The Friction Factor

By Kenneth Cline

Online lending has a bright future, roundtable participants say, as long as lenders make the origination process speedier and more convenient.

Online lending, like most things Internet-related, has been a bit of a disappointment. The vision of customers forsaking the brick and mortar world en masse to browse for personal, auto and mortgage loans on theWeb has long since faded, as startups like Mortgage.com, PrimeStreet.com and iOwn.com have flamed out.

Yet the online lending industry survives, with pockets of strength here and there. Companies such as E-Loan Inc. and MortgageIT.com reported their first profitable quarters last year. The recent decline in interest rates helped boost volume for all players, particularly those specializing in refinancing mortgages. IDC, a research company based in Framingham, Mass., estimates online mortgages will reach 15% of total originations by 2005, up from a current level of about 9%.

It remains the case, however, that consumers use the Internet more for information-browsing than actually applying for and closing loans. According to participants in a Banking Strategies roundtable, this will not change unless lenders reduce "friction" in the origination process, particularly for mortgages. "Until the lending community understands that it must go beyond paper-bound fulfillment processes, this activity will never be successful on the Internet," says Jerome J. Selitto, chief executive of DeepGreen Bank, Chicago.

Selitto and David Anderson, senior vice president of strategic initiatives at Charlotte, N.C.-based LendingTree Inc., both emphasize that lenders must constantly endeavor to improve the convenience and speed that gives online origination its value proposition. Only then, they say, will consumers take to online borrowing.

LendingTree is an online exchange, or referral service, that offers customers a choice of 140 lenders for personal, auto, mortgage, home equity and credit card loans. DeepGreen, which specializes in home equity loans and certificates of deposit, is the online subsidiary of Third Federal Savings & Loan of Cleveland, the nation's largest mutually-owned savings bank.

We spoke with Anderson and Selitto last December during BAI's Retail Delivery conference in Anaheim, Calif.

Banking Strategies: Online lending is a nascent industry. What have you, as pioneers in the field, learned so far about what works and what doesn't?

Anderson: At LendingTree we've learned there are no silver bullets. You can post a Web page that provides lots of information and attracts lots of online traffic, but that doesn't mean prospective borrowers are actually going to close loans. A lot of things happen between the time the mortgage customer accesses that information and reaches the closing table.

We've attempted to identify all the friction points along the way and slowly remove them. That can involve things such as technology, customer contact, and basic fulfillment processing. Some of our partners, like DeepGreen, have implemented technology to help reduce that friction.

People are using the Internet at an ever-increasing pace. We have relationships with more than 140 institutions, which says something about the Internet's potential to generate more loan volume. LendingTree facilitated more than $10 billion worth of loans last year, two-and-a-half times more than in 2000. Clearly, people are becoming more comfortable with online transactions.

Selitto: The Internet is definitely not a distribution channel for traditional products. If you follow that path, you will not succeed. You cannot offer the same products and processes on the Internet that you do offline. That's not what customers want.

DeepGreen Bank is a monoline lender focused on making home equity loans in a way that harnesses the Internet's speed and convenience. A customer can come to our site and complete a streamlined application in less than three minutes. In less than two minutes, they get an unconditional decision. No additional paperwork or documentation is required at the end of that two-minute period. So basically, a customer can complete the entire transaction in five minutes.

Banking Strategies: How fast can this industry grow?

Anderson: According to IDC, there were $150 billion online mortgage transactions last year, only about 9% of the total. Will the Internet take tremendous amounts of market share over the next five years or so? Probably not. But it will keep chipping away, and eventually account for a major share.

Selitto: Customer preferences are based on what's available in the market. To the extent that online borrowing really becomes a frictionless process for the customer, it's going to change customer behavior. It will be very similar to the growth of automated teller machines, where customers gradually became more comfortable using the technology.

The Internet is going to shift power from the suppliers of goods and services to the consumers, who now know much more about competitive offerings and product features.

Anderson: But again, you need to take the friction out of the process. Look at cell phones. Five years ago, they were clunky devices. Now they're small and easy to use, so lots of people have them.

Selitto: Most people today are using the Internet at least to get information. They look at pricing and product features, although they may not execute online. The technology is less daunting today than it was even two years ago. We are dealing with a much more well-informed consumer.

Banking Strategies: How do you drive customer traffic into your Web sites?

