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A New Focus on Primacy in Commercial Banking

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The definition of primacy in commercial banking is evolving for many clients during the pandemic, but too many banks are either unaware of the change or don’t know how to tap into it.

A primary relationship that is based on the payments business and the operating account instead of the traditional connection to lending can help pump up fee income at a time when margins are squeezed and clients are seeking new providers.

Banks can deepen relationships and drive new revenue opportunities by taking a fresh approach to identifying the characteristics of primacy for commercial clients.

THE VALUE OF PRIMACY

Primacy is defined as the state of being first, whether in terms of importance, order or rank. After all, what commercial relationship manager doesn’t want to be first in importance or ranked first by the client? Intuitively, being a corporate’s primary bank feels right and would seem to be an appropriate goal.

Achieving primacy for commercial clients is a comprehensive goal. Not only must the bank meet the company’s most important needs, but its bankers must be considered as trusted advisers who have an emotional connection and devotion to the company. In historic terms, this was defined as the bank that would “lend through the cycle.”

Beyond those emotional relationships, Novantas has identified a slew of benefits that are associated with being a corporate’s primary bank. These include larger share of wallet, higher retention levels and better credit quality. (See Figure 1.) There is also a pricing advantage: primary customers are less price sensitive and primary banks typically get the “last bite at the apple” in competitive situations.

Overall, the primary bank possesses an information advantage that can be leveraged to drive these outcomes and create higher levels of insights, engagement and satisfaction.

Figure 1: Value of Primary Relationships

PERFORMANCE METRIC SME LIFT FROM WINNING PRIMARY RELATIONSHIP MM/LC LIFT FROM WINNING PRIMARY RELATIONSHIP
Financials Average Deposit Balances 14x 11.6x
Average Loan Balances 7.1x 11.4x
Product Holdings Average Number of Accounts 1.8x 6.3x
Average Number of TM Services 1.5x 2.8x

Note: SME = Small/Medium Enterprises, MM = Middle Market, LC = Large Corporate
Source: SME | Novantas Case Study — includes businesses with 0-20mm in annual sales revenue; MM/LC: NDepth database

Figure 1: Value of Primary Relationships

Note: SME = Small/Medium Enterprises, MM = Middle Market, LC = Large Corporate
Source: SME | Novantas Case Study — includes businesses with 0-20mm in annual sales revenue; MM/LC: NDepth database

GUIDING THE CLIENT

There are compelling reasons to incent the client to move from non-primary to primary.

First, meaningful customer acquisition in the current pandemic environment is very difficult. Banks appear to be doing a good job of deepening relationships by cross-selling to existing customers. This becomes more difficult, however, in a world where banks are engaging remotely with clients.

Second, there is a defensive play to combat the increased levels of switching. Greenwich Associates recently reported that switching has increased to 16% from the historic levels of 10-11%. Novantas believes the pandemic has exposed customer service challenges, which has only been exacerbated by the industry’s often-poor response to and execution of the Paycheck Protection Program.

Finally, commercial lines of business are facing a profitability crisis. In a world where interest rates are likely to stay low for several years, NIM will be severely impacted. As a result, banks will turn their attention to driving fee income growth in treasury management, capital markets and other areas. The size of the prize is significant; Novantas estimates the typical regional bank can see an increase of 25% in treasury management fees by focusing on primacy and changing its orientation to treasury management services and the core operating account. (See Figure 2.) Furthermore, treasury management services are essential for the client and drive above-average profitability (based on modest capital allocations).

Figure 2: Credit Leverage Ratio (Average Bank vs Top Performer)

Illustrative of a Regional Bank with $175M in Annual Treasury Management Gross PxV

Note: CLR is defined as Annual Gross TM PXV/C&I loans; benchmark includes 14 banks
Source: Novantas analysis

There are compelling reasons to incent the client to move from non-primary to primary.

