Getting a Loan in the Checkout Line

NEW YORK (TheStreet) -- As big banks have stepped away from consumers with less-than-perfect credit, the companies that sell those consumers goods appear ready to step right in.

From Wells Fargo (WFC) to American International Group (AIG), the financial industry has taken a giant leap away from the so-called "consumer finance" business -- a term that often refers to a lender's least profitable customers. The trend began more than two years ago when subprime problems first became clear, but has increased recently for two reasons.

Some institutions are in the midst of restructuring, getting rid of businesses that have been loss-leaders or aren't core to the franchise. Citigroup (C) has been in the process of divesting its main subprime-lending division, CitiFinancial, for some time. AIG announced a deal to sell 80% of American General Finance - a leading U.S. consumer-finance business - to Fortress Investment Group (FIG) on Wednesday.

Lenders are also hesitant to move back into an area they're just recovering from, especially in light of dramatic regulatory changes. Recently-established reform measures have limited lenders' ability to price risk effectively. The Dodd-Frank bill will further curtail fee-driven practices and require banks to keep "skin in the game" for loans they make, rather than the "originate to sell" model, which passed risk down the line via securitization.

Combined with an ongoing lack of demand in the bond market for certain kinds of consumer debt, large banks like Wells Fargo, Bank of America (BAC) and JPMorgan Chase (JPM) have become a lot more selective about whom they provide loans to.

"Once you go through a mass default, the first reaction of lenders is to pull back and to pull way back," says Scott Colyer, CEO of Advisors Asset Management, a broker-dealer and investment advisory firm. "A credit bubble is like a forest fire: We get rid of the bad practices that were being done, and go back to basics."

Those tighter underwriting standards have made Colyer quite bullish on bank stocks: "If I could die tomorrow and come back as anything, it would be a bank."

But the picture isn't quite so rosy for those who relied on quick-and-dirty lending practices of the past to make ends meet. Nor has the situation improved quite so dramatically for the retailers, gadget-makers and automobile companies that benefited from a lending frenzy that allowed more people to buy more of their stuff.

As major lenders have cut back, major non-financial companies have stepped deeper into the lending fray, directly or indirectly. General Motors' recent agreement to buy subprime auto lender AmeriCredit is just one example. Wal-Mart's (WMT) recent partnership with Superior Financial Group to offer small-business loans to members of its Sam's Club division is another.

Theoretically, a less-than-prime borrower could get her mortgage from a Federal Home Loan Bank, her auto loan from GM or Toyota (TM), her loan to replace broken-down home appliances from General Electric (GE) and her loan to buy household goods from Target (TGT), while starting up a small business with a loan of up to $25,000 through her Sam's Club membership.
"The most important piece of context is to realize almost every enterprise -- whether it's a manufacturing operation or whether it's a retailing operation -- has been engaged in finance since the beginning of time," explains Lawrence J. White, a professor of economics at New York University's Leonard N. Stern School of Business.

Auto companies were among the first to enter the lending business in the early-1900s, and GE has a long history of consumer lending as well. Before the crisis hit, retailers and other consumer-driven companies were eager to gain federal or state banking licenses to operate as industrial lenders. Some, like Target, Nordstrom (JWN), Sears (SHLD), Home Depot (HD) and Harley-Davidson (HOG), achieved that goal, with mixed results.

After a drawn-out battle with regulators and advocacy groups, Wal-Mart did not. Instead, the retail giant withdrew its application in the United States., and settled for acting as a hub for other entities to provide financial services to customers. It collects fees from companies that offer check-cashing, money transfer, ATM and now, small business lending services through its stores. It did, however, gain approval to act as a traditional bank in Canada and Mexico, indicating a continued interest in the area.

White, a former banker who also spent years in various regulatory capacities, doesn't think it's such a bad thing for non-bank institutions to provide financial services.

"I think it would be great," he says matter-of-factly. "Wal-Mart has this business model of providing good value for low- and moderate-income households. If Wal-Mart would apply the same model to its financial services, Wal-Mart could assist low- and moderate-income households are underbanked."

Yet worries Target's foray into the credit-card business and GE's foray into subprime lending caused serious worries for investors during the crisis. Though the two companies made it past the perception that their lending divisions might seriously injure the broader franchises, the battles served as a cautionary tale: If banks can't handle lending to subprime consumers, what makes nonbanks think they're up to the task?

"Banks aren't lending because they don't have high-quality loan demand," Colyer points out. "A substantial number of the population still has fairly damaged credit."

If the broad pullback in banks' subprime lending is, in fact, a profitable opportunity for others, it only applies to a select few. Regulators are wary about the crossover of non-bank firms into the banking space, as the Federal Deposit Insurance Corp. made clear in regards to Wal-Mart. The financial-reform bill went a step further by instating a three-year moratorium on granting new licenses to industrial loan corporations, or ILCs.

"They will also be subject to the new bureau of consumer financial protection, as well as hopped-up laws by state attorneys general," says one lawyer who works with major corporations on this issue, but was not authorized to comment on the matter publicly. "Another worst-case scenario for a large, nonbank company is if it wakes up one morning and is very engaged in these financial pipelines and everything falls apart again."

It's also worth nothing that the window of opportunity -- foggy as it may be -- won't stay open forever.

The cyclical nature of economic booms and busts will eventually take over. Subprime balance-sheet nightmares will begin to fade from memory. Banks will get comfortable with new regulations. And the yields offered by subprime loans will begin to outweigh the risk, even if it takes a little longer this time than in previous downturns.

"Maybe as a former banker, I'm a bit biased," says Edward Kramer, the executive vice president of Regulatory Programs for Wolters Kluwer Financial Services, who also served as a New York State banking regulator. "But subprime and nonprime is not necessarily a bad thing. I, as a former bank mortgage lender, was overseeing the making of subprime loans 20 years ago, when those were really good loans. Those were loans we kept in our portfolio."

But he adds: "at least for the foreseeable future, that business is gone."

-- Written by Lauren Tara LaCapra in New York.