ALEXANDRIA, VA (Mar. 25, 1998) -- Gillette (NYSE: G) gets maybe $50 out of you every year; Nike (NYSE: NKE) might pump you for $100; and Estee Lauder (NYSE: EL) might get $200 per year. Your bank or consumer lending company, meanwhile, might generate over $167 in net interest revenues on your mortgage this month. That's a significant chunk of the average American's disposable income per year and doesn't even reflect the full payment you must make. Put in the principal repayment and you're sending more than $800 each month to the bank. There are few other consumer relationships that are denominated in these dollar amounts.
Yesterday, we talked about relationship banking and how it's not dead for consumers and small to midsize commercial customers. However, these groups of customers are rapidly taking advantage of services offered by financial disintermediaries. For instance, consumers can call Jim Palmer and get a loan from the Money Store (NYSE: MON), make a purchase of securities through a discount broker (bypassing their brother-in-law who's a full-priced broker with bad ideas), and deposit their cash in an online broker's money market fund on which they can write checks and from which they can make electronic payments. Unless banks want to lose more of their low-cost deposits and let more of their high-margin fee income be cherry-picked by specialists, they will get in front of the latest wave of disintermediation and offer these types of services. That is, in fact, what banks are doing now.
Recently, First Union (NYSE: FTU) signed an agreement to acquire the Money Store. This allows the company to deal with non-traditional borrowers who may not meet the prime credit scoring requirements of the larger parent company. That business can be very profitable, though, as those credits may be more profitable on a risk-adjusted basis than prime credits. That means that, adjusting for slightly higher losses, the higher net interest margin makes for a more attractive return on capital. Those customers are prime candidates for other First Union products and are a fine source of earnings even if they don't migrate to the larger bank.
Fleet Financial (NYSE: FLT) recently acquired Quick & Reilly, the pioneering discount securities brokerage. Fleet is not constrained by a branch network to expand this business, even if Quick & Reilly does have brick-and-mortar branches. To expand this business it needs Web and other electronic interfaces to reach a national and international customer base for its financial services and to leverage its service infrastructure to keep these customers in the fold.
Surviving and staying in the forefront of financial services in the next century demands that banks reduce their reliance on commodity products like plain vanilla lending. Although you can make a profit being a lender of this type, it's hard to build value for shareholders doing just that -- the economics of the market will push marginal production down to the cost of that marginal production. The economies of scale argument doesn't really work here because maximum profitability in mortgage lending is reached at a comparatively low level of revenues and assets.
Norwest (NYSE: NOB) does very well in mortgages, but that's because it brands the service aspects of the business -- the origination and servicing -- and sells off excess mortgages into the market for asset-backed securities. Norwest uses this point of contact as a starting point to sell more services to consumers. Holding the mortgage isn't the profit center -- originating it and continuing on with the relationship is. National branch banks and financial services companies that can figure out how to replicate relationship chains such as this and leverage brand names will continue to enjoy, and even increase, their current profitability. Those that cannot will muddle along and cost their shareholders missed opportunities.