Welcome to the September issue of This Month in Commercial Banking. This issue tackles a full range of topics that are at the top of the agenda for commercial bankers. Of course, managing the ongoing flood of deposits continues to be an important challenge for all institutions and it now looks like they aren’t going away anytime soon. This issue also offers tips on managing PxV exception pricing in the current environment. Finally, we take a look at ways in which banks can hone their RFP responses to fintech competition when corporations resume shopping for new operating accounts (as they inevitably will) and we track the growing adoption of electronic treasury management by hospitals.
AWASH IN SURGE DEPOSITS
Commercial balance sheets continue to be awash in liquidity. Novantas estimates that more than $1.6 trillion of surge commercial deposits have flooded into the system, with the vast majority coming from the Paycheck Protection Program, reduced capital spending and operational expenditures and drawdowns of corporate credit lines. (See Figure 1.) With the prospect of additional government intervention on the horizon in the fourth quarter, there could be even more surge deposits coming down the pike.
Figure 1: Sources of Surge
Source: Novantas Comparative Deposit Analytics, FRB H8, Bank Earnings Releases
How do you manage the surge? Most are choosing to sharpen pencils on analytics in an attempt to analyze, track and report on surge deposits, but they are stopping short of differential pricing or FTP treatment. (See Figure 2.) While many banks would like to have different pricing and value metrics for surge deposits, they cite execution difficulty and reputation concerns as two of the biggest reasons why they are keeping price and FTPs the same. Most banks are still struggling to implement disciplined, analytics-driven pricing that considers the value of specific pools of customer deposits.
Figure 2: Do You Treat Surge Deposits Differently?
Tracking / Reporting
Source: Novantas Comparative Deposit Analytics
Near the beginning of the pandemic, we focused on the potential for quick drains of the surge deposits. We and others believed that corporate line draws and flight to proximity dollars might evaporate with haste. We also believed that burn rates for many companies, especially small businesses, would cause surge deposits to dry up quickly.
While most of the original corporate lines have now been repaid, some funds have returned to their original homes and some small businesses have burned through PPP cash, the vast majority of funds have stayed put – causing balance sheets to remain swollen. Commercial executives increasingly believe that these funds will stick around. Indeed our recent survey conducted through our Comparative Deposit Analytics platform showed that banks generally expected more than half of commercial surge deposits to be on the books at year-end.
Figure 3: How Much of the Surge Deposits Will Remain...
Source: Novantas Comparative Deposit Analytics
But those funds could be around for much longer. (See Figure 3.) The multi-million-dollar question is what to do with these deposits, and specifically, how far out to invest them. With limited demand for new commercial lending, especially new C&I lending that fits most banks’ risk parameters, there are few attractive options for investment. Complicating matters, it’s no easy task to estimate the remaining life of these surge deposits. A crystal ball would be incredibly valuable; we believe misestimating the duration of surge commercial deposits costs $1.2M-$2.2M in annual NIM for each billion of surge deposits. (See Figure 4.)
Since we don’t have a crystal ball, we must rely on analytics. Banks are starting to perform increasingly detailed analytics to determine where the surge deposits have come from, how customers with different amounts of surge deposits have transacted and how these deposits are likely to perform going forward. Continuing to advance these customer-level analytics is the path to gain needed confidence in duration estimates of the surge deposits.
Figure 4: Benefits
1. Under-estimate assumes surge duration is 3 years and could be invested equally in cash, 3M UST, 5Y UST, and 7Y UST with average return of 23 bp, but instead is mis-estimated at 3 months and invested 25% in cash, 50% in 3M UST, and 25% in 6M UST with average return of 11 bp.
2. Over-estimate assumes surge duration is 3 years as above but is mis-estimated at 5 years, leading to an investment in 15% cash, 20% 3M UST, 20% 5Y UST, 20% 7Y UST, and 25% 10Y UST with an average return of 35 bp but necessitating a 2-year backfill in 3 years of brokered CDs at a cost of 85 bp.
MANAGE EXCEPTION PXV PRICING WHILE LIQUIDITY IS FLUSH
Commercial lines of business are compensated for the value they provide to their clients through loan and line interest income, access to low- or zero-cost deposits and hard dollar PxV fees. Last month, we discussed the profitability crisis that commercial lines of business are facing due to an overabundance of surge deposits with limited non-PPP loan demand and increased pressure on regular and exception PxV fees.
This profitability crisis is exacerbated by deposit remixing. When interest rates rise and the yield curve steepens, deposits flow out of ECR accounts as depositors seek higher yields in interest-bearing accounts or off-balance sheet investments. When rates are at ultra-low levels, deposits flow back into non-interest-bearing accounts. So far, more than 10% of commercial deposits have flowed back into ECR during the pandemic. (See Figure 5.)
