The value of retaining customers

Editor's note: David Oshan is quality process manager, and Kristin Triplett is communications specialist, at First Union Home Equity Corporation (FUHEC), Charlotte, N.C.

First Union Home Equity Corporation (FUHEC), a nationwide second mortgage lender based in Charlotte, N.C., recently discovered that if it could keep its customers on the books one month longer it would gain 6 percent net interest income per year.

That figure was derived from an extensive study on customer retention that was launched as FUHEC began to place an emphasis on its total quality management processes.

For FUHEC, one driver of the customer retention study was the realization that the cost to originate a loan is over $800, while it costs only $112 to service and collect a loan.

The customer retention study was initiated by Jim Maynor, FUHEC president, and spearheaded by David Oshan, quality process manager. "This study is important to FUHEC because various businesses, particularly sales organizations, spend time getting new customers and not as much time keeping those customers. We want to learn how to keep the customers we have," says Maynor.

FUHEC is a wholly owned subsidiary of First Union National Bank of North Carolina (FUNB), the ninth largest bank holding company in the nation, with assets exceeding $72 billion. First Union Corp. is based in Charlotte.

FUHEC began originating second mortgages in the 1950s and has grown from a small southeastern company to a $2 billion operation with a network of approximately 150 branches spanning 39 states. FUHEC has a National Accounts Group located in Charlotte that derives home equity referrals from national companies such as USAA, a financial services organization dedicated to serving present and former U.S. military officers and their families. FUHEC offers a complete range of closed-end second mortgage products and home equity lines of credit and currently serves approximately 76,000 customers.

Retention important

FUHEC utilizes a total quality management philosophy which is the centerpiece of the strategic planning process and employs the Malcolm Baldrige criteria as its Blueprint for Ongoing Success. The Baldrige criteria have seven broad categories of evaluation, including customer satisfaction. Within customer satisfaction, customer retention is one of the most important criteria and has emerged as a leading priority within First Union.

To learn more about customer retention, FUHEC conducted secondary research on other companies. The first step was to determine which companies are top performers in customer retention. Material from several sources was analyzed, including articles from Newsweek and the Harvard Business Review, benchmarking documents from Xerox and excerpts from a summary of the Consumer Bankers annual conference held in Tucson, Ariz.

Among the companies identified as leaders in retention was USAA. AT&T Universal Card Services and MBNA, both among the largest credit card services providers in the nation, were also singled out. Retention rates for these companies ranged from 90-98 percent.

According to a study completed by the Council for Financial Competition, a financial services group, the average retention rate in the banking industry is between 80-85 percent. Currently, FUHEC's average retention rate is consistent with industry averages.

FUHEC also met with Bain & Company in Boston, an international management consulting firm, and had extensive discussions with a former AT&T executive and a retention specialist from USAA. These meetings gave FUHEC valuable information about the practices that contributed to world class retention rates.

Among the practices discovered were the distribution of surveys to customers who closed their accounts and the use of information systems to cross-sell or identify customer demographics. USAA, for instance, uses demographics to market product lines to fulfill a lifetime of needs. For example, one USAA company may sell a middle-aged homeowner a life insurance policy, and another may sell that individual's children an automobile insurance policy. All of the companies researched track retention regularly.

For its part, FUHEC is exploring the possibility of introducing a survey of customers who pay off their mortgages to determine whether the pay off was controllable or due to a management or pricing issue.

Currently, FUHEC has several surveys in place, such as a quality customer service survey, an ongoing customer survey, and a survey of nontakers (those who are approved for a mortgage but who don't use FUHEC). They serve as FUHEC's primary gauge of how it is meeting its company priorities: customer satisfaction, employee satisfaction and long-term viability.

Most profitable customers

A main goal of FUHEC's customer retention study was to determine strategies for keeping the most profitable customers. The study used various measures to calculate customer retention rates, the length of time a customer keeps their loan open (customer duration) and the profitability of various customer groups.

From the study, several customer profiles emerged which reflect different duration and profitability thresholds. Once these profiles were established, the financial impact of keeping customers longer was developed. These profiles were based on the average loan life expectancy.

Various demographic factors were analyzed to determine the effect on loan duration. After analyzing many of the components, the ones that stood out as having the largest impact are:

  • Income - aggregate income presented by the customer on their loan application;
  • Loan source - the source of business that referred FUHEC the loan;
  • Market value - appraised market value of the home;
  • Profession type - job status;
  • Mortgage Type - mortgage position (refinance of first mortgage or second mortgage);
  • Credit history - credit rating at time of application; and
  • Loan size - amount of money that the customer borrowed.

