bg-arrow-down icon-arrow-up icon-back-to-top icon-linkedin icon-menu icon-search icon-twitter logo-white slider-arrow-left-gray slider-arrow-left slider-arrow-right-gray slider-arrow-right

This Month In Commercial Banking – November 2020

Welcome to the November issue of This Month in Commercial Banking. We begin with data from our CDA Executive Summary rate reporting that show commercial deposit portfolio rates have inched lower, but there are still a few more basis points to squeeze out. We flag a concern that, as banks increase their efforts to shed excess deposits, commercial units must have strong primacy metrics to avoid shedding their most valuable deposits. Then we take a deep dive into the manual process of signature verification, an area where more digitization is needed. Finally, we summarize key takeaways from third quarter commercial LOB reporting that shows some profitability relief for the largest banks, but seemingly unrelenting pressure on regional bank profitability.

Q3 DEPOSIT RATES DOWN SLIGHTLY,

But with Wide Variance

Interest rates on commercial deposits inched lower in the third quarter and nominal ECRs held steady. Pricing variance in the market remains high, especially given the absolute levels of rates and the high levels of liquidity that banks currently hold. This variance in rates, coupled with persistently high exception-priced balances (particularly in middle market and large corporate), suggests that banks have opportunities to sharpen pricing as we approach the end of 2020.

The recent Novantas CDA Executive Summary reported median middle market portfolio average rates of 30 bp for ECR in September, 13 bp for IB DDA and 15 bp for MMDA. (See Figure 1.) The spread in average portfolio rate between top and bottom quartile rate payers, however, is 38 bp for ECR, 30 bp for IB DDA and 36 bp for MMDA. (See Figure 2). While the majority of balances are concentrated in the lower-rate tiers, there is still material opportunity to reduce top rates (even when excluding contractually-agreed rates). This is, in part, driven by persistently high levels of exception pricing. (See Figure 3.)

Figure 1: Commercial Deposit Rates Over Time

Median Rate By Product for Middle Market Segment

March 31, 2018 – Sept. 30 ,2020

Target Fed Funds (End of Month)
Avg ECR
Avg IB DDA
Avg MMDA
ECR IB DDA MMDA
July 2020 Rate 29 bp 14 bp 19 bp
Sept 2020 Rate 30 bp 13 bp 15 bp
Change in Rate +1 bp -1 bp -4 bp

Figure 2: Variance in Average Portfolio Rates

Middle Market: September 2020

ECR DDA

IB DDA

MMDA

ECR DDA

IB DDA

MMDA

Source: Novantas Comparative Deposit Analytics

Figure 3: Percentage of Deposit Balances that are Exception Priced

Large Corporate

MIDDLE MARKET

2Q20
3Q20
2Q20
3Q20

Large Corporate

2Q20
3Q20

COMMERCIAL/MIDDLE MARKET

2Q20
3Q20

Source: Novantas Comparative Deposit Analytics

FTPs fell faster than deposit rates through the quarter, squeezing LOB profitability and reflecting the broader NIM headwinds that banks are facing. (See Figure 4.) As banks manage down the remaining higher rates in their books, we recommend an analytical approach that differentiates between primary relationships, where some level of relationship pricing is sensible, and non-primary relationships, where deeper cuts are appropriate.

Peter Serene (pserene@novantas.com)

Figure 4: Spread Between FTP and Portfolio Rate

MIDDLE MARKET

ECR DDA
IB DDA
MMDA

Source: Novantas Comparative Deposit Analytics

Figure 4: Spread Between FTP and Portfolio Rate

MIDDLE MARKET

ECR DDA
IB DDA
MMDA

Source: Novantas Comparative Deposit Analytics

FTPs fell faster than deposit rates through the quarter, squeezing LOB profitability and reflecting the broader NIM headwinds that banks are facing. (See Figure 4.) As banks manage down the remaining higher rates in their books, we recommend an analytical approach that differentiates between primary relationships, where some level of relationship pricing is sensible, and non-primary relationships, where deeper cuts are appropriate.