Anderson: We do a lot of marketing, both online and offline. We're particularly focused on television and radio commercials.

Two years ago, we were trying to build our brand, so we just talked about LendingTree and what it could do for customers, specifically by placing them in control of the process. Last year, we became more focused on the products customers were looking for, such as mortgages or home equity loans.

We also have relationships with organizations such as Yahoo, MSN Money, and more than 20,000 affiliates that direct traffic to our site. The online marketing is growing on a daily basis.

Selitto: From the financial institution's point of view, there are two ways to approach this: you can go to customers where they are or try to pull them in. For us, it's far more efficient to go where customers already are. LendingTree is a very big part of our business and a key strategic partner. They are far more efficient at leveraging advertising dollars than we would be. And at this point, I'm more concerned about building brand experience than brand identity. When consumers come to the LendingTree site, I'm perfectly happy to compete against other lenders in terms of our value proposition.

Banking Strategies: So you rely on LendingTree's brand to attract customers?

Selitto: Right. When customers come to LendingTree looking for a home equity loan, they can get four offers, including ours.

At the same time, we do use banner advertising, and we're on Yahoo as well. We use direct e-mail solicitations and permission-based e-mails. With the latter, customers who register on a site such as Yahoo! or Hotmail can elect to fill out a form saying they would like to receive information about special offers in certain categories, including financial products. It's a combination of all those things.

Banking Strategies: Is this money well spent? It's been said that 80% of Internet-researched loans are actually completed in the branch of the bank, as opposed to online.

Anderson: We do see fallout, but our metrics, in terms of loan closing rates, are going in the right direction. Roughly a third of Web-initiated home equity loan applications are closing online, which is a pretty high number. The ratio is not as high for first mortgages, but that's going in the right direction as well.

Selitto: There are more steps involved in first mortgages than in home equity loans, so there's more friction in the process. Today, unfortunately, sometimes there's more friction in the online process than would be the case if you picked up the telephone or went into the branch.

Because customers don't close mortgages online, you can't conclude they don't want to. The real problem is that the online origination process is still very cumbersome. Until the lending community understands that it must go beyond paper-bound fulfillment processes, this activity will never be successful on the Internet.

Anderson: It goes back to the fact that banks have processed mortgages the same way for years and years. The Internet doesn't fit seamlessly into that process.

Selitto: If you have an investment in brick and mortar operations, then you have a vested interest in maximizing that investment. There also hasn't been a lot of innovation coming from the two dominant investors in the mortgage industry, Fannie Mae and Freddie Mac, although they are starting to use automated underwriting systems. So it's not just the lenders who dictate the paper-bound process; it's also the investors.

But there's a lot that the lenders can do. Even if you can't grant an unconditional approval without a full appraisal, for example, maybe you can at least take the application online and perform the verifications electronically.

Banking Strategies: Is underwriting a problem? Some banks have complained that it's really hard to acquire high-quality assets online.

Selitto: At DeepGreen Bank, we target the high end of the credit spectrum. We use our own scoring system, which is entirely rules-based and totally automated. It targets credit quality that would be an equivalent to 680 and above on a Fair, Isaac & Co. Inc. scale. We have certainly not had a problem in fulfilling our volume projections because of that, although we turn down between 10% and 12% of our applicants.

Now, I'm not sure I would be as comfortable using an AU scoring system for applicants in the lower spectrum of credit. Those individuals need more hand-holding and counseling. You also need to apply more underwriting discretion than would be the case with a strictly rules-based system.

But so far, we haven't had any problem attracting high-quality assets on the Internet.

Banking Strategies: Is adverse selection a big problem elsewhere on the LendingTree site?

Anderson: We see the full spectrum of credit worthiness in applications for all of our loan products. Non-prime customers gravitate toward personal loans and credit cards, where lender approval rates are not anywhere near what you get in mortgages, home equity and auto loans. There aren't a lot of lenders out there willing to lend money in an unsecured fashion to someone who doesn't have a good track record of paying it back.

But when you talk about the higher-end mortgage and home equity products, some subprime lenders on our site are doing very well. It goes back to focus. They're very targeted in what they're going after. They use our system, our filtering capabilities, and then run the application through their own system.

A subprime transaction requires more processing, but the subprime lenders involved with our exchange are doing well.

Banking Strategies: How important is customer service in online lending? How do you bring a measure of human interaction to the process?

