A Rare Bank Without Defaults

by David Fessler, Advisory Panelist
Friday, December 19, 2008: Issue #904

No Credit… No License… No History? No Problem?

Even before our current mortgage meltdown, most banks would never touch a prospective customer with any one of the above issues, let alone all three. But there’s one bank in a quiet little corner of Pennsylvania that’s made thousands of loans – all to customers who have no credit history, zero credit scores, no drivers license and nothing beyond an eighth grade education.

The most amazing part is that they’ve never had even one customer default on a loan. And that’s thousands of customers over a 20-year period. How can this possibly be true?

A number of reasons…

This bank strictly adheres to one of the most basic principles of solid banking, and one we can all understand: Know your customers well, and only lend money to people you know can afford to pay you back. Sound like a bank you’d like to do business with? It gets even better – the banker goes to the customers, meeting with them right in their homes.

These customers are a dream-come-true for a bank-lending officer: They live well within their means, save a lot, and don’t have credit cards.

If you’re scratching your head about where this bank does business, I’ll give you a hint: It isn’t overseas or in a foreign country. It’s right here in the United States, and there’s a way for you to benefit from these dream customers.

Unique Loans, Unique Customer Loyalty

If you’re from Pennsylvania, you’ve probably guessed by now I’m talking about the Amish. And in the Old Order Amish Community of Lancaster County, the banking system is working just fine.

Hometowne Heritage Bank, a division of National Penn Bank (Nasdaq: NPBC), has offices in the heart of Amish country, and is the biggest lender to the Amish. Even the drive-up lanes have a special lane for horse-drawn buggies only. More on Hometowne in a minute, but here’s a brief history of the Amish for those of you not familiar with them.

The Amish, members of a Christian denomination called Anabaptist, first came to this country in the early 18th century to avoid persecution in their native Switzerland. They refer to themselves as “plain folk.” They’re best known for simple living, plain dress and for shunning modern conveniences, such as automobiles, tractors and electricity.

They are a hardworking people, leading mostly simple farming lives. As of 2008, they number around 227,000 mostly in the United States and Canada. Strict-order Amish seek to limit contact with the outside world. And they’re low maintenance: They never buy insurance and don’t accept any government assistance, such as Social Security or Medicare.

For daily living expenses – including buying the horse-drawn carriages they typically use for transportation – they pay by cash or check. They would never think of buying things like shoes, clothing or food on credit.

The only time they vary from the no credit rule is when they’re buying a farmstead. The problem is that there aren’t any Amish bankers, or Amish-owned banks, so they have to deal with local banks run by “English.”

According to National Public Radio’s David Gilkey, the one that stands out above the rest is Hometowne’s Bill O’Brien. Ninety-five percent of his customers are Amish, and he racks up nearly 1,000 miles a week visiting them.

Bill oversees about $100 million in loans, and he’s used to no credit score, no driver’s license customers who contact him about buying a farm. According to Bill, “I’ll find out who his dad is, and I’m also interested in who his father-in-law is. It takes a team to make a farm go. We’ve never lost any money on an Amish deal.”

Once an Amish man becomes a customer, Bill doesn’t worry about them missing a payment. The Amish feel that missing a payment brings shame… not just on the borrower and his family, but on the entire Amish community.

And unlike a lot of mortgages that are sold or securitized, Amish loans have to remain with the originating bank. An odd quirk in banking law states that mortgages on homes without electricity or commercial insurance can’t be securitized or sold.

As a result, Hometowne services all its loans and the system is obviously working: The company just wrapped up its best year ever. Hometowne’s parent, National Penn Bank, is doing just fine, too.

Its third-quarter income rose 14% over last year, and the company raised its cash dividend for the thirty-first consecutive year. In early 2008, it acquired two smaller regional banks and is now one of the largest regional banking operations in eastern Pennsylvania, with 127 offices available to serve its customers.

In this tumultuous year that’s seen nearly 30 banks fail and many others taken over and sold by the Fed, it’s refreshing to find a place where someone actually knows how to run one. And even more refreshing, happy customers who know how to live within their means.

Good investing,

David Fessler

Today’s Investment U Crib Sheet

Securitization is a process that has been mentioned a lot over the past several months, and it might be time for a refresher course on some of its principles.

Securitization is the process of taking an illiquid asset, like mortgages, and transforming them into tradable securities. One of the most common and widely publicized is a mortgage-backed security (MBS).

The process works like this:

A loan company, originator or bank sells a mortgage loan. These loans are secured against the value of the underlying asset, in this case a home. They bundle multiple loans into a mortgage pool.

This mortgage pool behaves very much like a large bond with absolute value, a stream of income and various degrees of risk. Large aggregators who had large pools of these mortgages would then divide the loans into subgroups called tranches.

Each tranche is assigned a value based off its income stream and level of risk. The income is secured be the numerous loans in that portfolio. The group’s credit scores and the number of estimated defaults defines the risk on each tranche.

The past year has shown the amount of weaknesses in the system when home values drop and when risk isn’t adequately measured. The purchasers of this debt buy one thing, and get another. It’s one of the main reasons numerous banks have failed, as these assets turned worthless.

Customers with low default rates and steady payment histories are needed to make MBS work. It’s why customers like National Penn’s are so valuable. But NPBC isn’t the only company profiting from a niche market. In fact, that’s what the White Cap Index aims to exploit. To get more information, and find out about one White Cap that’s up over 60% since its addition, go here.

Comments

**By submitting your comment you agree to adhere to our Comment Policy and Privacy Policy.

Check out our selection of daily Investment Research: