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This Month In Commercial Banking – December 2020

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The December Commercial Monthly comes early this month as the holidays are upon us! First, we take a look at how commercial banks are trying to limit surge deposit balances while also honing strategies for primacy. Then we examine how banks are diversifying away from net interest income into fees, which is critical given the expected long-term compression of NIM. Third, we focus on the often-overlooked opportunity to sell and implement purchase card programs that can help both banks and their corporate clients. Finally, we discuss the need for corporate cash forecasting, which is a valuable offering that banks can provide to clients.

BANKS SEEK DEEPER PRIMACY,

Discourage Surge Deposits

We reported last month on the variance in commercial deposit pricing and the persistence of high deposit interest rates even as the Fed remains near zero and the yield curve remains relatively flat. As a result, bank NIMs remain under pressure and the spread between deposit rates and FTPs continues to narrow.

With elevated balance levels showing no signs of reversal, the Novantas CDA Executive Summary finds that banks are taking more proactive measures to limit surge balances while attempting to bolster commercial profitability through a heightened focus on customer primacy. (See Figure 1.)

Figure 1: Annual Commercial Deposit Growth

3Q18 - 3Q20

YoY

Commercial lines of business remain open for new primary relationships, but 72% of banks report they took active measures during the third quarter to limit additional deposit balance growth. The most common lever that banks used was pricing, with 42% having reported paying declining or zero rates on some surge balances. Banks also employed a range of relationship-driven approaches, including communicating firm balance limits to clients (26%), requiring additional cross-sale in exchange for accommodating surge balances (21%) and even suggesting placement at another bank (16%). Additionally, 26% of banks have also implemented FTP reductions to discourage additional surge balances. (See Figure 2.)

Figure 2: Discouraging Account Deposit Growth

Have you discouraged additional deposit growth?

If Yes, which means have you used to discourage additional growth?

YES

72%
42% Pricing that will decline (but stay zero or positive) for additional funds (e.g., reverse tiering)
26% Firm balance limits for a client
26% Reduction in FTP to decrease profitability
21% Forced cross-sale (willingness to take additional balances if new products / additional volumes are brought in)
16% Improved linkage for movement off-bank balance sheet
16% Suggested placement at different bank
5% Reduction of / penalty incentive compensation for sales force or executives
0% Pricing that will decline and be negative for additional funds

Have you discouraged additional deposit growth?

YES

72%

If Yes, which means have you used to discourage additional growth?

42% Pricing that will decline (but stay zero or positive) for additional funds (e.g., reverse tiering)
26% Firm balance limits for a client
26% Reduction in FTP to decrease profitability
21% Forced cross-sale (willingness to take additional balances if new products / additional volumes are brought in)
16% Improved linkage for movement off-bank balance sheet
16% Suggested placement at different bank
5% Reduction of / penalty incentive compensation for sales force or executives
0% Pricing that will decline and be negative for additional funds

Source: Novantas Comparative Deposit Analytics

Figure 3: Customer Primacy

Do you measure customer primacy?

Which factors do you consider when measuring customer primacy?

YES

63%
71% Coverage of major product families (e.g., deposits, loans, PxV)
71% Length of relationship
64% Number of products used
57% Absolute revenue
57% Depth of product usage (e.g., volume of ACH)
43% Absolute profit
43% Analysis of level of operating deposits (e.g., from LCR calculations)
29% Revenue relative to estimated potential
29% Survey data from RMs
14% Profit relative to estimated potential
14% Survey data from clients

Do you measure customer primacy?

YES

63%

Which factors do you consider when measuring customer primacy?

71% Coverage of major product families (e.g., deposits, loans, PxV)
71% Length of relationship
64% Number of products used
57% Absolute revenue
57% Depth of product usage (e.g., volume of ACH)
43% Absolute profit
43% Analysis of level of operating deposits (e.g., from LCR calculations)
29% Revenue relative to estimated potential
29% Survey data from RMs
14% Profit relative to estimated potential
14% Survey data from clients

Source: Novantas Comparative Deposit Analytics

Figure 4: Primacy Relationships

Has your organization set specific 2021 goals with respect to managing / growing primary relationships?

YES

45%

Source: Novantas Comparative Deposit Analytics

As banks reckon with shrinking NIMs and balance sheets bloated with surge deposits, there is also a heightened focus on customer primacy. Nearly two-thirds of banks in the Novantas CDA Executive Summary reported measuring primacy in the third quarter, but there was little consensus about the practice. (See Figure 3.) To drive profitability, Novantas believes it is important for each bank to have a clear, consistent and actionable definition that emphasizes holding client primary operating DDAs. Despite the importance of primacy in driving profitability, only 45% of banks have specific 2021 goals related to primacy. (See Figure 4.) Those banks that haven’t yet developed specific primacy goals should start to focus on doing so.

