2017: A WINDOW OF OPPORTUNITY

SPRING 2017

REGULATION: An Opportunity to Get It Right Commentary by CBA’s Richard Hunt

STRATEGIC FUNDING OPTIMIZATION: A More Proactive Balance Sheet Management Tool for ALCO

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4 REGULATION: AN OPPORTUNITY TO GET IT RIGHTCommentary by Richard Hunt, President & CEO of CBAAs reforming the Dodd-Frank Act takes center stage in Washington, it is important for federal lawmakers to hunker down and get this one right. Consumers and bankers alike stand to benefit from reform, but balance is key.

DEPOSIT PROMOTIONS AT WHAT COST? MEASURING MARGINAL COST OF FUNDS

RETHINKING BANK M&A — IDENTIFYING, PRICING AND CAPTURING VALUE IN TODAY’S ENVIRONMENT

REGIONAL BANK CHALLENGES IN LAUNCHING A DIRECT BANK

ACCELERATING DIGITAL MIGRATION: NECESSARY, TOUGH AND REWARDING

REPLACING LOST SALES CONVERSATIONS WITH MULTI-CHANNEL APPOINTMENT SETTING

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17 |

22 |

26 |

30 |

6

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FED INCREASES RATES AS EXPECTED:RATES STILL LAGGING, BUT STARTING TO RESPONDAdam Stockton and Chrystal Pozin, with Andrew Frisbie

STRATEGIC FUNDING OPTIMIZATION:A MORE PROACTIVE BALANCE SHEETMANAGEMENT TOOL FOR ALCORyan Schulz and Pete Gilchrist

SPRING 2017 | 3

LETTER FROM THE EDITOR

The changes wrought by the election and by the improving economic environment open up new opportunities in 2017 for banks to prosper. Finally, banks may earn enough to fund the transformation needed in an increasingly digital environment. These articles discuss the opportunities

and what the banks need to do to capitalize upon them in 2017.

CBA’s President and CEO Richard Hunt provides us with a view from Washington, and the opportunity to come together and make balanced regulatory decisions for both the industry and consumers.

We follow with our assessment of how banks need to manage funding in a rising rate environment. The remaining articles discuss the agendas for banks in the ongoing digital transformation of the industry — from the opportunities for direct banks, to the implications for M&A.

Novantas believes the time to act is now. To be sure, the industry is still under stress. But 2017 represents a new phase for banks, as favorable conditions present new opportunities following the financial crisis. Improved financial performance allows banks to fund change, and picking the right priorities is an important management agenda to meet 2017 goals, and create a sustainable path forward.

EDITORIALInterim EditorKatie Mockler212-419-2562kmockler@novantas.com

CONTRIBUTORSAndrew FrisbiePete GilchristAndrew HovetRichard HuntRyan SchulzAdam StocktonMichael JiwaniChrystal PozinLeo RinaldiRyan RitzVladana Zlatic

DESIGNArt Direction and ProductionAdrienne Cohen

NOVANTAS, INC.Co-CEOs and Managing DirectorsDave KaytesRick Spitler

Corporate Headquarters485 Lexington AvenueNew York, NY 10017Phone: 212-953-4444Fax: 212-972-4602info@novantas.com

SUBSCRIPTIONS marketing@novantas.com 212-953-2712

Opportunities in a Promising New Environment

Katie MockerInterim EditorNovantas

4 |

COMMENTARY

As reforming the Dodd-Frank Act takes center stage in Washington, it is important for federal lawmakers to hunker down and get this one right. Consumers and bankers alike stand to benefit from reform, but balance is key.

When it comes to finan-cial policy, a balanced approach to reform is essential to a healthy

banking sector, and preserving consum-er choice and access to credit. These days financial regulation is so convoluted it rivals ObamaCare in its complexities, and navigating Congress is like finding your way out of a corn maze.

As reforming the Dodd-Frank Act — a 2,300 plus page behemoth of a bill — takes center stage in Washington,

REGULATION: An Opportunity to Get It Right

it is important federal lawmakers hun-ker down and get this one right because a poorly designed plan could prove disastrous. Consumers cannot afford an overzealous or lackadaisical approach to reform: balance is key.

WHERE WE ARETo date, the banking industry has invest-ed upwards of $40 billion dollars post Dodd-Frank in implementing internal safeguards and compliance programs to better the financial lives of consumers.

Wholesale repeal of Dodd-Frank would undermine these efforts. Bankers would be left spinning their wheels trying to keep up with evasive regulatory checkpoints. Once again, all at the expense of Ameri-can consumers.

Don’t get me wrong, Dodd-Frank is far from perfect. As is the case with all policy, financial laws and regula-tions must be periodically reviewed to ensure they are meeting their intend-ed purpose and the needs of those they govern.

BY RICHARD HUNTPresident & CEO

Richard Hunt is president and CEO of the Consumer Bankers Association, the national trade association representing the retail banking industry with a focus on consumers and small businesses.

SPRING 2017 | 5

REGULATION: AN OPPORTUNITY TO GET IT RIGHT

WHERE WE MUST GOTo modernize and improve Dodd-Frank, repealing a provision of the law known as the Durbin Amendment, which was snuck into the bill at the eleventh hour with no debate or study, is a good starting point. This provision promised consumers billions of dollars in savings in the form of lower prices through a government-backed price control on bank interchange fees. However, this provision failed to deliver for consumers.

According to a survey by the Federal Reserve Bank of Richmond, only 2 percent of merchants reduced prices two years after passage of this regulation. Furthermore, 23 percent of merchants actually increased prices. Instead of providing consumers with an increase in cash flow, retailers saw an influx of cash— having pocketed $42 billion over the past six years — which was originally promised to consumers.

But wait, that’s not all. Consumers have lost out on many beneficial bank products as a result of this disastrous regulation, including free checking, and debit card reward programs. Per the Richmond Fed, the availability of bank-sponsored free checking accounts dropped from 74 percent to 52.8 percent — a near 21 percent decrease — after the Durbin Amend-ment was passed. Not surprisingly, bank interchange revenue, which helped fund these accounts, fell by 27 percent when comparing one year before and after the law’s enactment. Consumers deserve better, and righting the ship on financial regu-lation should include repealing the Durbin Amendment.

While reversing the Durbin Amend-ment’s harmful effects is needed, establishing a five-person, bipartisan commission at the CFPB is essential to maintaining fair and balanced enforcement of consumer protection laws. Now, the issue goes much deeper than the Bureau’s governing structure; it goes to the heart of how regulation is crafted, implemented, and enforced by regulatory agencies. If we want consumers to benefit from a balanced,

deliberative, and thoughtful approach to regulation, a commission-based leadership structure overseeing con-sumer protection laws is in the best long-term interest of the industry and consumers.

Unlike the vast majority of other federal regulatory agencies, the CFPB is headed by a single individual who has jurisdiction over 15,000 separate entities — more than all other federal bank supervisors combined. Subjecting consumers, industry, and the economy to regulatory uncertainty, the CFPB’s governing structure produces many pain points for those concerned about the agency’s overall success. Shifts in political leadership are all too com-mon in Washington, which expose the CFPB’s leadership and policy direction to a whipsaw effect. A newly installed CFPB Director can upend entrenched consumer protection laws with ease. As Senator Elizabeth Warren always says, personnel is policy. A commis-sion-based governing structure will provide the industry and consumers with stable, balanced leadership for generations to come.

HOW WE GET THEREConsumers and bankers alike should be encouraged by the Trump Administra-tion’s stated commitment to economic growth. His appointment of individuals with consumer-facing business experi-ence to high-level cabinet and regulatory posts is a breath of fresh air in Washing-ton, D.C. With the heads of the OCC, FDIC, Federal Reserve and CFPB seeing their terms expire in the next two years, President Trump will have significant clout in shaping financial policy through

these leadership appointments. It is imperative President Trump promotes quality picks to fill these vacancies.

While regulatory appointments are key, to truly achieve balance in regula-tion Congress must act. With Financial reform measures currently working their way through Congress, there will be an opportunity to advance policies that take both consumers and the health of the financial services industry into consid-eration. While there is much to be done, full repeal of Dodd-Frank will cause more harm than good. Repealing the Durbin Amendment and creating a five-person, bipartisan commission at the CFPB would go a long way to restoring balance to our regulatory system.

HOW WE BENEFITToday, many consumers have a mixed view of banks. But as we know, banks provide millions of consumers with products and services they want and need. From financing a family home to a graduate degree to a car to get to work, banks help consumers realize their dreams. If Dodd-Frank is reformed in a meaningful, balanced manner, banks would be standing at the ready and be fully capable of investing additional cap-ital into their local communities. Con-sumers would once more benefit from banking’s strong, robust presence in the economy.

The time to act is now.

For inquiries please contact:Jacqueline Ortiz Ramsay

AVP, Media & Communications (202) 552-6371 | jramsay@cbanet.org

Richard Hunt @CajunBanker

If we want consumers to benefit from a balanced, deliberative, and

thoughtful approach to regulation, a commission-based leadership structure overseeing consumer protection laws is in the best long-term interest of the industry and consumers.

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BY ADAM STOCKTON AND CHRYSTAL POZIN, WITH ANDREW FRISBIE

Novantas has seen increasing deposit pricing shifts in direct banks, Commercial exception pricing, and regional differentiation that signal heightened competition.

On March 15th the Federal Reserve raised its benchmark Fed Funds rate by a quarter point, and signaled that the likely path for short-term rates continues to be two more one-quarter point increases in 2017. While Retail and Commercial deposit pricing trends have not shifted dramatically since the last Fed Funds increase in December 2016, Novantas continues to see market shifts that signal increased competition:

1. Retail Direct Bank Competition: Strategies Shift toward CDs

2. Non-Operational Commercial Pricing: Premium exception pric-ing sometimes exceeding 100% beta

3. Regional Differences: Beta differ-ences emerging more starkly

Given these pressures, banks must revisit key elements of their pricing strategy, e.g.: CD vs. savings-led growth, Commercial exception pricing policies, and leading vs. lagging market increases.

Fed Increases Rates As Expected: Rates Still Lagging, but Starting to Respond

AS SEEN IN THE NOVANTAS REVIEW

RETAIL DIRECT BANK COMPETITION: STRATEGIES SHIFT TOWARD CDSAfter little response to the first Fed Funds increase, the Retail direct bank market has heated up over the last two quarters, with increased competitiveness across both CDs and savings products. We expect these trends to continue, with additional new entrants representing the largest factor driving potential outsized moves.

There has been a marked shift toward CDs across the direct bank market. Six major direct banks that “led” with savings rates prior to the first Fed Funds increase have lagged savings and now have 1-year CD rates higher than sav-ings. Competition has crowded the top of the CD market — the number of direct banks within 0.25% of top-of-market has doubled from six to twelve. Ultimately, both betas and top of market rates have increased significantly since December’s Fed Funds increase.

The apparent decision by many direct banks to pivot to CDs as a lead product has generally muted liquid increases. The Top 5 Direct savings beta has remained constant at 16%, as direct banks are largely lagging pricing for liquid savings.

A compounding impact on betas is the likelihood of new entrants in the direct bank space. To gain share of mind, new entrants have historically priced headline products well above established competitors — as much as 0.25% in a lower rate environment, and up to 0.50% when Fed Funds was above 3.00%. The recent entry of PurePoint Financial may be an example of the typical strategy of new entrants. Shortly after PurePoint entered the market at a 0.05% - 0.15% rate premium, multiple competitors increased rates to retake top of market.