Peter Serene (pserene@novantas.com)

COMMERCIAL UNITS FACE RISK FROM AGGRESSIVE FUNDING OPTIMIZATION

Third-quarter earnings results suggest that the industry deposit surge looks to be more stable than originally anticipated, meaning banks will remain under margin pressure.

The industry’s current focus is on achieving short-term relief through shifting investments from Federal Reserve deposits to higher-yield investment portfolio securities such as MBS. While these balance sheet management tactics can provide a modest benefit to earnings, they expose the bank to extension risk. This is leading some to believe that reserving liquidity for the return of customer credit demand is the better strategy.

In short order, we expect the industry to shift to funding optimization as a way to preserve shareholder value in an environment defined by low interest rates and tepid loan growth. This means commercial deposits will be in the crosshairs — just as they were post-GFC when several of the largest banks chose to migrate some low-quality deposits off balance sheet. Winners and losers will be defined in large part by their ability to optimize funding mix in order to support the deployment of cash into earning assets. This means identifying and growing high-quality deposit segments and, for some, taking action to once again move low-quality deposits off balance sheet.

A premise of funding optimization is that not all deposits are created equal in terms of their liquidity value. Indeed, banks must hold more liquidity for less stable deposits in order to protect against stressed balance outflows. Banks with significant exposure to lower-quality deposits, such as non-operational deposits from thin-relationship corporates or financial institutions, will require larger liquidity buffers. This will dampen overall asset yields in an extended low-rate environment.

Commercial deposits will be in the crosshairs.

Commercial businesses should be armed with granular, empirical views of underlying depositor value to defend against unintended attrition of high-value customers or disruption of efforts to increase customer primacy. Ideally, commercial businesses should partner with Treasury so that insights around value can be used for both customer pricing and internal funds transfer pricing.

While banks will no doubt benefit from a focus on funding optimization, commercial business should build up analytic defenses to ensure the baby is not thrown out with the bathwater.

Gregory Muenzen (gmuenzen@novantas.com)

BACK TO THE FUTURE:

A Resurgent Case for eBAM

Banks continually face challenges updating legal information and incumbency certificates from their clients. It has always been cumbersome to obtain and update signature cards, entitlements and other legal documents. The legacy protocol of receiving “wet” signatures on paper documents when updating legal entity information or processing changes to signer authorities has always been, and continues to be, a very manual process. This exposes both the banks and their clients to costly errors, delays and records being out of sync.

Banks are aware of this inefficiency but haven’t done enough about it. Several years ago, there was a lot of discussion surrounding the development of Electronic Bank Account Management (eBAM) procedures that would digitize and automate the management of bank accounts. The goal: to facilitate easy real-time updates to open and close bank accounts or to add and delete individuals who have signatory authority over those accounts. This eBAM concept, originally designed by the SWIFT network, could conceivably expand to build a worldwide multi-bank solution to warehouse signer data.

But the eBAM idea lost steam among most banks that were more focused on complying with a wave of regulations. Banks can, however, support the original intent of eBAM by enabling the proper technology and infrastructure. Lately, we have seen process improvements in the digital documentation and signatures in the TM space, largely as a response to COVID-19, and banks have been responding with varying degrees of success. Most importantly, banks should create the digital rails, either by API or SWIFT messaging in the more fine-tuned ISO 20022 format, to allow these signer changes to transmit automatically.

This problem has only been exacerbated by the pandemic. Branches are closed or have curtailed hours and bankers are working remotely, creating a backlog of paperwork for branch-based compliance staff.

Banks are aware of this inefficiency, but haven’t done enough about it.

This sudden change, together with growing needs of corporates that are expanding globally, reinforces the need for supporting eBAM. Another driver to increase impetus towards digitization is the unfortunate reality that widespread corporate layoffs mean some corporate signers are leaving their companies.

It may be easy to assume that digitization is only relevant for the largest banks, but Novantas believes that regional and super regional players should also spend the time and resources to develop this client offering. Although treasury management (TM) investment dollars are in tight supply, banks that invest the resources in supporting eBAM will win a competitive advantage as they look to enter new relationships with larger companies.

In addition to signature cards, online entitlements information reporting and rapid user entitlements modifications is now a must-have for dynamic and growing companies. Although some large national banks have already implemented this, there remains a large opportunity for regionals and super regionals.

