Wednesday, November 10, 2010

How to see a Crisis – Opportunity or Danger?

Here we are, two-plus years from the epicenter of the financial crisis. September 2008 AIG and Lehman Brothers melted down within a few weeks. It began a run on the financial system that lasted for easily a year and a half, and is still felt today.

I was thinking about that week when Lehman Brothers went bankrupt in September 2008. TMG Financial Services was just starting to gain critical mass towards our business plan of acquiring portfolios from credit unions. We had thoughts on permanent funding for the portfolios and had put in place some temporary funding, but nothing substantive had come together. With the financial crisis, we realized our sources of funding weren’t coming from the usual suspects. On that Tuesday, we met as a management team to figure out what to do. Looking back, it really wasn’t a pleasant meeting. It was mostly dark humor and grim comments about what had happened to the financial industry and where we, as a start-up among giants, would end up. I imagine more than one person in the room wondered whether they would have a job down the road.

But as they say, necessity is the mother of invention. From that meeting came the idea for our Collateralized Advance Program (CAP) – the primary funding source for our portfolio today and an innovative lending syndicate that matches credit unions who have excess liquidity (money) with our need to purchase a portfolio from another credit union. To my knowledge, there is no wide spread program like this today. We have more than 60 financial institution partners that have brought more than $120 million together to fund the portfolio. The rate of return is at or above what they could have received in the market and is truly an example of a collaborative model.

So how did it happen?

This was, in fact, our third funding model. The first model, while brilliant (my perspective!) ran into regulatory constraints – it wasn’t prohibited, but it wasn’t allowed, so therefore it couldn’t move forward. Our second model was to approach large, wholesale financial institutions to fund the portfolio with collateral-backed debt (a traditional model). That approach went out the window with the financial crisis. That left us to move to Plan B (or really Plan C).

We had a few core principles on what we wanted from a funding perspective. First, we wanted credit unions that sold their portfolio to be able to invest in a risk-adjusted credit card portfolio. That is, if they were from Salt Lake City, they could fund a portfolio with a national distribution to lower the risk. Second, with the constraint that the credit union regulations would not allow them to invest in 100 percent of their portfolio value, we needed other funding partners. With that, we wanted them to be able to fund the portfolio in a risk-adjusted way – not by owning Joe or Jane’s credit card account that could go bad, but own a part of a pool of assets that we could back by taking the credit and fraud losses as a traditional credit card lender. From there, we just worked on the CAP model from our funding partners’ perspective. Why would we want to lend money through this syndicate? How could we make it attractive for them to participate? How could we be transparent in our processes so they could be assured that their money was secure? It was a few basic principles that we went to the market with.

That being said, we didn’t just open up the door and have money flowing in (ask my wife about more than a few sleepless nights). We had a few assets that made it work. We have a number of strong, long-term trusted partners who believed in us and the business model and stepped forward first. If they hadn’t, I’m not sure where we would have ended up – they saw the opportunity in the model, rather than focus on the danger that credit cards presented. We did have some potential funding partners that backed away given the perceived risk of credit cards – from my point of view they were focused on the danger rather than the opportunity. Other funding partners liked our model and yet saw ways to enhance the security and transparency (thus, the overall attractiveness) of the program. We continued to modify the program, and continue today as we add partners on a regular basis.

So what does this have to do with the financial crisis?

We have clearly been in a crisis. The old saying is that the Chinese character for crisis is a combination of danger and opportunity (Note: Apparently that saying is actually not correct, but it makes for a much better story if we suspend that small fact for the moment). In this current crisis, many people have focused on the danger. They have hunkered down, laid off staff, cut inventory, pulled back marketing and sales and hoped to ride out the storm. Certainly there was a market correction, but some decided this was the time to focus only on the danger. The danger was clear – unemployment rising, consumers pulling back, the stock market plummeting, the government bailing out banks, auto companies and the specter of “nationalization” being bantered about. The most self-righteous among us said, “I told you so.”

So where was the opportunity? I love the billboard that “Bill Gates started Microsoft in a recession.” By the way, Facebook saw its growth during that time. Apple has grown to nearly the leader in market capitalization since 2008. Why do those businesses see opportunity when others see danger?

The future and the ability to be successful is a matter of perspective and perseverance (ok, timing helps a bit, but it doesn’t start with P). The perspective is to see the opportunity, while not being blind to the danger. That might mean changing the business model, looking for new markets or figuring out how to do that thing that you always were going to work on that would change the game. The perseverance is the stick-to-itiveness to stay with that perspective even in the face of a playing field that seems to be stacked against you or with the rules changing every 23 minutes.

The environment doesn’t seem like it is going to change for awhile. So, the choice is yours – we have been and may still be in a crisis situation. Will you see opportunity or danger? I vote for looking at opportunity.