As we look at the retail direct banking landscape going forward in 2017, we ask:

SPRING 2017 | 7

FED INCREASES RATES AS EXPECTED: RATES STILL LAGGING, BUT STARTING TO RESPOND

First, how quickly will consumer deposits shift back to CDs. The gap between savings and CD rates has increased substantially — from 0.12% at the Top 5 Direct banks in 2005 to 0.24% today. Novantas’ Comparative Deposit Analytics consortium indicates similar shifts for brick & mortar banks — those who have grown CDs in the last 12 months have evidenced 0.24% higher rate paid on CD acquisition vs. on sav-ings acquisition, suggesting that a shift toward CDs may be near at hand. Addi-tionally, leading banks are analyzing whether leading with CDs might lower their marginal cost of funds relative to broad liquid product rate increases.

Second, how many new entrants will join PurePoint. Given the lack of brand equity of any new entrant, a rush risks pushing direct bank betas up, with knock-on effects to the brick and mortars.

COMMERCIAL NON-OPERATIONAL PRICING: “PREMIUM” EXCEPTION- PRICING APPROACHES 100% BETABanks generally held standard com-mercial deposit rates steady after the first Fed rate increase in December 2015. Deposit rate betas for standard earn-ings credit rates on commercial DDA accounts were zero — median rates actu-ally declined by 0.02%. Earnings credit rates had been at or above market rates for several years, with standard market ECR rates generally between 0.20% - 0.30% when the Fed Funds rate was at 0.25%. As ECR rates have held steady at 0.20%, they are now significantly lower than the Fed Funds target of 1.00%. The lack of rate movement is evidence that banks are not generally using rate to win operational deposits.

While rates for operational depos-its remain steady, rate competition is growing for non-operational commer-cial deposits — deposits that could be substituted with alternative short-term investments. Prime money market funds are offering rates of 0.55% - 0.57%, and Treasury and Government Institutional funds are offering rates of 0.32% - 0.33%. Banks are increasingly competing with money funds and non-banks for non-op-erational deposits, and we see banks

FIGURE 1: Average of Top 5 Direct Bank RatesDirect Bank CD beta is currently 38% compared to Fed Funds.

Source: Informa Research Services

FIGURE 2: Acquisition Rates for Banks Growing vs. Running off CDsBanks growing CDs have typically priced CDs well above Savings.

Source: Novantas Comparative Deposit Analytics

1.00%

1.05%

1.10%

1.15%

1.20%

1.25%

1.30%

1.35%

1.40%

Savings/MMDA 1 Year CD

Pre Fed Increases (9/2015) After 1 Increase (5/2016)

After 2 Increases (2/2017)

16% beta

38% beta

Banks Growing CDs(Average +7%/year)

Banks Running Off CDs(Average -8%/year)

CD Savings/MMDA

CD rates 0.24% higher Savings rates 0.16% higher

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

Banks Growing CDs(Average +7%/year)

Banks Running Off CDs(Average -8%/year)

CD Savings/MMDA

CD rates 0.24% higher Savings rates 0.16% higher

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

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COMMENTARY

FIGURE 3: Commercial Deposit Rate Betas (After First Fed Move in Dec 2015) Banks are making a tradeoff as interest rates rise — retaining low rates where possible while using aggressive premium rates to win rate-sensitive deposits.

Note. Data provided by participating banks, rates reflect Commercial / Middle Market segment.Source: Novantas proprietary U.S. Commercial Deposit Study, Dec 2015 and Oct 2016 data

88%

8%

- 24%

20%

72%

12%

0%

12%

20%

0%

- 24%

- 8%

-30% -10% 10% 30% 50% 70% 90%

Premium Exception

Typical Exception

Average Portfolio

Standard

Banks reported lower dollar weighted average portfolio rates, but reported much higher premium exception rates

ECR (DDA) MMDA IB DDA

Rate

40%

66%

31%

0%

14%

-12%

Savings/MMDA1 Year CD

Top 5 StatesN

ationwide U

S Average

Bottom 5 States

70%

60%

50%

40%

30%

20%

10%0%

-10%

-20%

Beta

88%

8%

- 24%

20%

72%

12%

0%

12%

20%

0%

- 24%

- 8%

-30% -10% 10% 30% 50% 70% 90%

Premium Exception

Typical Exception

Average Portfolio

Standard

Banks reported lower dollar weighted average portfolio rates, but reported much higher premium exception rates

ECR (DDA) MMDA IB DDA

starting to increase rates on MMDA and interest-bearing DDA accounts to maintain a competitive position.

Novantas surveys banks with Com-mercial deposits on a regular basis and divides the balances between standard rates, typical exception rates, and “pre-mium” exception rates. With that said, banks have increased standard rates and typical exception rates only modestly. However, banks reported significant increases to the premium exception rates they are willing to offer to win these deposits. Premium exceptions for these aggressive corporate rate seekers have risen such that the beta on some seg-ments has exceeded 100%. In addition, banks report using exception rates on bigger portions of their large corporate and public sector segments than before.

Given a general industry focus on securing operational deposits, which have more favorable LCR treatment, why would banks offer such high rates on non-operational deposits? Banks face disintermediation of deposits as rates rise

and corporations deploy cash to optimize yield. In higher rate environments, corpo-rates have historically held 30% of their cash in bank deposits. Today that number is artificially high at 60% and banks can expect some funds to flow out of deposits and into MMF and other direct investment instruments. While holding these balances is comparatively more expensive, some players may have HQLA headroom to make this feasible, or lack the capabilities and discipline required to gather operational deposits instead.

REGIONAL DIFFERENCES: EMERGING MORE STARKLY While rates appear to be rising rapidly and converging in the direct space, there are still substantial regional differences in promotional rates and betas that are increasing at the start of the rate cycle.

Regional macroeconomic and cus-tomer preferences play a role. However, experience from last time suggests that the largest driver is the concentration of deposit-needy banks, often regionals

and community players, who are push-ing for deposit growth. As the envi-ronment unfolds, a key question will be whether aggressiveness from select regional players continues to drive regional variances, or continued direct banking penetration begins to level the geographic playing field.

Regardless, banks will need to continue to hone regional pricing capa-bilities — down to a state level at a min-imum and increasingly at a sub-state level. Tracking and elasticity modeling is of the utmost importance to ensure not only awareness of geographic dif-ferences, but also optimization across markets to drive the lowest possible cost of acquisition.

KEY DEPOSIT STRATEGY QUESTIONS AND IMPLICATIONSShould retail growth be focused on CDs vs. liquid products?

While we expect re-mixing to term for the industry, banks may push for greater term growth earlier based on:

SPRING 2017 | 9

FED INCREASES RATES AS EXPECTED: RATES STILL LAGGING, BUT STARTING TO RESPOND

Source: Informa Research Services

FIGURE 4: 1 Year CD beta (Change since Sep 2015 vs. 0.50% Fed Funds increase)CD betas by state vary dramatically, with no consistent regional trends.

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%AZ NV CO UT CT GA OK DE LA AL FL MA NM WA ID PA MI OH KS OR IN NC SC NY CA TX VA NJ KY MD MO TN AR IL WI

average, banks may find it cost-ef-fective in the long term to lock in deposit costs before competition increases. However, to the extent that current market trends contin-ue, banks may pay in anticipation of competition that never arises.

• Lag the market — while margin-en-hancing in the short-term, banks who lag too long may find increased attrition of not only rate-sensitive, but also relationship deposits that will be much more expensive to replace.

• Market-by-market competitive dynamics — growth may be less expensive in some markets vs. oth-ers for banks with larger footprints. A few may find contrarian positions to grow less competitive products in certain markets.

• Existing portfolio dynamics — banks with difficulty in managing promotional leakage in liquid products may look to CDs as a natural “fence.”

• Funding demands — as a gener-alization, banks seeking larger incremental retail funding needs may find CDs to be a more effective growth lever relative to risking cannibalization in their low-cost liquid portfolio.

Where should we be more vs. less aggres-sive with commercial rate re-pricing?

Banks will face customer and compet-itive pressure to increase rates with each Fed rate move, but need the right segmen-tation, profitability, and pricing tools to be more precise in their rate decisions:

• Be cautious with rate increases — if banks increase rates too aggres-sively, they will degrade spread income, increase rate sensitivity, and reduce net fees. However, if they increase rates too conserva-tively, they risk losing deposit bal-ances, and their ability to attract new deposits.

• Segment commercial deposits — banks need to segment their commercial deposit portfolios to isolate and manage customers based on estimated rate sensitiv-ity, but many lack the capabilities to segment and manage their port-folios at this level of granularity.

Should we lead or lag the market in retail prices?

Absent a funding need that makes near-term pricing an imperative, banks may choose either strategy, though each will come with inherent risks:

• Lead the market — in less expen-sive markets, where growth may be obtained for under the national

Adam Stockton Director, New York astockton@novantas.com

Chrystal Pozin Director, Chicago cpozin@novantas.com

Andrew Frisbie Managing Director, New York afrisbie@novantas.com

10 |

BY RYAN SCHULZ AND PETE GILCHRIST

For too long, funding has been a neglected cousin in the strategic planning process. But there are storm clouds gathering — driven by rising rates, competition and increased regulatory focus on liquidity. Going forward, banks need an enterprise-wide strategic funding optimization approach.

Banks often short-change the liabil-ity side of their balance sheets when building out their strategic plans. In the current environment, why not? Most US banks have more cheap deposits than they can deploy. This situation is rapidly waning. Wholesale market rates are on the rise and banks are likely to face more funding challenges than ever before. Competitively, the largest US national banks are capturing most organic depos-it growth (in all lines of business), while direct banks are pressuring traditional pricing levers for convenient access to rate sensitive savings and CDs. Mean-while, regulation is requiring banks to balance a wide range of liquidity, capital, and interest rate risk constraints. Banks must have better funding planning to excel in this uncharted territory.

During the sustained low-rate environment, banks could afford to be

FIGURE 1: The State of Strategic PlanningPreviously neglected, funding is becoming more fundamental to long-term success.

Source: Novantas

Strategic Funding Optimization:A More Proactive Balance Sheet Management Tool for ALCO

AS SEEN IN THE NOVANTAS REVIEW

CURRENT STATE FUTURE STATEDetermine asset growth target, which leads to required funding growth

Set funding targets at the business unit level, often using rough “back of the envelope” allocations

Ask each business to minimize short-term marginal cost of funds

Manage to other constraints (e.g., liquidity) centrally in Treasury as the loans and deposits are booked

Build the asset plan and the liability plan simultaneously

Set funding targets at granular business unit and product levels, including all relevant deposit characteristics

Minimize all-in cost of funds across multiple time horizons and scenarios

Proactively identify and plan for implications on a range of scenarios, constraints, and goals

Re-assess performance against strategies as the year progresses

SPRING 2017 | 11

STRATEGIC FUNDING OPTIMIZATION: A MORE PROACTIVE BALANCE SHEET MANAGEMENT TOOL FOR ALCO

complacent about funding. Funding plans tended to be simplistic, with funding goals allocated to businesses using ad hoc budgeting analysis and relying on minimizing short-term cost of funds within the businesses. Now, leading institutions have begun lever-aging advanced deposit analytics to create more nuanced funding plans at the customer segment level (Figure 1). These plans consider the full range of balance sheet constraints and do so across longer horizons and more diverse scenarios. The result is a stra-tegic optimization of the liability side of the balance sheet. These banks are already seeing benefits to both cost of funds and net interest margin (NIM), thanks to rebalanced liquidity profiles. These benefits will only grow as whole-sale market rates rise.

