After a decade of challenges, there may be some new opportunities in the home-equity business if banks pursue the right strategies to capture them.
Rising rates should bode well for Home Equity originations; the days of cash-out refinance to tap equity should be nearing an end for many mortgage holders looking to preserve their low first lien rates. And secured residential lending still provides much better economics to borrowers than other products.
Novantas’ 2nd Home Equity Research study provides a glimpse of the strategies that lenders can pursue to capture these opportunities, including becoming more proactive to tap the millennial market and better educate customers who often don’t know much about the product.
The study, which surveyed more than 1,500 customers, was aimed at helping determine how banks can serve a shifting demographic landscape — a new generation coming of age, the desire for digital-based access and services, and how to deliver this higher capital-intensive lending profitably in today’s competitive environment.
While the profitable customers will require the most effort to win their business — both at origination and ongoing — many of these customers are currently underserved, underutilized, and are more than willing to respond to offers.
Home Equity has seen more challenges than most banking products over the past decade, including high default and foreclosure rates on second-lien position, high-leverage lending, and a steady balance run-off as customers refinanced to take advantage of historically low mortgage rates. The difficulties have pushed lenders out of the business.
Difficulties still abound, however. Originations have been steadily growing since bottoming out, but it has not been enough to offset overall portfolio declines. In fact, the most recent watermark on origination growth shows a YoY decline (Portfolio Size vs. Origination Growth).
Furthermore, the new tax code provides a possible disincentive to borrowers due to the removal of interest deductibility. It should only take a few quarters to see how much of a damper this may place on volumes and balances.
Against this backdrop, it’s important that originators focus on determining where new customers are going to come from, what they value most from the product, and how they want to interact with a lender.
Novantas research has consistently shown now that many customers of Home Equity products still prefer a branch experience over the other mediums. But trends have been heavily shifting towards a digital experience even in the short time between our two surveys (2015 vs 2017). The services of access through online banking and online transfers to checking are becoming commodities in the space. Establishing a strong digital presence as a lender can help address other challenges in the shifting demographics of customers, but this investment certainly adds to considerations.
TAPPING THE MILLENIAL MARKET
In order to remain successful in 2018 and in coming years, winning the battle for customer that are coming of age is paramount. Research shows that the behavior of this group is more nuanced and multifaceted in both their origination decisions as well as debt shopping. Reaching these customers via digital channels is increasingly important, but so is knowing what other product features drives this demographic to originate and use Home Equity.
While older demographics have a greater sensitivity to fees, millennials have a stronger reaction to introductory rate offers and consider this a top reason for choosing a lender. This increased sensitivity to rates differs from the rest of the population, where a considerable number of customers is unaware of the interest rate. Moreover, when presented with a rate offer, two-thirds of millennials say that they would take additional balance while one-third would pay down at expiry.
Made up mostly of the more profitable “Revolvers” and “Periodic Borrowers,” millennials have a wider and more balanced array of motivations for use of the Home Equity products. This plethora of potential uses could be connected to a higher propensity to shop for lenders, with almost 50% of the group getting a quoted rate from more than one bank — a much higher total than any other age.
As this population group continues to grow, understanding that introductory rates and rate offers can increase originations and utilization will be key to winning their business as well as understanding their potential reactions to the rising-rate environment. As rates continue to rise, our research indicates that while most customers will react singularly, millennials will look to react with multiple actions, e.g., refinance with another bank, pay off the balance with cash, use
credit card, etc.
EDUCATING THE CUSTOMER
Many Home Equity customers, not just millennials, are not aware of the full array of product features and uses. Rising rates will generate more questions that will need to be addressed, such as when to use fixed-rate options or the flexibility of a 2nd lien versus cash-out refinancing.
A large percentage of customers say that they will look to pay off or pay down their debt in the face of higher rates. Most customers fail to mention FRO as a potential solution, suggesting a lack of education about the product, which can be addressed through proactive communication from the bank.
While some customers frequently use the products, many customers are unaware of potential uses and could switch to a more profitable relationship with the lender by changing their behavior. Making up the largest behavioral segment, “Periodic Borrowers” are increasingly underserved. The profitable moderate-to-high utilization of this group suggests that banks should look to increase the frequency of this group’s sporadic draws, which can be done with more proactive offers. Even though lenders are not reaching out to this group, 40% of customers indicated that they would be likely to draw with a rate offer.
The profitability of Home Equity has changed more around the product than the product has changed with the environment. For most of its natural life, Home Equity products have been “fee-free” originated lines and loans, relying solely on interest income to cover origination expenses and return hurdles for use of capital. As both origination expense and capital have become more expensive, the “fee-free” features have remained, highlighting a serious need to understand potential usage of lines of credit throughout the life in order to ensure a mutually beneficial deal between customer and lender. The rise of both the digital channel and a new demographic of customers can add challenges to predicting these cash-flows.
Surprisingly, a good mix of the new generation of borrowers display behavioral characteristics of “Revolvers.” This segment of customers tends to have high utilization on lines of credit and make several or ongoing draws and paydowns throughout the draw period life. These are the most profitable customers, but they also require the most to win business and serve on an ongoing basis. Revolvers are also less motivated to take out a HELOC based on home-improvement needs — an interesting point since interest deductibility previously existed for this type of use.
Revolvers are more rate sensitive than their counterparts and also tend to shop debt, making them often more expensive to acquire and maintain. When asked in our survey what were their top three reasons for choosing a lender, the customers chose “Trust,” followed by “Best Rate,” and third “Primary Bank.”
For the complacent lender, the requisite ongoing maintenance and attrition risk is inherent for these customers, who understand the ability to refinance and who care about rate, especially now. Knowing where to spend this extra energy is crucial for maintaining a healthy level of profitability for the line of business.
PROACTIVITY IS KEY
Overall, we see customer demographics are shifting and banks must move towards a more proactive relationship that is focused on draw offers, line increases, or general reminders of product features.
Across all segments, we see that there is a lack of product education across Home Equity customers, with many not knowing information about product features or their current interest rates. By informing their customers of basic product features and uses, banks can better serve the shifting demographics of the customer base.
As questions about rising rates or the new tax code continue to arise, understanding how to increase service for customers while maintaining a profitable relationship becomes progressively more difficult. By understanding segment behaviors by demographic, banks can focus their efforts on educating the customers on potential uses and proactively communicating in order to re-engage the ever-disappearing profitable Home Equity customer.
Adam Lee Purvis
Manager, New York