Furthermore, many corporates have complex Report of Foreign Bank and Financial Accounts (FBAR) reporting requirements to comply with FinCEN regulations. Keeping track of all the necessary signer and bank balance data would be greatly eased if banks can support this effort through enhanced bank reporting. While this FBAR reporting offering would primarily benefit multi-national corporates, banks that can offer this will pull ahead of competitors and offer a greater value proposition.

This is the time for banks to go “back to the future” and respond to this resurgent corporate need by building a practical digitization solution to support the eBAM concept.

LOB TRENDS & OPPORTUNITIES

Commercial LOBs saw continued revenue growth and improved profitability in the third quarter as loan provisions surprisingly decreased after a major spike in the prior three months. (See Figure 5.) None of the business lines incurred losses, a reversal of course from the second quarter when large provisions cut into profitability.

Figure 5: Revenue and Net Income Growth YoY (Q3 ‘20)

Median Revenue Growth
Median Net Income Growth

Source: Quarterly Earnings Reports for BAML, Capital One, Citibank, Citizens, Comerica, Fifth Third, JPM (both C&IB, CML), KeyBank, PNC, USB, WFGO

The insights outlined in this review come from 13 banks that report commercial LOB results and are highly indicative of industry-wide trends. They represent the top five banks and nine of the top 15.

These LOBs should be commended for the significant business model transformation that occurred during this year to address the pandemic. The go-to-market model has moved from a model that was primarily in-person to one that is mostly a remote model. Banks accomplished this by accelerating the implementation of digital and remote engagement technologies while addressing increased credit needs (such as PPP, line utilization increases) and meeting the heightened need for digital operating products and procedures across TM.

Overall, the balance sheets of these LOBs showed a significant increase that reflect the deposit surge and modest loan growth. The median deposit growth was 38% year-over-year, while loan growth was a solid 5%. Moving forward, the obvious challenge in this long low-rate environment will be to find opportunities to deploy these “excess” deposits into higher-returning assets. Opportunities will be limited until we see a stronger economic recovery.

This dynamic puts an extraordinary focus on fee growth. Currently, these LOBs vary dramatically in their ratio of fees to total revenue. (See Figure 6.)  Not surprisingly, the largest banks have the highest ratios given their broader product offerings in investment banking and capital markets. But it is amongst the regional banks where the real opportunity presents itself.

Figure 6: Fees as % of Revenue (Q3 ‘20)

% of Revenue
YoY
Growth
0% 8% -4% 27% -10% 14% 7% -20% 11% -5% 0% 0% 2% 10%

Source: Quarterly Earnings Reports

Source: Quarterly Earnings Reports

For regional banks, it is imperative to accelerate growth in TM and capital markets (CM). Novantas sees three steps to achieving these goals:

  • Develop a centralized sales support capability that builds the advanced analytical insights to ensure the bank is getting its fair share from existing customers. TM is a particular challenge given its historically slow growth (2.5% over the last 7 years) and declining growth since 2016. Targeted lead lists, dynamic pipeline tracking and institutionalizing best practices will drive above market growth.
  • Conduct a comprehensive review of TM and CM capabilities. While it is common for regional banks to develop a TM roadmap, it is less common for the same rigor in the development of CM capabilities. Banks that have advanced these capabilities generate a significantly larger share of fee revenue from derivatives, F/X, syndications and capital-raising services.
  • Improve the automation of sales processes and accelerate the migration to a multi-channel model. Now is a terrific time to review the sales process and look for ways to automate activities (e.g., robotics, marketing automation), eliminate non-value-added activities and redirect activities (i.e., review roles and responsibilities and align activities appropriately). Novantas has found that introducing targeted sales force initiatives can increase RM time that is dedicated to prospecting/cross-sell to 55% from 40%, driving more RM production.

Regional banks must have a renewed focus on fee generation in 2021 as NIM compression and the economic conditions will negatively impact net interest income. The combination of advanced analytics, sales process automation and the expanded product portfolios can ensure fee income growth.

Mike Rice (mrice@novantas.com)
Subscribe

Stay up to date on the latest banking news