At their hearts, banks used to be asset-focused enterprises, meaning loan production was the driving force in planning. Even today, most strategic planning starts each Fall with the question “How much are we looking to grow next year?”, with the implication being growth in assets. This question

gets answered across the organization, the results are added together, and only then does the liability side of the balance sheet get introduced into the planning process.

Once the target has been set, busi-nesses get allocated a portion of the funding goal and are asked to achieve it as cheaply as possible. They are given leeway to find the deposits how-ever they can (occasionally with some high-level directives from Treasury). This leads to a bundle of deposits with a range of attributes from flighty high-yield savings, to relationship-based checking accounts, to locked-in term deposits. A well-crafted funds trans-fer pricing (FTP) methodology can help direct businesses to balance

sheet-friendly funds (sticky, low-beta, regulator-encouraged), but ultimately the businesses pass the baton back to Treasury to assemble a balance sheet with the desired interest rate risk and liquidity positions.

Given recent rate history, this plan-ning process has not been especially problematic. The unprecedented “low forever” rate environment gave rise to an equally unprecedented period of deposit excess (Figure 2). In the years after 2011 — when wholesale market rates fully bot-tomed out — loan to deposit ratios across US banks reached a new low of 69%. And the low rate environment inspired apathy in customers’ deposit decisions as well, leading non-interest bearing products to grow to 25% of all deposits. (At the bot-

FIGURE 2: Impact of Sustained Low Rates on Funding BehaviorsRate apathy has led to stockpiles of cheap deposits.

Source: FDIC Quarterly Banking Profile

L/D ratio

NIB deposits

‘92 ’94 ‘96 ’98 ‘00 ’02 ‘04 ’06 ‘08 ’10 ‘12 ’14 ‘16

100%

90%

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60%

50%

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25%

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15%

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Loan

to D

epos

it Ra

tioNon-Interest Bearing Deposits (%

of Total)Banks are already seeing benefits to both cost of funds and net

interest margin (NIM) thanks to rebalanced liquidity profiles, which will only grow as wholesale market rates rise.

12 |

FEATURE

tom of the last rate cycle, this figure was 19%.) In this environment, banks have been able to survive on relatively simple and straight-forward funding plans.

But fundamental shifts in the indus-try, driven by the hastening rising rate environment, are making simplistic funding plans untenable. The stickiness of newly found “core” deposits will be tested and some banks will be painfully disappointed. If the non-interest bearing deposit mix returns to pre-2011 levels (19% of total deposits), banks can expect a quarter of these deposits to move into rate paying or non-deposit alternatives. The funds that remain in deposits will be subject to increased competition from direct banks, which have proven they can pull hot money and even relationships from traditional brick-and-mortar franchises as consumer senti-ments trend ever more digital. On top of these funding pressures, banks bear the weight of heightened regulatory scruti-ny in the post-crisis environment: new interest rate risk, liquidity, and resolu-tion/recovery planning regulations pile additional constraints on top of existing economic and strategic considerations. Unfortunately, competing constraints often send different signals, making Treasury’s job of assembling the balance sheet exceedingly complicated.

Many of the challenges of current funding plans are attributable to the singular focus on near-term cost of funds. While obviously a key component of a bank’s profitability, it is too dominant in a more broadly optimized funding plan. Because banks are not actively plan-ning around other funding constraints, Treasury must optimize on these other constraints reactively as funding arrives. This reactive position increases focus on short-term funding levers and “flavor of the day” tactics. Longer term, higher val-ue long-term funding levers are left in the lurch as the plans rarely provide the time to allow slower moving relationship-driv-en funding to be built and maintained (e.g., commercial operating funds).

Say Business XYZ gathers its next billion in deposits, and does it with minimal impact to near-term interest expense. Job well done. Treasury, on the

other hand, is worried about more than just the interest expense of the deposits. Depending on the deposits acquired, Treasury now must consider mitigating the new LCR outflows through the securities portfolio, rebalancing key rate durations, and hedging the interest rate risk. Each of these actions could incur additional costs, costs that were not con-sidered when the deposits were being acquired. In our evolving environment, this ex post management can cause sub-stantial harm to the bank’s balance sheet.

Current enterprise funding plans also lack the granularity to optimize effectively across businesses. Broad tar-gets make it difficult to capture the trade-offs between products overall and their marginal volume. The first incremental $100 million in funding might be cheap-est in retail MMDA, but what about the next $100 million? Determining where to draw these lines is challenging with blunt enterprise funding plans. These tradeoffs only become more compli-cated as constraints such as liquidity and interest rate risk are factored in to cross-business and cross-product decisions. It may be cheaper to acquire the next $100 million from commercial, but what knock-on effects will the higher outflow deposits have on LCR and what will it mean for investment yields if the bank has to rebalance high-quality liquid assets?

Few banks currently have the capa-bilities to make these decisions efficient-ly and effectively. As external pressures grow, enterprise funding planning will become increasingly necessary to build strong NIM and shareholder value. Banks that master these skills will realize substantial advantages in a more dynam-ic macroeconomic, wholesale market rate, and competitive environment.

To rise to this challenge, banks need

to change the way they think about enterprise funding planning. This requires an evolution of the enterprise funding framework as well as the devel-opment of the appropriate analytic tools to perform strategic funding optimiza-tion in support of the new framework.

The basis of strategic funding opti-mization is an expansion of the scope of the business-specific funding opti-mization problem. A top-tier enterprise funding framework considers:

• The various constraints the bank faces, not just marginal cost of funds. This includes management targets (core funding ratios and segment concentration limits), eco-nomic constraints (interest rate and basis risk), and regulatory require-ments (LCR and NSFR)

• The evolution of the bank’s posi-tion relative to these constraints over both a short term (≤1 year) and long term horizon (3—5 years)

• A range of different potential sce-narios including macroeconomics, wholesale market rates, and com-petitive dynamics.

These new dimensions of planning allow the bank to see the true impact of enterprise funding decisions. The bank is no longer just answering the question “How much will it cost me to grow funding by $X billion over the next 12 months?” It will also address how that funding will impact the bank’s rate sen-sitivity, what position it will leave the bank in 2 years’ time, and what impact that strategy will have if rates stay low for another 6 months. This requires shifting ALCO’s mindset and harness-ing deposit analytics to support it.

The key analytic underpinning of this effort is the ability to estimate the impact of strategic, competitive, and macroeconomic changes on deposit

A bank cannot let the liability side of the balance sheet “happen” —

it must proactively plan and be prepared for a range of potential scenarios.

SPRING 2017 | 13

STRATEGIC FUNDING OPTIMIZATION: A MORE PROACTIVE BALANCE SHEET MANAGEMENT TOOL FOR ALCO

balances and rates. Many of these ana-lytics are in place throughout the bank; unfortunately, they are rarely leveraged for enterprise funding planning. The first step is to inventory what exists already at the bank. Novantas sees four primary components to estimating deposit behaviors (Figure 3).

Ideally, these analytics would be integrated through an existing system. However, existing software rarely has the flexibility to quickly and intuitively run strategic scenarios. In working closely with banks, Novantas has helped banks deploy a top-level tool that can aggregate these analytics and provide real-time results in various scenarios for an array of strategic decisions and initiatives.

These tools reside at the front end of the funding planning process to provide early directional input to ALCO. While the results are less precise and granular than what is provided by full

instrument-level ALM cash flow projec-tion software, they are streamlined and flexible to allow for rapid iteration of strategic options, which is difficult to achieve in ALM software. Products are aggregated for simplicity, while main-taining sufficient granularity to compare the differences across major product groupings and customer segments to optimize across meaningful dimensions. The tool accepts assumptions on the characteristics of deposit categories (e.g., LCR outflows, interest rate sensitiv-ity) to provide a simple means of com-paring across a myriad of constraints and scenarios.

As banks look forward to the rising rate environment and the projected return of stronger yields, it bears remind-ing that NIM often gets worse before it gets better. Typically, loan books have been slower to adjust to new rates, while liabilities reprice more rapidly. Indus-

try-wide betas for the first rate rises have been low, but historically these catch up in the second 100 bps of a rising rate environment. Purportedly, this cycle will be different, with rates having been lower for longer and banks starved for improved NIM. But different banks will require different disciplines on deposit rates. Banks that are still funding myopi-cally will be forced to accept higher cost deposits and liquidity positions. Perhaps for the first time, the winners of the next cycle will be determined by excellence in liability management rather than asset gathering.

Source: Novantas

Pete Gilchrist EVP, New York pgilchrist@novantas.com

Ryan Schulz Principal, New Yorkrschulz@novantas.com

ACCOUNT ACQUISITIONHow many accounts will

I acquire and why?

ACCOUNT DECAYHow many accounts

will attrite?

ACCOUNT BALANCEWhat will the average account balance be?

CUSTOMER RATEWhat will I pay for

deposits?STRATEGIC FUNDING

FIGURE 3: Key Analytics for Strategic Funding OptimizationUnderstanding deposit behavior in different environments unlocks deeper strategic planning insights and options.

Pricing Model Marketing AnalysisStress Testing (CCAR/DFAST) ALM Model Strategic Planning

Typical Sources

14 |

BY ADAM STOCKTON AND ANDREW FRISBIE, WITH VLADANA ZLATIC

As rates continue to rise, it is critical to deploy a better metric to compare the costs of rate based deposit raising strategies against one another, and against alternative marketing or investment spending.

As banks continue to grow loans, they are seeking different avenues to maintain deposit growth at the same pace. Already we are seeing that the betas associated with promotional MMDA accounts are surpassing the historic industry’s experience early in the cycle. A deeper worry is that the Marginal Cost of Funds (mCOF) — the total cost of incremental deposit-raising after taking marketing, cannibalization and changes in duration into account — is for many banks unsustainable. The Marginal Cost of Funds in the current rising rate environment threatens to render certain aggressive loan growth goals uneconomic from a funding perspective alone. Deploying a better metric to compare the costs of rate based deposit raising strategies against one another, and against alternative marketing or investment spending, is an emerging imperative.

Deposit Promotions at what Cost? Measuring Marginal Cost of Funds

PROMOTIONAL DEPOSIT PRESSURE IN A MORE COMPETITIVE MARKETIn an environment where Retail deposits are more valuable and more expensive, the competition for deposits continues to heat up. Banks lacking liquidity often turn to promotional pricing to raise rate-sensitive deposits through promo-tional rates on both MMDA and CDs. These banks are seeing pressure on results from four areas:

• Acquisition: The continued shift in consumer preferences toward banking online, combined with new direct bank market entrants and increased sophistication in region-al pricing analytics, has put pres-sure on interest rates required for acquisition. In addition, to achieve maximum acquisition, rate cam-paigns must be supported by addi-tional marketing expenses, which

must also be taken into account when analyzing deposit promotions.