Peter Serene (pserene@novantas.com)

Facing Long-Term NIM Compression,

Banks Turn to Fees

Surge deposits and the economic environment have created long-term pressures on commercial bank profitability. Deposit growth has dwarfed loan growth during the pandemic and continued low interest rates have resulted in NIM compression. Commercial banks are now looking at fees as a way to make up some lost profitability. It is a worthwhile strategy because Novantas believes many banks still have room to capture more fee-based revenue.

Many commercial LOBs already have a large portion of their revenues coming from fees. (See Figure 5.) Among the banks that publicly report commercial LOB performance, the range of fees as a percentage of third-quarter total revenue was between 24% and 70%. Banks on the low end of this range have between 24% to 29% of revenue in fees due to a narrower product set and aren’t getting their fair share of fees from clients. For a bank that has only 25% revenues in fees, a 20% drop in NII results in a 15% drop in total revenue. Banks that have a more comprehensive offering and capture a fair share of fees can have a revenue mix that is 40% or more in fees, which insulates their performance from uncontrollable market pressures on NIM and NII. The top three banks in this analysis – Bank of America, Citi and JPMorganChase’s corporate and investment bank – have much more diversified fee revenue sources, with at least 50% of their fees from capital markets and trading activities.

Figure 5: Fees as % of Revenue (Q3 2020)

Source: Q3 2020 Quarterly Earnings Reports

Commercial banks must craft a strategy to grow fees to insulate against NIM declines, while being mindful that corporations are also under immense financial stress. Novantas sees three steps that banks can pursue to generate additional fees. (See Figure 6.)

Figure 6: Steps to Generate Additional Commercial Banking Fees

Foundational Platform

  • Ensure competitive suite of transaction banking services
  • Articulate value proposition
  • Develop go-to-market strategy to grow fees

Customer Primacy

  • Define primacy to align with financial metrics
  • Invest in data and analytics
  • Create incentives to capture primacy

Growth Potential

  • Expand scope into financial value chain with analytics, advice, insource processes
  • Develop and sell products into other departments in client organization

First, banks need to establish a foundational platform that includes a go-to-market strategy to capture more fee income. In the 2010s, many regional banks responded to the global financial crisis by ensuring they offered a comprehensive, competitive suite of transaction banking services including treasury management, trade, foreign exchange and derivatives to generate fees and offset losses in interest income. Some banks still have that opportunity today by bolstering the capabilities of these services.

Once these capabilities are established, commercial banks can turn their focus to relationship primacy. Based on Novantas research, banks that focus on primacy can increase treasury management fees alone by 25%. Most banks, however, lack even an effective definition of primacy. Commercial banks must have an operational definition of primacy that aligns to important financial metrics. After that, investments must be made in data and analytics as well as disciplined program management, incentives and organizational alignment.

Banks can turn their focus to relationship primacy.

Finally, instead of fighting for share within the traditional product set, banks should focus on going deeper into their clients’ financial affairs. As of today, commercial banks only capture 15% of the $500 billion that U.S. businesses spend on cash flow management. Using their scale and expertise, banks can outsource client processes like collections, account management and underwriting. Commercial banks can also use their existing client data to provide benchmarks and recommendations to improve the working capital cycle. In both contexts, industry specialization and expertise will enable banks to bring even more value to their clients.

Long-term NIM compression forces commercial LOBs to advance other sources of fee income that are robust enough to enhance financial performance. Some banks are still very reliant on NII and are thus disproportionately exposed to these pressures. Understanding and responding to where they stand on the fee generation maturity model will help to grow fees in a difficult environment.

Scott Musial (smusial@novantas.com) and Mike Rice (mrice@novantas.com)

HOW TO REV UP REVENUE FROM PURCHASE CARDS

The gradual migration from paper to electronic payments has accelerated as a result of corporations’ concerns about the vulnerability of check production during the pandemic. In the early weeks of the pandemic, numerous companies experienced disruption of their check printing operations. Recognition of this vulnerability has motivated companies to accelerate their migration to card and ACH payments. This heightened interest presents banks with an opportunity to redouble efforts to sell corporate card programs to companies. In addition to providing efficiency for the client, these programs also represent a potential opportunity for the bank to boost fee income.

The banking industry has always faced a two-step challenge with purchasing card programs. The first is the sale itself. The second is the challenge associated with implementation of these programs by corporate customers. Corporate treasury and finance staff understand that the implementation of a card program will strain the lean resources of the finance function, which is often too stretched to assign people to specific projects. This gap between the sale of a card program and the commencement of widespread use of the cards delays and/or limits bank revenue from the program and delays benefits to the corporate customer.

