economics of forbearance—have hamstrung the industry, according to Novantas.

Moving early with large breaks also runs the risk of making needless concessions. People who lose their jobs can find new work, for example, and late borrowers can regain their footing.

And, as in the mortgage sector, where borrowers frequently fall behind again after receiving a modification, there also is much doubt about the effectiveness of concessions.

Improvement in delinquency rates due to lender forbearance could mask credit problems that will emerge later.

Without core improvement in macroeconomic factors, such as employment and housing, industry experts say lenders could experience a default rate greater than 50%.

Aggressive in Mortgages, Visions Federal Credit Union Sees the Pay Off

Matt Blumenfeld
March 3, 2010

Thanks to extremely strong performances in mortgage and commercial lending, Visions Federal Credit Union in Endicott, New York posted a net income of $37 million and 1.5% ROA for 2009, despite a $3-million charge for the corporate assessment.

Widespread economic uncertainty prompted the $2.3-billion institution to tighten its operations and become very aggressive in its lending practices. CEO Frank Berrish explained that it ran a number of promotions throughout the year, including 3.9% one-day loan sales, to get money out the door.

"We had a record year on mortgages—we just did a tremendous amount of mortgages, many coming from the banks," he said, pointing out that Visions Federal Credit Union did about 180% of its original goal on mortgages for the year. It also posted extremely strong commercial lending numbers as it posted 120% of its 2009 budgeted goal, and overall saw 6% loan growth, "which is real good in this economy."

Consumer lending remains an area of difficulty, however, as a weak job market has made Americans hesitant to take on additional debt. To counter that trend, Visions plans on even more aggressive rates and continue with its special promotions.

"We're going to have a one week "sweetheart sale" the week of Valentine's Day, with rates as low as 1.9% to get money out the door." said Berrish . "Last year when we did it, the rates were a little higher, but we brought in 500 new accounts. But instead of doing for just one day, this time we're doing it for a week."

Two-year loans will get the 1.9% rate while a five-year loan will be as low as 3.9%. Those headline rates, however, will only go to A and A+ borrowers to ensure the credit union is not taking on too much risk. Borrowers with less-than-stellar credit will receive risk-based lending rates, but will get one percentage point off the typical rate during the sale.

Chief among the reasons for its aggressiveness on the lending side is the huge influx of deposits that Visions experienced last year. Berrish noted that deposits were up 12% last year, even though the credit union "didn't do anything to get it—if anything we've lowered our costs of funds which was one of the factors in our great numbers."

He called the trend as a genuine "flight to safety," pointing out that "every time there was an article out there [negative towards banks], there was new money and new accounts coming in."

This article appeared at www.cujournal.com and is reprinted with permission.

SBA to Reactivate Recovery Loan Queue

Michelle Samaad
February 25, 2010

The SBA has notified credit unions and other lenders that it will reactivate the Recovery Act loan queue by February 22 to ensure that the $125 million appropriated to the agency in December will go out the door much faster to small businesses.

The SBA received $730 million through the Recovery Act including $375 million to support raising the government guarantee to 90% on its 7(a) loans and reducing some lender and borrower fees on its 7(a) and 504 loans. The funds ran out in November 2009. SBA received an additional $125 million appropriation in December 2009 along with authority to continue both of the programs through February.

The agency said it is in the process of finalizing the plan for transitioning its 7(a) and 504 programs back to their pre-Recovery Act terms and communicating those plans with its lending partners. This plan, when implemented, will include re-activating the Recovery Act loan queues no later than February 22. The queues will operate in the same manner as when originally implemented in November 2009. 

The authorization for the 90% guarantee on 7(a) loans ends February 28, though funds may be exhausted sooner, the SBA said. Applications in the queues after February 28 will only be eligible for decreased or eliminated borrower fees when funds become available.

Small business owners and lenders will have transparent access to the queue via www.sba.gov/recoveryq and will be able to remove themselves from the queue at any time to be considered for a non-Recovery SBA loan with all applicable fees and, for 7(a) loans, standard guaranty levels.

This article was originally published in Credit Union Times at www.cutimes.com and is reprinted with permission.

Cards Shift to Thrift

CUNA’s CU360/E-Scan Newsletter
February 19, 2010

It's a sign of the times: The credit card industry is moving away from lavish rewards programs that encourage consumer spending to features that promote thrift and savings.