• Cannibalization: At the end of the long low rate environment, most banks have large books of low-cost deposits sitting in statement sav-ings, grandfathered MMDA, and even checking accounts. As banks look to compete for rate-based deposits, they open themselves up to significant repricing risk.

• Duration: With banks’ increased pricing sophistication, teaser rate pricing has become more prevalent, but customers are catching onto the game. Banks doing aggressive teaser pricing have seen higher balance decay levels and are paying customers a high rate for the intro period, only to see them hop to a different bank’s promotional offer at expiration.

SPRING 2017 | 15

DEPOSIT PROMOTIONS AT WHAT COST? MEASURING MARGINAL COST OF FUNDS

• Opportunity cost: Offering promo-tional rates not only risks repricing the existing book of business, but also risks repricing BAU acqui-sition — deposits which would naturally have joined the bank at existing rates. This may represent significant incremental interest expense, particularly for banks with strong core checking and con-venience-oriented savings growth.

Without accurate measurement, banks are unlikely to avoid some or all of these pitfalls. In a world where National banks continue to gain share, Regionals and Super Regionals cannot afford to misallocate scarce resources. Maximizing efficiency of both interest and marketing expense is critical.

MARGINAL COST OF FUNDS: AN ALL-IN MEASURENovantas has developed a Marginal Cost of Funds (mCOF) calculation to measure the financial impact of pro-motional pricing. It empowers banks to trade-off rate-based pricing against other potential growth investments. In addition to an all in acquisition cost, which includes both dollars of rate paid and incremental marketing costs, mCOF takes the expense of repricing/cannibalization of lower-cost savings into account, attrition after the promo-tion expires, and the effects of ‘promo hoppers’ who reprice to a subsequent promotional rate after their first promotion expires.

The Marginal Cost of Funds across Novantas’s Comparative Deposit Ana-lytics benchmarking consortium pro-vides a number of insights into both typ-ical and outlying promotional deposit gathering performance:

• The Marginal Cost of Funds for a typical bank using promotional pricing can be 2x to 3x higher than the nominal coupon rate — e.g., a bank offering a 1.00% promotion for 3 months might frequently see annualized Marginal Cost of Funds at 2.00% - 3.00%.

• Outlying results on any individ-ual mCOF lever can significantly worsen the metric for a bank.

For example, one bank, with no constraint on where the pro-motional funds came from, saw cannibalization comprise 75% of the promotional funds. The result was an mCOF of over 3.00% for a 1.25% promotion.

• Aside from cannibalization, bal-ance decay of promotional funds after the promotion ends has an even higher impact on Marginal Cost of Funds compared to the cannibalization effect. The 12 month decay of balances acquired through promotions can range from 30% to 70% depending on the magnitude of acquisition rate, the differential between promotional and base rate, and the frequency of promotional activity.

For any individual bank, a detailed understanding of the overall mCOF and the levers that impact it, along with a comparison to benchmarks, allows the bank to diagnose potential issues. For example, some Novantas clients have used mCOF analysis to identify the

need for tighter controls on new money criteria and the difference between compliant and non-compliant regions. Others have moved to more targeted pricing to specifically seek balances from customers with low potential repricing impact.

Ensuring accuracy of mCOF is clearly of the utmost importance as it is used to trade off investments. Consistency across the enterprise and organizational buy-in are crucial to identify and correct tradeoffs. Bench-marking is also critical to identify key areas of underperformance and monitor industry-wide trends.

INCREASED URGENCY AS RATES RISEIn a rising rate environment, we expect the Marginal Cost of Funds betas to exceed promotional betas. Put another way, the beta on the Marginal Cost of Funds is likely to significantly exceed 100%, making banks that have historical-ly relied heavily on promotional tactics vulnerable to margin compression as rates increase.

FIGURE 1: PROMOTIONAL RATE BETA VS. MCOF (POINTS IN CYCLE)Betas on funds raised at the margin may exceed 100%.

Novantas Comparative Deposit Analytics and Proprietary mCOF Methodology

Fed Funds: 2.00% Fed Funds: 4.00%

Promotional MMDA(coupon rate)

Marginal Cost of Funds Promotional MMDA(coupon rate)

Marginal Cost of Funds

100%

90%

90%

160%

120%

140%

100%

80%

16 |

Novantas projects 90%+ betas to Fed Funds increases for promotional acquisition rates in both MMDA and CDs. While broadly in line with the last rising rate environment, promotional betas could exceed 100%, especially in CDs, as rate information becomes more transparent online and competi-tion increases, including among banks that are currently not competing for rate-based deposits.

Retention will also be impacted. Novantas benchmarks demonstrate bal-ance churn increases by 50% in a rising rate environment compared to a low rate environment, impacting both can-nibalization and decay. Cannibalization rates will increase as more customers are attuned to rate-based offers and as the offers increase in magnitude — especially around handle round number rates like 2.00%. Decay rates will also increase as customers become less tol-erant of remaining at a base rate after promotions expire.

Finally, higher dispersion between

promotional and base rates will increase the cost of repricing. While promotional rates will see betas of 90-100%, base rates and the ‘back book’ may only see betas in the 10-30% range. For each 100 bps that Fed Funds increases, the cost of cannibalization will therefore increase by up to 90 bps. The cost of cannibalization and opportunity cost of acquisition will begin to severely challenge promotional pricing.

HOW MCOF INSIGHTS ARE DRIVING ORGANIZATIONAL DECISION-MAKINGBest in class organizations have embed-ded Marginal Cost of Funds in sever-al ways. First, they have socialized a standard calculation for Retail in con-cert with their Treasury and Finance colleagues. Often their Commercial colleagues undertake a similar exer-cise, facilitating trade-off calculations across businesses.

Second, they are making better informed spot decisions on near-term

funding needs. For example, by shift-ing strategy between a mass Savings promotion, mass CD promotion or targeted DM campaign, Marginal Cost of Funds can identify the optimal time to grandfather a product, and the correct cadence for increasing base and promotional rates. This dialogue enables the business and Treasury to look beyond average spreads to the incremental impact of specific pricing decisions.

Third, banks that have embedded the Marginal Cost of Funds logic into their strategic planning and resource allocation process are improving their returns by addressing issues proac-tively rather than opportunistically. This approach, keyed to the annual planning and resource allocation pro-cess, enables these banks to answer questions like “Should we allocate more in marketing spend to support new balance acquisition, or instead, accept that we may need to price our rate paid on promotional deposits incrementally higher? Which approach is more efficient overall?”

Finally, the Marginal Cost of Funds can be used to influence decisions well beyond resource allocation within Retail. As a part of an enterprise funding planning exercise, the Marginal Cost of Funds, in concert with metrics from other lines of business, can help a bank decide whether, on the increment, the next $1B of funding should come from Retail promotional CDs or Commercial non-operating deposits. The Marginal Cost of Funds can also help deter-mine whether, on the increment, asset growth might be slowed down to avoid spread disintermediation.

Andrew Frisbie Managing Director, New York afrisbie@novantas.com

Adam Stockton Director, New Yorkastockton@novantas.com

Vladana Zlatic Lead Associate, Torontovzlatic@novantas.com

FIGURE 2: MMDA VS. CD MCOF (ALL PROMOTIONS >1.00%)While many assume CDs are always a more expensive vehicle, on an mCOF basis CDs can sometimes be more attractive.

Note: MMDA Timeframe: March 2015 — April 2016 (n=26), CD Timeframe: March 2015 — November 2016 (n=74) Source: Novantas PriceTek Database, Novantas Analysis

Mar

gina

l Cos

t of F

unds

4.5%

4.0%

3.5%

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%MMDA CD

2.10%

3.50%

1.75%

2.70%

1.75%

1.35%

Marginal Cost of Funds: MMDA vs. CD Products

Highest 25% Average Lowest 25%

Legend

SPRING 2017 | 17

RETHINKING BANK M&A — IDENTIFYING, PRICING, AND CAPTURING VALUE IN TODAY’S ENVIRONMENT

BY MICHAEL JIWANI AND PETE GILCHRIST

The value of M&A is changing. Traditional acquisition synergies are giving way to new sources of value and banks will need to adapt.

U.S. merger and acquisition transactions involving larger community and region-al banks are back on the table. Above the continuing consolidation of some 10,000 smaller community banks and credit unions, and beneath the regulator-lim-ited national banks, mid-sized banks are looking at M&A — not simply opportu-nistically, but now out of urgency.

The urgency arises from dual pres-sures: (1) to restore long-suffering prof-itability to support investing in digital transformation; and (2) to counter the dominant lead U.S. national banks have opened up in acquiring new core cus-tomers across all lines of business. For brick-and-mortar-centric intermediaries that wish to survive, M&A is a necessary strategic consideration. However, in searching for the right deals, successful acquirers appreciate that the under-lying value of target institutions has decidedly changed.

Credit quality is, and always will be, an integral part of deal economics, but the nature of the value created from the

liability side has evolved. Traditionally, acquisition justification was largely about realizing scale and, more importantly, expanding non-toxic assets, branches and customers, with only limited focus on the quality, fit and longevity of deposits. In today’s environment, we see three major areas where underlying industry econom-ics have altered relative M&A value:

• Core transacting customers with “sticky” and growing deposits are now more valuable than ever.

• Branch consolidation must be more aggressive than ever before because of the diminishing asset value of the network in a digital age.

• Finally, banks are in need of niche lending and fee businesses with high ROE potential to improve fee and spread performance over traditional intermediation.

Acquirers must find ways to identify and correctly price these sources of val-ue, and then single-mindedly seek and execute deals that bring the right cus-tomers and deposits. This will help them

compete in-footprint with the nationals and add fee generating options.

We see three new tasks needed in the acquisition process to account for the changes in value:

1. Enhanced screening of the deposit franchise for target identifi-cation, and in particular using better analytics and benchmarks to find banks with higher quality deposits and customers, as well as greater consolidation potential.

2. More focused due diligence of the deposit base before provid-ing an offer to better understand the intrinsic customer and deal value, and price accordingly

3. Use of “clean room” teams after a deal announcement to allow for accelerated and optimal merger integration decisions reflecting the new liability-driven sources of value.

The costs and time of these additional efforts are clearly outweighed by the risks of an M&A “error”.

Rethinking Bank M&A — Identifying, Pricing and Capturing Value in Today’s Environment

18 |

ACQUISITION TRENDSWith the end of interstate banking

restrictions in the 1980s, M&A became an integral component of transfor-mation for the U.S. banking industry. Since then, bank M&A has largely been responsible for bringing the number of U.S. banks down from over 15,000 to under 6,000 (with credit unions seeing a similar reduction). Banks have consolidated at a pace of roughly 3-5% per year, slowing down following the financial crisis, but since recovering to historical averages (see Figure 1a). We expect this rate of consolidation to con-tinue over the next several years.

In terms of deal size, the real estate crisis saw a crescendo of large bank mergers, which thereafter went into hibernation. Since 2014, larger bank transactions have returned. We expect to see a return to regular M&A activity for larger community and regional banks in the next decade, leading to an increase in the number of banks with $200 billion and more in assets (subject to regulatory asset threshold changes).