This information was used as a basis for building customer profiles, which were developed by tabulating the above data based on various loan life thresholds. An example of a threshold was the average income, market value and loan size for customers that paid their loans off between one and two years. Four customer profiles were defined based on demographic data obtained from the 33,000 customers who paid out (closed their accounts) between 1991 and 1993.

They are:

Profile 1: The Mobile Affluent Customer. This customer has the highest income, market value and loan amount and is generally a white-collar professional. The loan life is under two years.

Profile 2: The Career Ascending Rate Conscious Customer. This customer is slightly younger than the Class 1 customer with an ascending income, mid-range loan amount and is a white- or blue-collar employee. The loan life is between two to three years.

Profile 3: The Value Driven Customer. This customer is most representative of FUHEC's portfolio, encompassing a broad income range, market value and loan amount. The loan life is between three to five years.

Profile 4: The Payment Driven Customer. This customer has a lower income, a lower market value, a smaller loan and is generally a blue-collar employee. The loan life is over five years.

The breakouts based on years were based on the overall percentage of customers who paid off within the specific time horizons listed above. Within each time horizon, unique income, market value, loan size and loan source classifications stood out.

The profiles were used to estimate profitability per customer. For example, the Class 1 customers had the lowest loan life expectancy but because the average loan size associated with these customers was highest, the profitability impact of keeping these customers longer was highest.

Overall, the study found that if FUHEC kept all customers who paid out in 1993 one month longer, it would have earned over $750,000 in net interest income annually. If FUHEC increased its retention rates by one percent it would mean an additional two months in net interest income, or over $1.5 million.

Synthesizing information

Once FUHEC's retention rate was derived, various factors that contribute to retention rates were analyzed. These factors were: office age (how long the office has been open), market values, mortgage position (refinance of first mortgage or second mortgage), level of branch personnel experience, and market size.

Market size, branch experience and market values had the largest impact on retention rates. Market size has a large impact on retention rates because it is an indicator of how competitive various markets are. FUHEC discovered that in larger market areas retention rates tended to be lower.

Using information from the study, a formula was derived to give operational managers a working methodology to integrate retention data and allow them to determine which branches have high and low retention rates and develop strategies for improvement. For example, one of FUHEC's largest branches, in Edina, Minn., now has a full-time employee who is devoted to managing payoffs. Her task is to retain customers who are at a high risk of paying off their loan and leaving FUHEC.

Research of FUHEC's portfolio indicates that customers payoff for a variety of reasons. Most payoffs are either a refinance into another FUHEC loan, a refinance into a mortgage with another company or a decision by the customer to sell the property, which requires the mortgage to be paid. Since FUHEC refinances are not considered lost customers, data derived from the study didn't include these customers.

The final component of the study was the compilation of a Scoring Guide for Payoff Prediction. This model takes several demographic and management factors such as income, market value and market size, and breaks them into various scoring thresholds. With this model, branch managers can develop a prediction of how long their customers will keep their loan with FUHEC.

Validated assumptions

All of the data learned in the customer retention study was recently shared with FUHEC's leadership team. The data validated many widely-held assumptions and highlighted the importance of proactively managing relationships with customers. Leaders are now using the information to streamline the goal setting process within their respective areas.

Customer retention has recently been incorporated into each leader's STEP Plan, or performance outline, for the year. Mike Blackthorn, coordinator of all the broker branches (branches that derive loans from third-party, fee-driven referrals) in the network, feels that the customer retention study has revealed vital information about how he can expect the branches in his group to perform. "Now that we know more about loan duration, we can begin to plan a strategy to better manage customer retention," says Blackthorn.

Reports that identify customers who are likely to pay off their loans early based on income, market value, loan size and loan source are now being developed for all of the branches in FUHEC's network.

Eventually, FUHEC's goal is to incorporate the scoring guide into an automated branch system, now in development, which will link FUHEC branches to the main office. After the system is in place, when an application is entered into the computerized system, a predicted number of months will be estimated for the life of that loan. FUHEC will then solicit customers by mail about six months before it is predicted they will pay off the loan. Lists of customers who have been solicited will be sent to the branches where they will also be contacted by phone.

By using these approaches FUHEC can now differentiate customer groupings and effectively manage customer relationships to meet its goal of retaining its most profitable customers.