Behind the trend is a stressed consumer—and a bleak economic landscape with rising unemployment and mortgage foreclosures. In better times, most issuers relied on attractive perks and rich reward programs to spur card usage. But that was expensive and was based on an economy in which consumers were encouraged to keep spending. Today's sluggish economy requires a different approach.

CU360 is an online portal for benchmarking tools, market insights, industry data, and analytical information. This article was orginally published online by CU360 at cu360.cuna.org. Reprinted with permission.

Leading the way, San Antonio-based Security Service Federal Credit Union is the first financial institution to debut MasterCard's Money Manager—a new budgeting feature that institutions can add to their debit card programs and eventually to their credit cards. The feature enables cardholders to track expenditures by category and by household members. They can also designate specific projects or events and track expenses related to these projects.

“MasterCard Money Manager gives our members a simple and convenient way to create a budget and then track how and where they're spending,” says Keith Sultemeier, executive vice president and chief financial officer at the $5.2 billion credit union. It first offered the product to its employees, with plans to make it available to all debit card holders early this year.

Money Manager is just one of the new approaches geared toward customer retention rather than increased spending. Many offerings provide budgeting tools and more convenient payment choices, which are important features during times of austerity.

Take, for example, the Blueprint card—introduced last fall by JPMorgan Chase and profiled recently in the Bank Administration Institute's Banking Strategies magazine. Blueprint's feature can be integrated into existing customers' credit card accounts to help them manage spending, pay down balances, and pay off major purchases.

During a two-and-half-year card user study, Chase found that consumers wanted more control over their card spending and better tools to help them manage their money and pay down debt. Many people have a system in which they use multiple credit cards for different types of purchases—for everyday spending, big-ticket purchases, and revolving balances, for example. Blueprint offers a way for cardholders to do everything they want on one card.

Currently, many consumers can download their transaction data into consumer software, such as Intuit's Quicken, but that requires them to do a lot of data sorting, notes Trish Preston, vice president of U.S. debit cards for MasterCard Worldwide. With Money Manager, the transactions are automatically sorted into the proper category, and cardholders can create their own categories in addition to the common ones provided.

One Money Manager feature likely to attract financial institutions is that the budgeting capabilities will only be available on purchases made with the MasterCard debit card, for which the institutions receive interchange revenue on each transaction, according to Preston . “This should stimulate the use of the card product as opposed to paying with cash or checks because consumers won't get the same features on those other transactions,” she says.

Contactless Innovations

While Chase and MasterCard are focusing on budgeting tools, U.S. Bank is piloting a number of different card offerings, mostly with contactless payments-oriented innovations. One is an instant-issuance debit card. With this program, customers are immediately handed a fully functional card just printed at the branch. The card includes contactless transmission—a feature frequently used for purchases at gas stations, convenience stores, and fast-food restaurants.

Other U.S. Bank pilot projects:

• Testing automatic money transfer from Visa debit cards, which enables funds transfers from customers to the account of a friend or family member so long as both parties have a Visa prepaid debit card issued by the bank.
• Issuing a bank debit card that can be used to make contactless purchases from vending machines and other point-of-sale units throughout a corporate campus and as a building-access device.

Other innovations seem to be responding to negative consumer sentiment concerning the card industry. Last fall, Bank of America introduced its Basic Card, which features one interest rate for the life of the account, no over-limit fees, and the same rate on all transactions, even balance transfers and cash advances.

Innovation is also occurring in the rewards area, where issuers including Citibank are adopting simpler benefits, such as free Sony music downloads, that will appeal to certain demographics. “This type of benefit appeals to a younger audience that's not able to earn high point totals,” Scott Strumelo, an analyst with Auriemma Consulting Group, tells Banking Strategies . “It appeals to consumers' desire for immediate gratification. You can get rewards with fewer dollars spent rather than needing to accumulate points over months or years,” he adds.

Another type of rewards program, talked about but not yet seen in the market, involves card issuers teaming up with retailers to offer immediate discounts at the store when cards are used. With such a model, big banks would team up with national retail chains, and community banks or credit unions could work with smaller, local retailers. Financial institutions could then provide a list of participating retailers to their cardholders to earn the rewards.

This concept is expected to gain traction in the near future because it has a lot of appeal to both banks and retailers. Banks like the fact that retailers pay most of the cost of the rewards and retailers like the fact that they're paying out only when they receive a direct benefit.