First, meaningful customer acquisition in the current pandemic environment is very difficult. Banks appear to be doing a good job of deepening relationships by cross-selling to existing customers. This becomes more difficult, however, in a world where banks are engaging remotely with clients.

Second, there is a defensive play to combat the increased levels of switching. Greenwich Associates recently reported that switching has increased to 16% from the historic levels of 10-11%. Novantas believes the pandemic has exposed customer service challenges, which has only been exacerbated by the industry’s often-poor response to and execution of the Paycheck Protection Program.

Finally, commercial lines of business are facing a profitability crisis. In a world where interest rates are likely to stay low for several years, NIM will be severely impacted. As a result, banks will turn their attention to driving fee income growth in treasury management, capital markets and other areas. The size of the prize is significant; Novantas estimates the typical regional bank can see an increase of 25% in treasury management fees by focusing on primacy and changing its orientation to treasury management services and the core operating account. (See Figure 2.) Furthermore, treasury management services are essential for the client and drive above-average profitability (based on modest capital allocations).

Figure 2: Credit Leverage Ratio (Average Bank vs Top Performer)

Illustrative of a Regional Bank with $175M in Annual Treasury Management Gross PxV

Note: CLR is defined as Annual Gross TM PXV/C&I loans; benchmark includes 14 banks
Source: Novantas analysis

PRIMACY CHALLENGES

Although the concept of primacy isn’t new, there is a renewed interest by banks to make meaningful progress in this area. Challenges abound, however, and if left unaddressed, it will be almost impossible to rally the troops and measure the opportunity.

From a corporate’s perspective, the designation of a primary bank is changing from lending-centric to primary operating account/payments-centric. (See Figure 3.) There are multiple drivers for this shift.

First, the extension of credit has become commoditized and plentiful. As a result, banks can’t charge a premium on the credit side. Even more significant is the burst of innovation that is improving efficiency in the payments industry. As companies come under pressure to cut costs, advancements like integrated payables/receivables and real-time payments can make a bank stand out from the crowd.

This pivot can give the largest treasury management banks an advantage due to their more advanced brand/marketing, operating leverage, technology investments and decision support/analytics. Many regional banks, meanwhile, still have embedded credit-centric models (even when they’ve added a veneer of relationship focus) and haven’t grasped the importance of the payments/operating account model.

Indeed, most banks don’t even have a purposeful program to achieve primacy or understand how to get there. They lack a standard definition of primacy, both qualitatively and quantitatively, and have difficulty defining it by business line. They often don’t measure or embed primacy into employee goals and incentive plans. Furthermore, Novantas has found that relationship managers routinely over-estimate how many and which customers are primary because it isn’t well-defined by the institution.

Finally, advice-based selling is table stakes to winning new and retaining existing relationships, but many banks are falling short. Novantas research indicates that more than half of companies indicate that it is “very important” that their core/primary bank provide business advice. In all, 87% said it was “very important” or somewhat important.” So why don’t many regional banks have the infrastructure or processes to consistently deliver actionable advice to their clients?

Although the concept of primacy isn’t new, there is a renewed interest by banks to make meaningful progress in this area. Challenges abound, however, and if left unaddressed, it will be almost impossible to rally the troops and measure the opportunity.

From a corporate’s perspective, the designation of a primary bank is changing from lending-centric to primary operating account/payments-centric. (See Figure 3.) There are multiple drivers for this shift.

First, the extension of credit has become commoditized and plentiful. As a result, banks can’t charge a premium on the credit side. Even more significant is the burst of innovation that is improving efficiency in the payments industry. As companies come under pressure to cut costs, advancements like integrated payables/receivables and real-time payments can make a bank stand out from the crowd.

This pivot can give the largest treasury management banks an advantage due to their more advanced brand/marketing, operating leverage, technology investments and decision support/analytics. Many regional banks, meanwhile, still have embedded credit-centric models (even when they’ve added a veneer of relationship focus) and haven’t grasped the importance of the payments/operating account model.