Looking at deal pricing (see Figure 1b), tangible book value multiples have declined post crisis: median P/TBV exceeded 2.0 in 2003-07, plummeted to 1.1-1.2 in 2008-13, and then inched up to 1.3-1.4 by 2015-16. Part of the low multi-ple reflects stunted industry profitabil-ity prospects and bottom basement bank stock prices — both of which have improved markedly of late. Despite these positives, we do not expect bank profitability to return to pre-crisis levels; hence, while we have seen a significant increase in deal multiples in Q1 2017, we do not expect a return to prior multiples, except when it comes to unique deals.

Premiums over market price for pub-licly traded companies have returned to roughly normal values post-crisis. The median 1-month deal value premium over market price spiked to around 60% in the slow recovery period of 2009-12, reflecting low trading multiples of that period. Since then, premiums have dropped into the low 30s. We expect premiums to fall slightly further into the high 20s, as both acquirers and

FIGURE 1A: Bank M&A (2000-2016)Mergers continue to reduce industry bank count by 3-4% a year, while larger bank deals are picking up after a post-crisis hiatus.

FIGURE 1B: Annual Median Deal Price Metrics (2000 — 2016)Deal pricing to tangible book value remains in the low ones though rising, while premiums are back to the low 30s.

Merger size measured by target bank assetsSource: FDIC, SNL, Novantas analysis

Deal Value to Tangible Book Value, Deal Value to Market Value for publicly traded targets; annual medians.Source: SNL, Novantas analysis

# La

rge

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Target Bank Assets

SPRING 2017 | 19

RETHINKING BANK M&A — IDENTIFYING, PRICING, AND CAPTURING VALUE IN TODAY’S ENVIRONMENT

sellers better appreciate reduced target prospects absent a sale.

CHANGING VALUE OF BANK M&AHistorically, M&A has reflected

the centricity of the branch — to bank intermediation, as well as to the goal of building franchises. Deal announce-ments, while typically first mentioning the safety of assets, prominently touted branches and to a lesser degree depos-its. Deal rationales typically split into: out-of-footprint franchise expansion to build a regional or national franchise versus in-footprint franchise expansion to increase share and build scale. The term “footprint” is itself a reference to branch networks.

But in the years since the Great Recession, the combination of technolo-gy, customer preference, and regulation has fundamentally altered industry dynamics — and along with it, the value of bank M&A. With technology enabling mobile and online banking for both

FIGURE 2: Median Cost and Branch Reductions, Ten Largest Deals by Year (2009 — 2016)Acquirers now more aggressive in cost reduction and branch consolidation.

Branch Overlap: target branches within 5 miles of acquirer branchSource: SNL, Novantas BranchScape, research and analysis

shopping and purchasing, customers are increasingly shunning the branch and shifting to digital channels. Addi-tionally, liquidity regulation favors more stable deposits — transaction accounts as opposed to savings accounts or large, non-operating balances parked await-ing better uses or rates.

More ominously for regional and local banks, these industry trends have downgraded the importance of local branches — giving the national banks higher customer acquisition rates and creating opportunities for direct online banks. Separately, industry profitabili-ty remains subpar, and large swaths of banks are failing to meet their costs of capital. Even with economic expansion and rising rates, profitability is unlike-ly to return to pre-crisis levels.

Thus, all but the most successful regional and community banks are caught in a vise: how to simultaneously compete with the nationals, improve profitability, and invest in digital dis-

tribution realignment. Many regionals are again looking to M&A for some of the solution.

The pitfall is that the sources of value from bank M&A have funda-mentally been altered. We see three major changes to M&A value — some of which are quite difficult to discern:

Core transacting customers and their stable deposits are now far more valuable. We believe the differentiator of profitability for banks going forward is increasingly access to a growing base of “sticky,” transaction deposits. Payments-related, relationship-driven, and other stable deposit balances incur lower interest expense and are less likely to be “shopped” and switched to another bank. In contrast, hot money and balances acquired through promo-tion will require higher rates or leave the bank.

Accordingly, acquiring deposits with limited regard to their source puts M&A deal economics at risk — espe-

% o

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70%

60%

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40%

30%

20%

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2009 2010 2011 2012 2013 2014 2015 2016

Branch OverlapCost TakeoutBranch Consolidation

20 |

cially as rates rise, online shopping increases, and deposit competition intensifies. With stable customers and low-cost deposits, M&A becomes a contributor to long-term profitability, and a supplement to organic growth. But with fleeting customers and rate-sensitive deposits, rising interest rates will push deals underwater.

In-footprint branch consolidation affords greater value. In-market deals are now doubly valuable. Cost savings have risen markedly (see Figure 2) — the median stated cost takeout for the ten largest deals (as a percentage of the target bank’s expense base) has risen from under 20% in 2009 to over 36% in 2016. We expect 35-40% and even higher to be the norm for cost takedown going forward.

This is only possible with deals involving substantial branch overlap and consequent branch closures. It should not be surprising to see branch closures in excess of 50% of the target bank’s base, nor should it be to see acquirers use M&A to restructure their legacy network and reinvest in digital transformation. Out-of-footprint deals will likely need special circumstanc-es — e.g., Canadian or other foreign entrants, or mergers of equals with little to no premiums, or extremely low valuations driven by other factors.

There may also be revenue value from the right in-footprint deals as they can help offset the advantage of national banks in new customer acquisition. Novantas’s Shopper Survey results show that regionals have better acquisition rates in markets where they have top-tier presence and deposit share. Hence deals that give regionals primary share position in their local markets should be more attractive and thereby help stabilize regional deposit and customer growth.

Niche lending and fee businesses can help. Even with scale and share from M&A, acquirers compete in a U.S. banking industry with substantial overcapacity. That means relationship cross-sell and ancillary fee revenue are essential, and targets with unique businesses are more valuable. Exam-

ples include strong in-footprint com-mercial, mortgage, and indirect auto lending, or specialized businesses in brokerage, insurance, and health sav-ings accounts. These businesses are especially attractive if they can scale and grow.

CAPABILITIES FOR WINNING IN TODAY’S M&A ENVIRONMENT Understanding the altered value from M&A, and using that to identify and win the right deals, is critical for success-fully leveraging merger transactions. We see three critical steps to ensuring acquiring institutions are identifying the right targets, paying appropriate prices, and capturing these sources of increasing value (Figure 3):

Enhanced screening of the depos-it franchise for target identification. Clearly there is abundant publicly available information about potential target candidates that acquirers comb through today — call report data pro-vides important details about target financial performance, as well as asset mix and quality. But to identify true underlying value in today’s environ-ment (e.g., whether a target’s deposits are more stable or more fleeting) an acquirer needs either proprietary or benchmark data. Some of the available data and analysis includes:

• Historical detailed deposit pricing information to estimate how much deposit balance growth has been driven by price, and therefore likely “hot money”

• Shopper survey results that detail brand perception and consider-ation, new customer acquisition purchase rates, and reasons for leaving the institution

• Competitive assessments to deter-mine how a target is performing in

each of their micro-markets relative to key competitors

• Distribution analysis to assess the level of overlap between acquirer and target, as well as attractive-ness of location of non-consolidate branch candidates

More focused due diligence of the deposit base before providing an offer. Once further down the path with a potential target, acquirers should go beyond credit portfolio due diligence and assess the stickiness of bank deposit bases. This is not an easy task as many deposits are masquerading as core deposits in our prolonged low rate environment. Digging deeper into the behavior of deposit customers provides a better understanding of how a customer base will react to basic post-merger changes (and, perhaps more importantly, rising rates), and will directly affect deal valuation.

• Branch consolidation. Customer attrition depends on each custom-er’s use of and attachment to the local branch. Understanding cus-tomer-level behavior improves the forecasting of attrition under likely branch consolidation scenarios.

• Re-pricing. Some banks have attracted notably more price sensitive customers, and some markets are inherently more price sensitive than others (largely due to varying levels of competition). Understanding the impact of potential pric-ing changes is a crucial step before estimating true revenue synergy opportunities.

• Rising interest rates. The industry has never before experienced such low interest rates for such an extended period of time. Rising rates will reveal which

It may be toxic loans that blow up a deal, but subpar deposits

relentlessly bleed deal value over time, especially as rates rise.

SPRING 2017 | 21

RETHINKING BANK M&A — IDENTIFYING, PRICING, AND CAPTURING VALUE IN TODAY’S ENVIRONMENT

banks are hosting “parked” DDA/MMDA balances waiting to shift, and which will have much higher deposit betas. Too many banks reflexively consider these bal-ances “core”. Modeling these will directly affect deal valuations.

• Improved product and sales capabilities. Understanding the degree to which the target bank is underpenetrated in its markets and among its existing customers provides a better view of the

potential upside opportunity. We have seen cases of fourfold sales productivity increases, depending on underlying opportunity.

Combining proprietary data with deposit tapes and basic supplemen-tary information that most targets are willing to provide (e.g., acquisition reports, branch transaction sum-mary reports), thorough diligence can help acquirers more accurately forecast pro-forma deposit balances, rates, and fees to appropriately price

transactions and begin developing integration strategies.

Use of “clean room” teams after a deal announcement. As soon as an acquisition has been announced, acquir-ers need to jump-start integration. This can be done prior to deal close with a dedicated and isolated clean room team that can collect and analyze sensitive customer information that can be shared in summary (but not in detail) to help make optimal integration-related deci-sions. The focus of clean room efforts should be on customer-level analysis and actions, including:

• Identifying high-value customers in terms of current and potential revenue — with a focus on those stable deposits with larger rela-tionship potential.

• Assessing the likely impact for these customers from key inte-gration decisions, such as product conversion, product pricing, and distribution network changes, and determining how to better accom-modate them.

• Communicating impending changes (positive and negative) to high-val-ue customers so they are not sur-prised, and so the acquirer can manage/maintain the relationships through the transition.

Establishing a clean room team quickly is important for both timely communication and ensuring higher quality information for key decisions. This is increasingly becoming the case as the value of M&A lies more in a target’s customer base and less in its branch network.

By investing in these steps, acquir-ers will be well-positioned to identify valuable deals and execute effectively. For many banks, this will be critical for the transformation required to succeed in today’s banking environment.

Pete GilchristEVP, New Yorkpgilchrist@novantas.com

Michael JiwaniPrincipal, New Yorkmjiwani@novantas.com

FIGURE 3: Capabilities for Winning in Today’s M&A EnvironmentThree critical steps to ensuring acquiring institutions are identifying the right targets, paying appropriate prices, and capturing these sources of increasing value.

Source: Novantas

Supplement public data on target with key benchmarks:• Pricing vs. market

• Shopper survey on deposit customer acquisition

• Micro-market competitive success

• Network attractiveness

Assess stickiness of deposit customers

Leverage customer-level data from target to gauge customer reaction to:• Branch consolidations

• Re-pricing

• Rising rates

• Improved product and sales

Create post-announcement “clean room” team to jump-start and optimize integration:• Identify high value customers

• Assess likely impact of integration decisions

• Communicate to priority customers

THOROUGH PRE-SCREENING

DEEPER DUE DILIGENCE

“CLEAN ROOM” TEAM

22 |

BY RYAN RITZ

Executive teams contemplating a direct bank should prioritize three major agendas: strategy, analytics and the target growth model.

Facing increasing pressure to grow deposits, many regional and community banking executives are asking: “Should we take the plunge and launch an online direct bank?” — not online access to the existing bank but a direct bank with its own strategy, value proposition, and customer franchise if not brand.

