In addition to the balancing of savings and mortgages, other lenders are looking at the commercial advantages of clients with multiple product holdings.
While lip service has been paid to this in recent years, in reality most banks and building societies have not pursued it. That said, it is a strongly held principle in the rest of Europe, with Santander, for example, having on average five products per customer.
Most banks and building societies have retained simple deposit accounts and, although they represent vast sums of money, their growth has been fairly limited in recent years. The dilemma lenders face is that traditional savings contracts may be the default option but customers may prefer other vehicles that offer similar security but with a bit more zest.
However, the infrastructure required to support products that typically span savings, investments, insurance and wealth management are not available to many lenders.
Before looking at product diversification as the panacea, the starting point for any lender is the profile of its current customers and its distribution network.
Lenders that have specialised in sub-prime business are unlikely to find a pot of gold among their customers wanting wealth management or exotic investment structures, and equally their distribution is less likely to have investment custom-ers on the books.
The same can be said for lenders that have more mature customer bases. Many may enjoy AAA profiles but are likely to be conservative and sitting on fortunes in conventional deposit accounts. Many may not have had contact with financial advisers to take advice on what they should do with their savings.
So if you are considering direct funding options, you need to think about what products are suitable for your clients, your current distribution strategy and whether you have the resources internally to provide structured products or if this needs to be outsourced.
What products are suitable will vary according to customer profile and distribution capability. In essence, this is quite a simple procedure – if your clientsare mature and risk-averse, simple savings contracts can work best. If they are more affluent, possibly with interest-only mortgages and investment contracts in place, they are likely to have higher risk appetites.
The other factor is your distribution strategy. If this has traditionally been via general financial advisers, they will already have clients looking for investment contracts. But if it has been through sub-prime brokers, the likely opportunities for savings contracts are fewer. Direct marketing should also be included in the distribution mix, but thought must be given to the marketing material to ensure it doesn’t resemble junk mail.
Recent examples of organisations that have launched investment contracts to bolster their lending facilities include the likes of sub-prime lender edeus and one of the larger bridging loan companies, Tiuta. In the current economic environment, with providers looking to increase liquidity, I expect further launches in the coming months.
The products that are grabbing most attention are so-called structured products. Since their heyday almost a decade ago, these products have been conspicuous by their absence in many investors’ portfolios. However, in the past 12 months, with the onset of the liquidity crisis, the world has changed dramatically and structured products are enjoying a renaissance.
As an administrator of these products, we have seen a significant increase in demand from traditional providers. There has also recently been more interest from organisations such as high street retailers, mortgage companies and financial services companies looking to diversify their portfolios such as banks and investment companies.
According to website structuredproducts.com, in 2007 structured products raised £7.8bn – a 14% increase compared with the previous year. In 2008, we anticipate growth will be higher still, as more than 450 products have already been launched so far this year compared with 721 in the whole of 2007.
From a provider’s perspective, the turmoil caused by the change in the market has resulted in savers adopting a safety first approach to investments as they look for options with reduced risk.
As most lenders have had limited exposure to these products, it is worth explaining how they work.
The term structured product is almost as generic as ‘mortgage’, Some are completely benign but there are also more exotic options such as heavy adverse self-cert deals – not that any such products exist in the current economic climate.
The London Stock Exchange defines the products as follows – ‘The term structured products simply refers to a group of financial instruments with varying terms, payout and risk profiles on a range of underlying assets.’ At a basic level, the products are structured around a certain investment class or collection of investments. They offer a range of risk exposures from risk-averse to more exotic classes which, for most investors, would be impractical or not cost-effective enough to invest in. Products can be structured around single stocks, baskets of stocks, currencies, in-terest rates, commodities or funds.
The two main performance criteria for structured products are income and growth.
Income products normally offer interest levels significantly above those of bank or building society deposit accounts but nonetheless fit nicely alongside them. Investors have a capital guarantee so long as a major event does not occur, such as the stock market falling significantly. As the investments are geared towards an asset class, any falls can have a significant effect.
The other advantage for investors is the beneficial tax regime. For higher rate tax payers, the standard dividend tax is reduced from 32.5% to 25% while for basic rate tax payers, the rate is reduced from 10% to 0%. To generate equivalent net returns, an investment subject to savings income tax would have to offer 8.75% annual income or 0.71% monthly income. A good example of this is NDFA’s fixed income plan.
Growth products work in reverse as the investment is guaranteed but the return is not. Most plans base their returns on standard indices such as the FTSE 100 index. An example of this is the Accelerated Growth Plan from NDFA which offers 10 times FTSE 100 growth to a maximum of 85%. The FTSE 100 would only have to rise 8.5% over the course of the six-year term for the maximum 85% growth to be realised. Capital is secure if the FTSE 100 remains above 50% of its starting index level throughout the term.
To diversify in an increasingly difficult market, specialist lender edeus has partnered Newcastle Building Society to offer two of the society’s products – the Guaranteed Minimum Return Account and the 50:50 Balanced FTSE Account.
The former offers index-linked growth for five years while the latter also offers index-linked growth for five years on 50% of the capital invested, with the other 50% deposited in an easy access account paying a fixed 7.5% gross/AER for the first 12 months and tracking Bank of England base rate for the remaining four years. The FTSE tracker also offers a cash ISA option.
The above is a snapshot of what is available but products can be tailored to the needs of lenders and structured to work alongside a variety of loans.
However, structured products are not the only option for lenders looking to diversify their portfolios. Many other products offers providers the opportunity to branch out including regular savings, bonds, ISAs, unit trusts, annuities and insurance deals.
One of the main problems facing organisations looking to diversify into other areas is the investment and commitment required. One option is to partner with an outsourcing company such as Opal. Outsourcers can help clients respond to market opportunities, whether what is needed is full lifecycle management or tactical support.
Product development, marketing and administration of white label products can all be supported by outsourcers. The sales and underwriting processes, from new business through to maturity, can be looked after, giving providers the chance to monitor potential new markets withLSout damaging their brand.