Consumer Finance in and after the Era of COVID-19

– Justin Haley

Everywhere you turn, you encounter the phrase “the new normal.” Even the State of Utah, where Medallion Bank is headquartered, refers to the green status in its color-coding system as New Normal. Society is changing, adapting to life in a pandemic, but what does that mean for consumer finance? Everything below is speculative, so please take it with a large grain of salt.

Effects on Everyday Operations

Medallion Bank, like many lenders and loan originators, is currently operating 90%+ remotely. We were fortunate to have already transitioned many of our back-end systems and processes to the cloud and digital offerings, both internal and for our customers. That made this disruption less painful for us than for some. Any gaps we identified are already filled or have active projects in place to fill them. We count ourselves lucky; the pandemic hit at a time when we were largely prepared.

Lenders and originators caught earlier in their preparations (or not preparing) suffered as a result. In both of our consumer finance niches, we heard stories of lenders failing to adapt operationally. Such stories benefited us to some degree, but that is unlikely to be a long-term benefit. We expect there will be a swift acceleration in transformation efforts for all lenders who seek to remain competitive. Any advantage the fully digital lenders have, or the mostly digital lenders like us, will be eliminated in the coming quarters.

Effects on Business Models

Similar to the 2008-2009 recession, the strengths and weaknesses of the two primary business models in the consumer finance industry became more evident. Business model, in this context, means the way a company designs its business to deliver value and create profits. The two most common business models in consumer finance are the portfolio retention model, where the originator intends to keep the loans on their books, and the originate for sale model, where the originator intends to sell the loans or originates them for others to begin with. As an outsider, you may have trouble telling the difference between these business models, but to insiders, they are night and day. However, whichever business model you choose, preparation is important and large amounts of cash/capital can overcome .

For example, Medallion Bank has chosen the portfolio retention model and is often referred to as a “portfolio lender.” Most of our income comes from interest on the loans we own and service. In our case, the immediate effects of the pandemic were not on our origination capability, but our servicing resources. We had to help borrowers cope with the (hopefully temporary) loss of their own incomes by offering payment deferrals/due date extensions. We will feel the effects of the pandemic over time as those borrowers either resume loan payments, or do not.

The originators utilizing the originate for sale model, who sell loans or originate on behalf of others, rely more on fee income or income from loan sales/securitizations to generate revenue. As loan buyers pulled back and securitizations became challenging, they had to immediately restrict their origination capability. The originators with cash/capital and backup funding pulled back much less. Those without such arrangements, or for whom the arrangements fell apart, pulled back sharply or exited. There were several examples of both in the niches we compete in. To some extent, the hybrids, or those who retain a portfolio and also sell some loans (or originate on behalf of others), experienced the best and worst of both worlds.

Going forward, it is safe to expect that each of these business models, and the hybrids, will continue to exist. The long-term competitors will learn from their mistakes, putting in place more firewalls and acquiring additional capital and/or funding as a hedge against risk. Backup plans and backups to the backup plans should increasingly become the norm. If you are a dealer or contractor, working with an originator who operated well through both the 2008-2009 recession and the 2020 pandemic should mean working with a safer entity than before those events. There is a silver lining to this dark cloud.

Effects on Consumer Behavior

Consumer finance-oriented lenders and originators are largely in position to take advantage of expected changes in consumer behavior. For a period of time, at least, some fairly standard entertainment options will fall out of favor or be unattractive to many. For example, a family that takes a big long-distance trip each year, goes to the movies on weekends, eats out at restaurants 1-3 times per week, and belongs to a gym, might see wholesale changes in their entertainment and recreation habits. They might not want to risk flying, or stay in packed hotels, or sit in crowded movie theaters and tightly arranged restaurants, or exert themselves in close proximity to others.

Instead, they might want to travel locally, controlling the environment where they sleep, eat on their own, watch their own movies in the comfort of their home, and work out with family. To do so, they might buy an RV, drive to local attractions, buy a new TV, renovate their home, and put together a home gym on the cheap. It is likely they will want to finance many of these outlays. Consumer lenders should have plenty of demand in the coming quarters and years. Other types of lenders, such as those making loans to the entertainment, travel and recreation options abandoned by consumers, may not be so lucky.

Summing it All Up

A lender like Medallion Bank is in an enviable position regardless of which lens you view us through. We are not alone in this; there are others just like us, possibly many more than you realize. That bodes well for the financial services industry as a whole. But as far as the effects on everyday operations, our choice of operating models, and the anticipated effects on consumer behavior, being dedicated to consumer finance during and after COVID-19 is a good option. And, if we’re right, we’ll have more company in this space in little time.