Figure 3: Stated Definition of Core/Primary

Source: Novantas Research | 2018 Commercial Banking (US)
Base: Total respondents (Less than $100MM: n=219, $100MM to less than $500MM: n=168, Over $500MM: n=201)
Question: “A bank is considered a core / primary bank…”

Figure 3: Stated Definition of Core/Primary

Source: Novantas Research | 2018 Commercial Banking (US)
Base: Total respondents (Less than $100MM: n=219, $100MM to less than $500MM: n=168, Over $500MM: n=201)
Question: “A bank is considered a core / primary bank…”

Indeed, most banks don’t even have a purposeful program to achieve primacy or understand how to get there. They lack a standard definition of primacy, both qualitatively and quantitatively, and have difficulty defining it by business line. They often don’t measure or embed primacy into employee goals and incentive plans. Furthermore, Novantas has found that relationship managers routinely over-estimate how many and which customers are primary because it isn’t well-defined by the institution.

Finally, advice-based selling is table stakes to winning new and retaining existing relationships, but many banks are falling short. Novantas research indicates that more than half of companies indicate that it is “very important” that their core/primary bank provide business advice. In all, 87% said it was “very important” or somewhat important.” So why don’t many regional banks have the infrastructure or processes to consistently deliver actionable advice to their clients?

MEETING THE CHALLENGE

Deepening primacy within a commercial business requires a clarion call to action. It also requires investments in data and analytics, disciplined program management and alignment of organizational structures and incentives to enable, drive and measure change.

In fact, banks must first meet the challenge of deepening primacy by defining it. A successful primacy definition must be simple, measurable and aligned to financial metrics. Primacy brings myriad benefits, but ultimately, it should be clearly reflected in higher fee revenue, growth in primary operating deposits and increased cross-selling across the organization.

While definitions and measurements require some calibration across lines of business, banks should resist the temptation to make these overly complex. The notion of being a “first call trusted advisor” and leveraging a broad range of capabilities to meet the full spectrum of a client’s financial needs should sit at the core of any definition.

Once primacy is defined, data and analytics become critical enablers. Banks must establish a robust fact base around the levels of primacy within their back book as well as in their new-to-bank relationships. This requires aggregating loan, deposit, treasury management and capital markets data. Stronger programs will also integrate data from wealth, bank-at-work programs and other related products to form a comprehensive view of the current relationship. External benchmarking data can then overlaid to determine fair share.

Primacy brings myriad benefits, but ultimately, it should be clearly reflected in higher fee revenue, growth in primary operating deposits and increased cross-selling across the organization.

To capitalize on this fact base, banks should provide RMs with both structured action plans and analytical insights to prioritize activities that deepen relationships. Segmenting clients based on relationship characteristics and switching propensities will enable RMs to focus their activities on the clients who are most likely to reward calling efforts with incremental core business. Moreover, banks still need to compete on the value of their advice, products and service, rather than on price. Integrating customer scoring is a valuable tool in driving pricing discipline through the process.

The effectiveness of the RM will remain the greatest determinant of success. But by putting the right data and analytics in the hands of RMs, it is possible to dramatically elevate performance.

ULTIMATE GOAL

Redefining and deepening primacy is a journey and it requires both sustained program management discipline and cultural transformation. A primacy initiative can and should be self-funding from the outset. With the right data and analytics, banks can and should identify ample near-term opportunities to redefine and deepen primacy within the existing book.

Still, realizing the full potential of the initiative will take time. It’s no small feat to work deeper into opportunities within the back books and enhance go-to-market practices that are used over extended commercial sales cycles. Sustaining this behavior requires tracking, but also requires aligning incentives within RM / TMO scorecards.

The ultimate measure of success is when deepening primacy evolves from an initiative to a way of life within the organization.

mike-rice

Mike Rice

Managing Director, Chicago
mrice@novantas.com

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