For banks that have spent decades assembling extensive regional branch networks, such a move would seem to border on heresy. But multiple forces are pushing brick-and-mortar banks more firmly toward this form of digital deposit competition:

• Many players are nearing their limits for in-network deposit growth and struggling to keep up with the acquisition rates seen at national banks.

• Regulation has discouraged the use of wholesale funding and sparked new urgency to win local retail deposit market share.

• Consumers have already embraced digital shopping for many purchas-es and could flock to higher-yielding online accounts as deposit rates rise.

Add to the mix further funding pressures as loans grow and rates rise in an expanding economy, as well as low barriers to entry and the stage is set for an explosive digital deposit battle. We expect to see a number of direct bank launches this year and next.

But regionals face a complex set of challenges in the new space. For exam-ple, use of the parent brand for the direct banking unit risks cannibalizing the core brick-and-mortar franchise. Further, launching and sustaining a direct bank requires a quantum shift in marketing resources, as well as finely-honed skills in balancing rates, brand expense and experience, and promotional outlays. There is also the question of how to build durable customer relationships in a market largely driven by rate-shoppers.

Given these critical variables, execu-tive teams contemplating a direct bank should increase their preparation in three major areas- strategy, analytics and the target growth model:

Strategy. A strategic assessment of the bank’s funding needs is a must to make the fundamental choice of wheth-er to compete solely on rate or other factors (e.g. product features, access, relationship rewards, existing or new brand) and how much to invest in which appropriate capabilities.

Analytics. The large incumbent direct banks have honed their customer analyt-ics for the online space, and do not have to worry much about internal conflicts with companion physical networks. Even though many regionals are skilled in local market customer management analytics and capabilities, a direct bank launch will pose significant new requirements that are both different and deeper. There are no person-to-person

Regional Bank Challenges in Launching a Direct Bank

SPRING 2017 | 23

REGIONAL BANK CHALLENGES IN LAUNCHING A DIRECT BANK

contacts in the direct banking world to explain the value proposition.

Growth via rate or branding/mar-keting. While rate competition is top-of-mind with direct banks, media spend, branding and marketing information are hugely influential as well. An integrated framework for precision balancing of deposit rate and marketing spend (and related brand positioning / unique value proposition) is essential to guide direct bank deposit acquisition campaigns.

COMPETITIVE LANDSCAPEThe fundamental attraction of a direct bank is the opportunity for out-of-foot-print deposit acquisition in a fast-grow-ing niche market. Collectively, eight of the best known incumbent direct players racked up a 15% compound annual deposit growth rate over the last four years, compared with a 4% average among the top 15 regional banks.

Digital direct banks fall into three competitive categories: 1) Monoline credit card providers; 2) Banks in need of deposit funding; and 3) Banks looking not just for funding but also to build customer relationships. These banks differ in their goals, the urgency of funding needs, and the extent of their product offers (Figure 1).

In contemplating launching a direct bank, is critical to understand the dynamics of the monoline card direct banks. They can be fierce rate compet-itors. When setting a deposit pricing strategy, these players have balance sheets filled with high-yield credit card receivables, which, even adjusting for higher losses, provide hefty yields on earning assets. As a result, they can pay the very highest rates for online deposits while maintaining profitability higher than most traditional banks. For new direct bank entrants, trying to com-

pete on price with these players is not in the cards.

A second competitive space is occu-pied by funding-hungry banks that are willing to pay up for direct deposits, but cannot keep pace with the card monolines in a bidding war. Only occa-sionally do their rates approach the top rankings at the online comparison sites — selectively as circumstances warrant and not usually for extended periods of time. While today’s incumbent players in this space are typically specialty lenders without large deposit books, tomorrow could tell a far different sto-ry. This is the logical point of entry for traditional banks with high loan-to-de-posit ratios looking for supplemental deposit funding.

Both for card monolines and depos-it-hungry banks, the bulk of their direct bank funding is derived from rate driv-en savings and time deposits. They are

FIGURE 1: Direct Banking — Strategic LandscapeTo grow deposits aggressively “Funding-Hungry Banks” will need to deepen relationships (move right) or increase rates (move up).

Source: Novantas

Product Set

Rate

Highest

Competitive

Funding Focus

Relationship Focus

Savings & CD only Savings/CD & Checking All Deposit & Lending

Funding + Relationship Building

High Loan Yield Card Monolines

Funding-Hungry Banks

24 |

not necessarily looking for long-term customers, just funding. Some do not even offer checking accounts and strict-ly emphasize price competition. By way of example, Synchrony Bank states “Our rates are consistently above the nation-al average . . . not just once in a while or on a few products.”

A third group of direct banks have dual objectives — both to gather online deposits and to build bank customer relationships. Checking accounts are a major offering here, even though savings and time deposits still generate most of the funding. But the offers and selling propositions are different. The target audiences more diverse and multiple offers across the deposit and lending spectrum are the norm. Deposit rates, while competitive, do not have to be the highest in a category, reflective of stronger customer relationships and lower price sensitivity. USAA is a clear example of such a bank with a strong brand and a highly-focused relationship play, custom-built around a target cus-tomer segment.

PRE-LAUNCH ESSENTIALSThe technicalities of launching a direct bank are the least of management’s concerns. The barriers to entry are low, especially when using a national bank charter. There are also many options with technology platforms and support vendors. But the big picture questions remain:

Strategy. Planning starts with a projection of the bank’s deposit needs relative to the pace and composition of loan growth and new regulatory guidelines on core funding. From there, the bank needs to consider the possi-bilities within the network footprint, given the current growth trajectory and

alternative scenarios in light of possible changes in strategy. The assumption in many cases is that the bank has already reached the point of diminishing return with product revisions, incentives and promotions.

Then come the questions of what type of direct bank to create, and for which objectives. Clearly, near-term liquidity needs are a core objective, but the desire and likelihood of building online relationships need to be thought through. Even if this goal is largely aspi-rational, it requires early attention to the online checking product and overall site positioning. In addition, launch decisions must reflect factors that play into long-term viability like the breadth of product offers, brand positioning and marketing, as well as technology.

Critically, the interplay between the new direct bank and the established fran-chise will also require careful planning and management to avoid cannibaliza-tion. Use of a prize regional bank asset — the bank’s brand — is not an easy option for a new direct bank, given the potential to cannibalize established balances from the core franchise. Alternatives include an off-label brand or an offshoot of the parent brand (e.g. Cap One 360) — the former more dependent on higher rates and promotional support to attract customers, and the latter possibly more economic for a larger regional but more subject to cannibalization of existing customers. Almost regardless, a signif-icant marketing push will be needed, both to convey a value proposition that attracts consumers, and to sustain a rela-tionship context that inspires customers to entrust a larger share of wallet to the direct bank.

Analytics. While the customer ana-lytics required for direct bank deposit

competition do share some of the key principles used in regional deposit pricing — propensity models, segment targeting, price elasticity of demand, reference rates — the assumptions and techniques from branch based customer management are not cleanly portable.

Pricing is perhaps the most obvious example of different customer analytic. New approaches include:

• Using behavioral insights to adjust rates according to purpose (acquire vs. retain) and according to custom-er origin (switched from another direct bank vs. migrated from a traditional bank).

• Setting reference rates that reflect the influences of both digital and traditional bank offers on customer expectations and purchase propensity.

• Mapping the digital customer journey — Where do the best cus-tomers come from? What products do they start with? How have they responded to price movements? Why do they leave and where do they go?

• Evaluating the interplay between price position and account dura-tion and stability based on acqui-sition vehicle, source and strategy.

“Rate vs. marketing/media spend” growth model. Marketing and media spend is the second huge driver of digi-tal direct deposit competition, as reflect-ed in the sky-high marketing budgets for direct banks. Such spend can be 5x to 10x what a conventional network bank spends. Media buys are often national in scope, requiring different planning and campaign management skills com-pared with a regional bank. How a direct bank supports its price position with marketing/media spend heavily influ-ences acquisition success and, by virtue of resonant messaging that attracts loyal customers, the stability of those deposits as well.

Incumbent direct banks have learned to strike a scientific balance between rates and media spend to achieve their deposit growth objectives (Figure 2). The typical question is: “If we spend an incremental $1 million for deposit acquisition, is it more effectively used for

Critically, the interplay between the new direct bank and the

established franchise will also require careful planning and management to avoid cannibalization.

SPRING 2017 | 25

REGIONAL BANK CHALLENGES IN LAUNCHING A DIRECT BANK

media spend or to offer higher rates?” To manage acquisition volume and costs as rates rise and competition increases, new entrants must learn how to answer this question with high precision.

Other factors include the potential for effective media messaging to attract customers who are less price sensitive than those strictly driven by rates, and the long-term impact of media invest-ment in building customer awareness and consideration.

THE TIME TO ACT IS NOW — ARE YOU PREPARED?With regional bank loan-to-deposit ratios hovering in the 85% to 90% range, most are carrying far higher deposit leverage than the 72% industry average. More than a few players are seeing dwin-dling prospects for in-footprint deposit growth, and executives are in active discussion about the possibilities for

online deposit acquisition in the digital direct marketplace. But what are they getting into?

While network banks are solidly immersed in the digital space by virtue of their online banking offers and ser-vices, there are unique requirements for success with a direct bank, extending to strategies, skills, and resources. The consequences of inadequate preparation can be substantial for regional entrants into direct banking.

Without adequate marketing and media support, for example, the startup will have a crippling dependence on rates to attract customer attention and win balances, especially if an off-label brand is being built from scratch. Clum-sy rate/media tradeoffs will sacrifice opportunity, as will liquidity-focused deposit acquisition strategies that fail to build durable balances and fuller customer relationships.

Compounding the urgency is the fleeting window of opportunity. Rates are rising and the sleepy money that was parked in low yield MMDA and checking accounts is likely to awaken. With the overall field set to perhaps double by 2018, early movers will have the best shot at establishing a distinct presence and customer value proposition.

Well before launch, management teams at better-prepared banks will have inves-tigated the success drivers and required resources and skills needed to advance the direct bank agenda — yielding a much more solid action plan and timetable. While rash entrants are forced to circle back and correct deficits mid-stream, well-launched players can squarely engage customers and competitors in the digital direct space.

FIGURE 2: Direct banks trade off deposit rate and media spend to hit growth targetsRate offered and marketing spend investments have diminishing returns at higher levels. Successful incumbent direct banks have optimized investments and established an efficient frontier for targeted growth.

No Growth/Runoff

Low Growth

Moderate Growth

High Growth

$50

$40

$30

$20

$10

$0

Med

ia S

pend

($ m

il)

Rate Paid (bp)Below Market Average Top of Market

Source: Novantas

Ryan Ritz Managing Director, Charlotte rritz@novantas.com

26 |

BY LEO RINALDI AND ANDREW HOVET

In the next phase of customer migration from branch to digital, every aspect of face-to-face and voice-to-voice interaction needs to be mapped and evaluated for digitization.

The smart phone era — heralded with the iPhone’s launch in 2007 — has accelerated in earnest what prior bank-ing innovations only suggested: true consumer substitution of transaction volumes to electronic channels from the branch. As a result, digital migration is now a key cost reduction lever for banks. Additionally, research indicates that great self-service experiences can enhance customer loyalty by providing convenience, immediacy, and reduc-ing customer effort. But progress on migration is uneven, and the stakes are getting higher, creating a mandate for action in 2017.