Novantas often assists corporations in their purchasing card RFPs. All of our recent clients consider implementation assistance and vendor enrollment to be important factors when they choose a card-issuing bank to support them.

Based upon our experience helping companies implement their p-card programs, Novantas has identified the following critical elements to successful rapid implementation of card programs.

Incentives

Banks can offer hard-dollar savings to companies and motivate them to meet certain deadlines and card spending levels. The use of incentives is considered a positive when companies are selecting their card-issuing bank. It also encourages rapid implementation.

Implementation Plan

Corporates expect the bank to play a leading role in the implementation of the card program. The most successful implementations include a project plan that is updated weekly and escalates any issues that are causing delays to a corporate sponsor in the senior management team.

Vendor Enrollment

This is the single most common factor that delays sharply-elevated spend levels for companies using a virtual card in their accounts payable function. Enrolling the existing vendors into a p-card program requires individual communication with each vendor. Some of the vendors will resist accepting card payments that further slow the process. Banks that offer vendor enrollment support services have an advantage in both the selection and implementation process.

The vendor enrollment program should include drafting of letters that the bank customer will send to its vendors. It is also important for bank employees to initiate follow-up calls to vendors. For many companies, the elimination of checks is a higher priority than the implementation of cards. Companies prefer to pay with cards, but will be satisfied if a vendor accepts an ACH. Banks that can successfully sell both card and ACH programs to a corporate customer can profitably enroll vendors in either program. Banks that sell only a card program, however, are in an awkward position when they are forced to handle vendor requests to accept payment by ACH rather than card.

New Vendors

Banks should strongly encourage their clients to make acceptance of card a requirement during the new vendor onboarding process with exceptions made only with the approval of a finance manager. The natural turnover rates of suppliers will provide an efficient way to increase the proportion of suppliers accepting cards.

While a successful p-card push won’t win any awards for product innovation, it can be a win-win for banks and their corporate clients. At a time when commercial LOBs are desperate for fee income, rejuvenated p-card sales are a worthy priority.

CASH FORECASTING:

A Pandemic Priority for Corporates & Banks

For years banks have investigated whether they could offer cash forecasting to their corporate clients as a value-add service. Banks already have much of the data and the expertise to provide a huge benefit to their corporate clients. In an environment where fee income is at a premium, this service offers a potential to build a new revenue stream while advancing client primacy.

First, consider the opportunity. This has been a year like no other for companies that try to forecast cash levels with any degree of accuracy. As the vaccine rollout begins, companies are plotting their recovery and transition to life after COVID-19. This includes planning how to manage through a recession and emerging from the pandemic stronger than ever.

While companies are in the thick of managing the pandemic and navigating liquidity, the next steps are to consider different potential market conditions and start planning for the recovery. For example, what capex is needed to adapt to the new world and when should it be spent? The first steps in the recovery process call for developing a solid 13-week rolling cash flow forecast, setting up a cash war room and close review and oversight of upcoming spending needs.

The pandemic has caused many treasurers to take a fine-tooth comb to forecasting. Short-term cash forecasting, which includes weekly inflows and outflows, is a necessity in a crisis. Companies need to forecast 13 weeks into the future and update forecasts with new information as it becomes available to reduce high variances. The smaller the variance between actual and forecasted cash flows, the better. Key metrics, including available cash and cash burn rates, should be monitored frequently. Keep in mind that the short-term forecast should align with the company’s long-term forecast.

Once a company moves into recovery, a cash war room will be needed to monitor liquidity closer than ever. A cash war room is a process of creating a cash culture within the company.Key executives should be aligned around a cash mindset that includes understanding cash needs and anticipating future cash events. There needs to be a leadership team that oversees and manages all cash-related items, including receivables and payables. The team may include leaders from Treasury, Accounts Payable, Accounts Receivable and others.

The pandemic has caused many treasurers to take a fine-tooth comb to forecasting.

The pandemic has caused many companies to have a lean project approach. That means they must identify projects or major expenditures that can be postponed, canceled or accelerated. Projects that assist in forecasting and implementing cash management tools that were “nice to have” pre-pandemic are now a top priority. When determining which projects or expenditures are needed, take into consideration the strategic metrics in addition to funding and resources available. High priority projects should be those that ensure operations run smoothly and reduce risks.

Banks have the data and the skills to help their corporate clients implement advanced cash forecasting. Can the impetus of COVID-19 finally convince banks to seize on this opportunity?

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