Figure 5: As Rates Have Fallen, Balances Have Flooded Back Into ECR
Fed Fund Rate vs. ECR as % of Total Commercial Deposits
Dec 31 2017 – June 30 2020
Source: Novantas Comparative Deposit Analytics
With higher ECR balances and ECR rates that remain elevated, companies can offset a large portion of their PxV fees. And many banks have scaled back plans for an annual standard PxV pricing increase this year. Thus, the near-term revenue opportunity lies in rationalizing exception PxV pricing. This delicate exercise requires precise identification of incremental opportunities based on pricing elasticity and behavior analysis. Opportunities may be few, but banks are finding pockets that exist. Among them: revisiting exception pricing where client-promised volumes didn’t materialize.
Novantas’ proprietary database of corporate account analysis data (NDepth) substantiates the opportunities as illustrated by the widely-variable pricing outliers in Figure 6. Bank prices for specific treasury management services remain all over the map, giving banks the chance to drive incremental PxV revenue by changing specific exception prices for specific clients.
Figure 6: Effective All-In Unit Price by Unit Family
Source: Novantas NDepth
While overall 2020 revenue growth is severely challenged, there are ways to nudge revenue higher around the edges. With the right data and the right analytics, exception-priced TM services can provide one of these needed nudges.
HOW TO PREPARE FOR A JUMP IN SWITCHING
Corporations tend to switch their primary bank provider much more frequently during and after crises, historically rising to an annual rate of 25% from the typical 10%. Although that hasn’t happened yet during the pandemic, chances are it’s coming – and banks need to prepare by improving the way they handle the RFP process.
In normal times, switching is largely driven by negative customer experiences, loan pricing, access to credit and moves among relationship managers. As we eventually emerge from the pandemic, however, switching will likely be driven by a desire to improve efficiency through reduced fees and fintech partnerships.
These enhanced levels of switching will correlate to higher levels of RFP issuance. In analyzing dozens of banking-services proposals, Novantas has found that banks can take specific actions to better prepare for heightened RFP activity and increase their chances of winning. In addition to developing a compelling RFP response, there are traps that can be avoided.
Corporations tend to switch their primary bank provider much more frequently during and after crises, historically rising to an annual rate of 25% from the typical 10%.
First, start with a strategic understanding and response of your competitive landscape. In addition to other banks, a growing number of fintechs are expanding their offerings and are in effect becoming more bank-like. Indeed, Novantas has found that fintechs are great at responding to RFPs with future visions as opposed to current realities. Community banks are more responsive to their client needs and are now part of the competitive process. In addition, other third-party firms offer integrated payables, receivables and billing, FX trading and other operational products. All these non-bank providers are meeting a need in response to corporations’ desire for ease of use. To adapt, banks should highlight their advice and domain expertise for a competitive edge while also focusing on pragmatic, operative solutions.
Secondly, banks can shift their focus in the RFP process to some key tenets: brevity, directness and proof points – all of which align with core bank value propositions.
Finally, banks should be aware of the following traps that will hinder their chances of winning (or retaining) the client. These include:
- Answering with long “sales pitch” responses
- Not answering the direct questions provided in the RFP
- Failing to demonstrate specific knowledge about the corporation’s industry
- Not clearly spelling out the bank’s value proposition
- Failing to cite proof points
With a strategic competitive positioning in place and following a few simple rules, banks can deliver RFP responses with much greater odds of success.
COVID-19 SPEEDS HOSPITAL SHIFT TO ELECTRONIC TREASURY MANAGEMENT
As the pandemic began, the cancellation of elective surgical procedures caused hospital revenue to dry up. Although hospitals were busier than ever, revenues declined 20% to 30%. The resulting short-term liquidity crisis prompted hospitals to draw down lines of credit and await government financial support through CARES and Medicare Advance. Hospitals began to update liquidity forecasts weekly, or even daily, and took whatever measures they could to conserve cash. Amid it all, all Treasury Management volumes were down 10%-30%.
By late July, most organizations were past the initial pain. Elective surgeries were again on the calendar. Liquidity concerns eased. Revenues returned to 80+% of targets. Business felt closer to normal.
But an interesting thing happened to Treasury Management volumes. Electronic volumes rebounded toward pre-pandemic levels, but paper-based volumes remained depressed. Having just experienced a liquidity crunch, hospitals have now redoubled efforts to move from paper to electronic.
Banks can help. Leading banks see the digitization of industries like hospitals as an opportunity to partner more closely with clients to solve their financial problems. Opportunities include encouraging more card-based payments from patients instead of checks and implementing remote deposit capture for physicians’ offices, many of which are now owned by hospital systems. Hospitals also need support in integrating receivable systems.
Figure 7: Percent Change in Bank Transaction Volumes for Healthcare Companies Since Beginning of 2020
Source: Novantas NDepth
Unfortunately, it took a pandemic for hospitals to move toward their long-sought desire to become more digital. Banks can help their hospital clients take the next big step toward digital by continuing to find components of their financial management that no longer require paper.