The banks that have proactively harnessed this channel substitution trend are gaining ground, taking the lead in slashing branch transaction bur-dens as more of their customers switch their daily banking activities to mobile/online banking and advanced ATMs. However, it is becoming clear that many others are mired in passive, par-tial programs, with real implications for future competitiveness.

Many banks have concentrated in a few high-visibility areas (e.g., ATM and mobile deposits), proceeding without a

full set of transaction metrics or a formal companywide plan. In the early going, this sparked enough true channel substi-tution to permit cost-saving reductions in teller staffing across the industry.

Now many U.S. branches are approaching feasible staffing mini-mums, and resulting staff productivity improvement has slowed. To reach the next level of meeting customer expecta-tions and further improving efficiency banks must go further and automate even more branch services such as softer inquiry or informational services. Simultaneously, they must look at accelerated branch consolidations and closures, which is potentially far more disruptive to customer relationships.

At this point, executives must ask, “Do we have a thorough plan to digitize more of the branch experience as the physical network shrinks? Do we have a plan for originating online the relation-ships that were otherwise originated in the branches being closed?”

In this more comprehensive phase of digital migration, every aspect of face-to-face and voice-to-voice cus-tomer interaction needs to be mapped and evaluated for digitization. And it is

not just about economics and technol-ogy. Considerations must also include the promotion, education, incentives, and segment tailored approaches that are needed to usher customers and staff through delicate transitions.

Winning banks will pull all of this together in a holistic digital migration pro-gram that includes four major components:

• Measurement. The bank needs a detailed map of migration rates across all channels for all transac-tions, service, and sales — not just a few areas, but the total picture.

• Segmentation. Channel-based treat-ments must be tailored for major customer groups, especially remain-ing heavy users of branch and call center services.

• Prioritization. For solid planning, all migratable channel activities must be analyzed and financially quantified, clarifying tradeoffs and potential rates of return on various digital investment options.

• Execution. A customer-centered, cross-functional program is need-ed to assure smooth, appealing transitions and wide consumer acceptance, participation, and

Accelerating Digital Migration:Necessary, Tough and Rewarding

SPRING 2017 | 27

ACCELERATING DIGITAL MIGRATION: NECESSARY, TOUGH AND REWARDING

retention as additional layers of digital self-service are rolled out.

THE ROAD AHEADDigital migration would be much more manageable in a forgiving setting of high banking profitability. But the current and foreseeable environment is one of pressing conditions and hard choices. Recently hovering at a roughly 9% return on equity, industry profitability is down sharply from a 13.4% average prior to the 2007-08 housing crash.

In turn, banks are eager to reduce branch-related expenses, and staffing in particular, as transactions go digital. Novantas research reveals that over the past five years, the industry has engi-neered a 20% decline in average teller staffing per branch in full-time equiva-lents, from 379 FTEs per 100 branches in 2011 down to 302 FTEs per 100 units in 2016 — a roughly 4%-5% decline per year. In contrast, branch counts have come down by a lesser 1%-2% annually during the same period.

Looking out over the next five years, we expect banks will need an additional 20% proportionate staff reduction, plus

an equally sharp increase in branch reductions (Figure 1: Mandate for Further Transaction Automation). This sets the realities of minimum branch staffing on a collision course with aggressive produc-tivity assumptions, with the bank stuck in the middle. In fact, our research indicates that teller productivity improvement has hit a period of diminishing returns, with staff reductions out-pacing declines in branch transactions.

The only way out is additional trans-action automation that will further lower the branch workload. However, remain-ing branch transaction volume will be more difficult to migrate (Figure 2: Breaking the Barriers to Further Migra-tion). This challenge is coming at a time when more aggressive branch consol-idations and closures will be needed to wring out the overhead associated with obsolete physical capacity.

To be sure, variations on this call to action have been floating around for 20 years, with pundits repeatedly hailing an impending industry inflection point in branch usage that has historically never materialized. But this time around, it appears to be different:

First, the substitution effect is real with image deposits leading the way. With new technology such as ATM digital imaging, mobile phone cameras, and OCR software, banks can now digi-tally receive checks for deposit, directly displacing teller activity and branch visits. Customers are rewarded with new convenience and enjoy expanded service outside of branch hours, not to mention better availability. With such a powerful precedent in place (substitution with an appealing customer benefit), the stage is set for accelerated digitization.

Second, the financial urgency is real. Branch reductions can be a primary source of cost savings, needed not only to improve profitability, but also to fund critical transitions to digital channels and offerings. Accelerating channel substitution paves the way, but must be managed correctly. Yanking the rug out can provoke customer defection rather than growth, with a direct impact on core deposit formation.

Third, the competitive urgency is real. While most banks now offer remote deposit capture via mobile and ATMs, the largest banks have led the way and seen

FIGURE 1: Mandate for Further Transaction AutomationStaff efficiency and branch consolidation will need to accelerate, and consumer digital migration will be essential to progress.

* Teller FTE as of second quarter of the yearSource: Novantas’s SalesScape

2011 2012 2014 2015 2016

379

331312 302

-4.5% CAGR

-4% to -5% CAGR

Tellers per 100 Branches

U.S. Branch Count-1% to -2% CAGR

-2% to -4% CAGR

365

2017E 2018E 2019E 2020E 2021E

28 |

both better customer acquisition rates and lower branch usage. In contrast, other banks have taken a “build it and they will come” posture, with weak change man-agement support. The result: weaker cus-tomer channel shift and lowered returns on automation technology investment. Meanwhile, the proactive players race ahead, realizing more digital migration benefits that permit further investment in additional initiatives.

Finally, migration efforts are one key element of a broader repositioning of the bank for an increasingly digital future. These investments are more than just tactical moves to capture near term efficiencies, enhance customer experi-ences and maintain customer loyalties. Migration programs also build long term digital capabilities and cultural changes that are core to reinventing the everyday banking experience.

STEPS IN MANAGING THE MIGRATIONTo reach this optimal zone in digital migration and channel substitution,

FIGURE 2: Breaking the Barriers to Further Migration Following early substantial progress with deposit migration, remaining branch transactions will be more difficult to migrate.

Other category includes Account Maintenance, Admin Corrections, Card Maintenance, Checking Inquiry, Close Account, Fee reversals, New Accounts, Stop Payments, Portal InquirySource: Novantas’s SalesScape

banks will need a holistic migration pro-gram that addresses critical questions and capabilities in the four major areas of measurement, segmentation, prioriti-zation and execution (Figure 3: Keys to a Holistic Digital Migration Program).

The bank must develop sophis-ticated measurements of migration rates across channels over time for all transactions, service, and sales. Many activities were traditionally measured separately within different channel silos, depriving management of a full customer-centric view across all channel touchpoints.

In order to set effective migration targets, it is critical to see how customer behavior is changing and moving from one channel to another by transaction type. For example, a year-over-year view may indicate that deposits are still migrating to mobile, but ATM deposits are stalled. Some of the largest and most advanced institutions in the field of digital migration now have dedicated analytic teams to measure transaction

activity across channels. We believe many others must and will follow.

The bank needs a deep under-standing of different customer seg-ments, their transaction patterns, and their likely migration rates. A particular focus is needed on behavioral drivers: where is channel migration stalled; what is preventing further switching; and what will motivate significant change.

For any transaction type, a small percentage of customers will generate the majority of transactions. Even among these customers, some will be using digital channels sparingly; others have never used them at all. Some will need face-to-face technology education; oth-ers may respond to promotion and/or incentives. Small business customers will need a separate and distinct plan, given their importance and different needs. So the actions a bank must take will differ by segment.

To prioritize properly, the bank needs a comparative analysis of poten-tial rates of return on various automa-

• Small businesses have large volumes of checks and cash • Large dollar deposits may be riskier to accept remotely

• Check cashing not enabled on ATMs• Long hold times may degrade ATM experience

• Timely acceptance of loan payments is critical

• Large external transfers have fraud risk• Large variety with small volumes

58% Deposits 29% Withdrawals/Check Cashing

4% Payments

2% Transfers7% Other

SPRING 2017 | 29

ACCELERATING DIGITAL MIGRATION: NECESSARY, TOUGH AND REWARDING

tion investments. Often priorities are set without an apples-to-apples business case analysis. Specifically, all migratable channel activities must be analyzed and financially quantified. Current transac-tion volumes and associated costs must be determined. For example, if customers are checking current balances by calling the contact center or visiting their branch banker, the total cost of this service can be computed.

Then a realistic projection of migra-tion rates to automated channels is needed. In many cases, the bank has already provided digital options for cus-tomer activities, but activation and usage rates still lag. Here, incremental outlays may be required — e.g., marketing, com-munications, employee incentives — to accelerate customer transitions.

Also, a bit of creativity helps in evalu-ating the best way to support a particular digital migration objective. For example, instead of encouraging customers to use mobile banking to check their account balances, perhaps real-time alerts and balance updates could be provided fol-lowing transactions, negating the need to “look-up” information.

A better sense of digital priorities

will emerge as this migration investment analysis is completed across the full spec-trum of transactions, service, and sales.

Finally, the bank needs a cross-func-tional migration execution program. A “migration project office” is needed to influence and track substitution behav-iors and resulting staffing levels. Great execution begins with a realistic plan. Channel migration is challenging because it requires teamwork and coordination across areas such as retail, digital, market-ing, and real estate.

For example, many banks are retool-ing branch formats to reduce space for teller lines while providing more ATMs and digital stations for self-service or assisted-service. These reformats are challenging to execute without disrupting the customer experience, and the level of synchronization required is similar to the complexities of a new store opening or a product launch. Yet even more of this type of activity is necessary if the full benefits of migration are to be realized.

An additional benefit of digital migration is that customers begin to relax their general sense of branch dependence, becoming less likely to leave the bank when it reformats, combines or closes tradi-

tional branches. Novantas research shows that the closure attrition impact is much lower for multi-channel or digitally-centric customers than for branch traditionalists. Increasing digital adoption across transac-tion, service, and sales dimensions will support not only the reduction of FTE staffing requirements, but will also allow for the large, “chunky” cost take-outs provided by branch closures.

DIGITAL MIGRATION PRIORITIESThe levels of branch consolidation and staff operating efficiency needed for future digital-centric competition simply cannot be achieved without extensive customer channel substitution. Once executives understand this, they will place digital migration high on their list of corporate priorities.

Most of the early action in digital migration has centered on deposit activ-ities, but deposit migration is just the beginning of a long journey to digitize all aspects of the banking experience. New technologies are unlocking a large number of opportunities across transac-tions, service, and sales.

In fact, the “shopping” component of bank sales has already substantially gone online, and as sales fulfillment improves, even more change is in store. In combination, this expanded array of revenue and efficiency initiatives will generate self-funding for additional digital investments and simultane-ously transform the bank into a true omni-channel organization.

The catch is proactive management of customer migration. Coordinated efforts across functions (e.g., marketing, finance, and staffing) are needed to set, measure, and achieve migration targets. To accelerate the journey, many banks are in need of a holistic planning exer-cise in 2017 that begins to address the specifics of this challenge.

FIGURE 3: Keys to a Holistic Digital Migration ProgramFor a solid digital migration program, banks need to develop capabilities in four key areas: measurement, segmentation, prioritization, and execution.