Anderson: We have a customer care area that acts as an advocate for customers, who call and e-mail us quite a bit asking for advice. We listen to them and try to make them comfortable throughout the process. They want to know someone is on the other end of the line.

Selitto: One of the few things we didn't outsource was our call center. We have a very efficient internal voice response system that answers a lot of the basic questions. Then we have service reps available about 20 hours a day, seven days a week. They are knowledgeable loan officers who can guide customers through the loan application steps.

The underlying question is whether people are satisfied with human interaction via communications channels such as the telephone and the Internet, or whether they want actual face-to-face human contact. I don't think people want face-to-face contact. They want answers and help. They want to make sure someone is there.

Internet customers may not need handholding every step of the way. But when they have a question, they want that question answered immediately. They expect customer service. They don't want to wait online. If you, as a lender, are not delivering speed and convenience, you have a problem.

At some lender sites, customers are told they will be contacted by a loan officer to complete the application. Or, a paper application will be shipped to them to fill out and submit. That is not what the customer wants.

Banking Strategies: Let's talk about your own business models at LendingTree and DeepGreen Bank. How do you earn your money?

Anderson: At Lending Tree, consumers pay nothing to apply for some form of credit on our site. We generate fees from our lender partners. These lenders pay a nominal fee for every application that passes their filter criteria. They might say, for example, "I want to see customers that have a FICO score above 680 and live in these particular states." We charge anywhere from $2 to $9 for each application that emerges from that filter. Once a transaction closes, we receive a larger fee, depending on the loan product.

On average, our fees represent about half the typical acquisition cost for a loan product, so our lender partners are happy to leverage our model. And as they improve their processes and start treating the Internet the way it should be treated, by providing the appropriate service levels, the number of closed loans goes in the right direction.

Selitto: The Internet requires a huge initial investment. It's technology-centered, and that technology is expensive. But once you make that initial investment, your marginal cost for serving additional customers is essentially zero. So success depends on reaching a critical mass of customers.

At DeepGreen Bank, we spent a sizable amount of money developing the online technology. But now we can increase our customer base with no incremental cost. We could easily double the amount of business we're doing now, and the only place I would have to add headcount is in my call center. Now that's scalability!

As a federal savings bank, however, we do have restrictions on our growth, in that we have to manage our asset base in proportion to our capital. In a year, we've gone from zero to $550 million in loans, but we want to stay at about the $600 million level in asset size. So we'll manage to that limit by selling or securitizing loans.

I would love to be, say, a $3 trillion portfolio lender, because the product has very attractive spreads. But I can't find the capital to do that.

Banking Strategies: And those spreads are attractive because of lower operating costs in the online model?

Selitto: Yes. I'm a national lender processing 12,000 applications a month with only 65 employees.

Most online banks did not build an asset-generating model. They focused on gathering deposits and didn't spend the money to build the technology for the asset platform.

We took a totally different focus. We built an asset-generating model in the belief that the liabilities would come. In our first eight weeks, we advertised high certificate of deposit rates and pulled in four times more CDs than we needed, 80% of that online. Today, we do not accept any CD application that's not Internet-driven.

For us, the liability side of the equation is very easy: you turn up the rate and attract liabilities.

Banking Strategies: What are the key things for people to think about if they want to play in this space?

Anderson: You have to have the right people, processes and technology. Those three things work in concert. It doesn't matter if you're selling books or loans online. Those are the basic building blocks.

Secondly, replicating traditional channels probably won't work. You have to keep your eyes open and realize it takes a lot of investment to succeed. It's not just a matter of putting a few bodies in cubicles and saying, "Go!" You have to look at the entire online channel and try to understand how you can be successful.

At LendingTree, we're trying to help our partners succeed by providing best practices and enabling technology.

Selitto: The Internet is more than just a channel of distribution. You cannot use it as a catalogue or brochure for your existing products and then provide those products through your current processes.

Banks need to be aware that non-bank players can take their franchises away, like the way Mercedes took over the brand loyalty in upper-end automobiles that once went to Cadillac. You have to be alert to these shifts in customer preference. Today, for banking services, people want convenience, speed and value and will respond to anyone who provides those things.

We have a saying in our company: "If you don't understand the full power of the Internet, someone else will."

Mr. Cline is senior editor with Banking Strategies.

Copyright © 2003 by Banking Strategies, published by BAI.

back to top