Source: Novantas

Migration rates by channels for all transactions, service and sales

Customer-level movements across channel by transaction type

Dedicated analytics teams to measure activity across channels

Deep understanding of transaction behavior by segment

Barriers to further segment migration; what will it take to overcome

Segment migration scenario.

Cross-functional migration project roadmap, with project office

Branch-level migration targets by transaction type

Training, incentives, metrics, customer feedback loops

Business cases and ROIs for potential digital investments

Key assumptions, incentives

Best path of projects over time

MEASUREMENT

SEGMENTATION

PRIORITIZATION

EXECUTION

Andrew HovetDirector of MDS, New Yorkahovet@novantas.com

Leo RinaldiDirector, New Yorklrinaldi@novantas.com

30 |

BY ANDREW HOVET

With the continuing decline of branch visits, a robust appointment setting process for both customers and sales associates is now an integral component of retail sales.

As bank customers are increasingly shopping online for financial products — surfing for better interest rates and deals — as well as doing more and more of their transactions via online and mobile banking, banks are faced with a dual quandary. Can banks find new ways to draw customers and prospects into sales conversations at the branch. How can banks limit the drop-off when cus-tomers try to open via a digital channel but fail to complete?

Enter multi-channel appointment setting. This simple digital tool, if

implemented comprehensively and inte-grated into new branch sales tactics, can substantially improve new-to-bank and existing customer sales. And it can raise account opening rates as more people choose to begin applications in digital channels as opposed to the branch.

FEWER IN-PERSON AT BATS; LOWER ONLINE BATTING AVERAGEWhat we mean by “multi-channel” appointment setting is an integrated combination of both inbound and outbound appointment management

through multiple customer contact points, which can help generate more quality face-to-face sales conversations. The inbound component involves multi-ple calls-to-action and a digital appoint-ment setting tool that allows digital shoppers to schedule a branch visit for a sales consultation. The outbound component includes proactive outreach to existing customers (or to prospects with contact data), to suggest sales con-versations based on their likely needs. While neither of these approaches is revolutionary, uniting them with a

Replacing Lost Sales Conversations with Multi-Channel Appointment Setting

AS SEEN IN THE NOVANTAS REVIEW

SPRING 2017 | 31

REPLACING LOST SALES CONVERSATIONS WITH MULTI-CHANNEL APPOINTMENT SETTING

*8% neither

Fail, goto branch

Digital

Drop outor fail

Branch

25% Both

13% Branch

54% Digital

How do you prefer to shop? How do you prefer to apply?

common multi-channel appointment platform where both customers and bank associates can create, modify and monitor their appointments is the next step where banks should be heading.

Why is this a critical move now? With the declining check usage, increas-ing adoption of ATM/mobile image deposits, and mobile banking prolifera-tion, teller transactions have been on a multi-year downward trend with no sign of abating. According to data compiled by Novantas SalesScape™ benchmark-ing, teller transactions continue to decline at about 4% per year. This trend is clearly eroding the opportunity to leverage teller referrals for generating sales opportunities. Additionally, with the fallout from recent and well-publi-cized overreach in branch selling tac-tics, banks may be even more hesitant to push products at the teller line. (Don’t expect to hear tellers ask “would you like to apply for a credit card?” as often or

aggressively as they did in the past.. Declining branch visits are chang-

ing the shopping behaviors of consum-ers. According to the 2016 Novantas U.S. Shopper Study, overwhelmingly consumers prefer to research financial products using digital channels in whole or in part (See Figure 1). This shopping behavior has created a major disconnect in the “purchase funnel” (i.e., in the Awareness Consideration

Purchase process). Specifically, awareness and consideration are being formed via online research and shop-ping. Yet purchase and fulfillment are still largely occurring in the branch — whether due to purchaser preference or fulfillment process limitations. The migration to shopping digitally has many implications for banks — which is why banks need to step up their use of digital tools that can help clients through the purchase funnel — includ-ing online chat, click-to-call 800-num-

ber support, and digital appointment setting. As most product sales still hap-pen in a branch, helping clients book a pre-scheduled visit to the branch may be the best way to limit abandonment in the buying process.

Offering multi-channel appoint-ment setting gives existing customers and prospects an alternative route to closing the deal on a new loan or deposit product, should the online process frustrate or stymie them. Completion statistics for online applications are telling, revealing major drop-off rates. For new checking accounts, the average booking rate for customers who start an application online is between 10 and 40 percent, depending upon the bank and where you start counting. If measured after the applicant has completed enter-ing personal information, around three in ten applications result in a funded account; if measured earlier in the process, completion rates are far lower.

FIGURE 1: U.S. Shopper PreferencesCustomers overwhelmingly prefer to shop for financial products digitally, yet purchase still largely occurs in the branch, either because of preference or due to failure in the digital process.

Source: 2016 Novantas U.S. Shopper Study

32 |

With the option of an in-person alter-native to complete their application, banks give online shoppers an in-person parachute — a chance to pull the ripcord and still land at one of their branches to complete the purchase of a new product.

MAKING IT WORKReviewing publicly available materials, we see several examples of North Amer-ican banks that have deployed digital appointment setting to help smooth the seam between preferred digital shopping and the cross-over to in-branch purchase.

An early adopter was Bank of America, which began offering “Bank by Appointment” to its digital banking customers as early as 2013. Bank by Appointment now enables mobile and online banking customers to schedule same-day appointments at branches with specialists in retirement, investment, home loans and small business, as well as everyday banking. Mobile users can automatically add in-branch appoint-ments to their smartphone-based cal-endar. BofA customers booked 317,000 digital appointments in the fourth quarter of 2016 — 65% more than the same quarter in 2015. This equates to roughly one appointment per branch per day. In an industry that averages only a couple of daily product sales per branch, one more digital appointment may be the difference between declining sales and sustained growth.

Canadian banks are moving in the same direction. Bank of Montreal offers a similar integrated application through its mobile and online banking platform, which allows customers to book a real-time branch appointment. TD Canada Trust and CIBC also use these capabil-ities to bridge the gap between online shopping to in-branch advice.

Equally important to having appoint-ment setting is the effective integration of the capability into digital channels. In our work with clients, we have observed that many digital appointment setting deployments are not being fully leveraged. There are at least five areas where banks should deploy prompts for appointment setting in both online and mobile experience:

1. Within digital account opening (DAO), to support customers who want to “bail out” of the digital process;

2. Within product pages as a simple call-to-action to bridge online shop-ping over to in-branch buying;

3. Within the secure digital banking environment (online/mobile bank-ing) for customers who need either sales or service support, with auto-mated pre-fill of customer contact information;

4. On the Branch Locator pages, right along-side the branch phone number; and

5. On the Contact Us page.One of the major benefits of

multi-channel appointment setting is that it allows banks to collect contact information for new-to-bank prospects, which can then be used to help pull the customer through the sales funnel. If the prospect does not show up for the appointment, the branch associate can reach out to reschedule. Additionally, the bank can potentially leverage digital channels to re-market to the prospect.

MOVING FROM ONE-WAY TO TWO-WAYGiving customers multiple opportuni-ties to request and schedule a branch or phone appointment is a large step forward. Linking that to proactive customer outreach to generate branch appointments is another large step. Two-way appointment setting allows both sales associates and customers to book appointments in the branch, giving way to a better opportunity for a two-way dialogue between the branch personnel and the customer or prospect.

A public example of this multi-channel approach is Citizens Financial and

its “Citizens Checkup” program. As described to investors, the outreach is an invitation for customers to come in for an annual financial review with a trusted advisor. At one point in 2016, Citizens had contacted over 327,000 of its customers, resulting in 82,000 appointments booked. Proactive appointment setting takes advantage of the excess capacity of branch sales associates and gen-erates additional sales and referral opportunities. The Checkup initia-tive dovetails with ongoing efforts by Citizens to retool and reduce the size of many of its 1,200 branches, as they move from transaction centers into advisory centers.

Similarly, PNC Financial has been using this tool to help customers bridge between the digital and physi-cal worlds, and along the way improve its organic growth. About half of PNC’s customers are primarily digital and over 40% of transactions are non-teller. PNC is using technology investments to reduce the size of its new branches — down to around two-thirds the tradi-tional square footage — while maintain-ing these physical outlets as a place to close transactions and engage custom-ers. Proactive appointment setting is a big piece of this strategy, as PNC was able to make 350,000 appointments in half a year, with 25-30% leading to new products sales.

While calling for appointments may represent a new sales skill for retail branch associates, it is superior to asking associates to sell over the phone. Clearly, “selling an appointment” is easier than selling a product, and having a face-to-face appointment in the branch gets the associate onto their home turf, where they are most comfortable having a sales conversation.

Giving customers and sales associates multiple options to

schedule branch appointments is a large step forward in shoring up declining branch sales.

SPRING 2017 | 33

REPLACING LOST SALES CONVERSATIONS WITH MULTI-CHANNEL APPOINTMENT SETTING

Additionally, selling an appointment has fewer regulatory concerns than phone-based product sales. From a sales process perspective, pre-scheduled appointments also provide branch associates the ability to prepare for a quality sales conversation. In short, proactive appointment setting provides an opportunity to increase branch sales productivity and effectiveness. Also, linking inbound meeting requests with outbound meeting offers to consumers perusing a bank website can tie together the virtual and the physical worlds for a bank’s existing customers who are shop-ping on the bank website. While it may feel like “Big Brother” to some — getting con-tacted by the bank after reviewing its web-site — several banks are already marketing digitally to existing customers based on their online shopping. Proactive outreach for an in-branch appointment is the logical next step to helping meet customer needs.

KEY COMPONENTS AND ADDED BENEFITSWhile a number of North American banks have embraced successful

appointment-setting programs, putting all the right pieces together holistical-ly will yield the best results. A compre-hensive and integrated multi-channel appointment-setting strategy should include the following components (see Figure 2):

• Digitally enabled customer appoint-ment setting throughout online and mobile channels, available in both the public as well as secure (online/mobile banking) environments;

• Consistent use of appointment-fo-cused “calls to action” in all digital and direct marketing;

• The ability for both customers and bank associates to schedule (and re-schedule) appointments on a common platform, regardless of originating source;

• Integration of digital marketing, contact management, and appoint-ment management platforms;

• Proactive outreach via a calling plan to existing customers to schedule in-branch appointments; and

• Defined sales practices for setting and conducting pre-scheduled appointments, including custom-er-oriented services or assistance.

For banks that track drop-off from various points of the online application process, the value of integrated multi-channel appointment setting will be demonstrable. If only a fraction of online drop-offs instead take up an in-person appointment, pull-through rates (depending on the difficulty of the application process) could as much as double.

With the change in customer preferences toward digital channels, the use of multi-channel appointment setting is one capability that banks can simply and easily implement. It can help customers in migrating across the digital divide, and ensure for the bank more face-to-face quality sales conversations.

FIGURE 2: Multi-Channel Appointment SettingA comprehensive, integrated multi-channel appointment-setting strategy should include multiple calls-to-action, as well as connectivity to branch associates for scheduling and conducting sales conversations.

Source: Novantas

Multi-Channel Appointment SettingTransition Customers to Branch Pull Customers into Branch

Transition Customers to Branch Pull Customers into Branch

Andrew HovetDirector of MDS, New Yorkahovet@novantas.com

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