SUMMER 2020

THE DIGITAL RECKONING

Digital Prowess

Modernizing Commerial Pricing

Fintechs Enter Everyday Banking Cover Story 4 DIGITAL PROWESS WILL GUIDE SUCCESS AS COVID-19 LINGERS

9 | SITTING DOWN WITH NOVANTAS 12 | THE NEW BRANCH BAROMETER: TRAFFIC PATTERNS 14 | CLIPPING THE BRANCH 16 | NEW STRATEGIES TO MODERNIZE COMMERCIAL PRICING 19 | SURGE DEPOSITS: HOW TO MANAGE THE BALANCE SHEET IN A COVID-19 WORLD 22 | THE CD CYCLE: MANAGING RUNOFF WITH CUSTOMER TREATMENTS 26 | CHECKLIST FOR EFFICIENT CONSUMER DEPOSIT GROWTH 28 | DISTRESSED M&A: UNDERPRICED GEM OR EMPTY FRANCHISE? 31 | FROM FINTECH TO FULL SERVICE: HOW FINTECHS CAN ENTER EVERYDAY BANKING 35 | FOR TREASURY MANAGEMENT TEAMS, A CHANCE TO HELP STRESSED CLIENTS 37 | AT THE PODIUM WITH NOVANTAS

2 | A Note from the

CEOs EDITORIAL elcome to the Summer 2020 issue of the Novantas Review. We hope that Director, Novantas Center for the you and your loved ones are safe and healthy. Future of Banking Robin Sidel There are no words to appropriately describe the upheaval that we have all experi- +1 212.901.2742 [email protected] enced in the past several months. Even if COVID-19 abates and economic activity resumes, the damage won’t be easily or quickly repaired. Daily lives will be disrupt- CONTRIBUTORS ed, businesses will struggle and the country will be in the throes of a combative Jeff Diorio presidential election. Pete Gilchrist Gordon Goetzmann Banks have met many of the operational challenges by adjusting branch hours, Andrew Hovet directing customers to digital channels and keeping employees safe. It is impossible Mike Jiwani to predict what will happen next. One thing is certain: the COVID-19 crisis is accel- Brandon Larson erating the transition to digital and virtual access to banking. Bryan Moore Jacob Nygren This issue of the Novantas Review addresses actions that bank executives can take Michael Rice in coming months to ensure they have quality deposits, efficient operations and the Ryan Schulz Robin Sidel proper tools for this transition. Rick Spitler Bob Warnock We knew that our banking clients were hungry for real-time data and analysis during the pandemic, so we took a hiatus from the Novantas Review in the past few DESIGN months and began publishing weekly insights about deposits and retail banking. We Art Direction and Production tracked the flow of federal stimulus payments into (and out of) consumer checking Adrienne R. Cohen accounts, analyzed traffic patterns to help banks identify where to re-open branches and offered suggestions for re-training staff to ease strain on call centers. We will NOVANTAS, INC. continue to present this analysis to our clients on a weekly and monthly basis. Novantas is a leading provider of data, technology and advice to Finally, we also made some news of our own recently. In a move to help clients accel- financial institutions globally. erate their digital-marketing efforts, Novantas acquired the intellectual property Co-CEOs and Managing Directors and assets of Amplero, a Seattle-based AI-marketing optimization platform. We are Dave Kaytes incorporating Amplero’s machine-learning engine into our suite of offerings to help Rick Spitler banks further transform their digital capabilities. You will learn even more about these benefits in coming months. Corporate Headquarters 485 Lexington Avenue We wish you good health. New York, NY 10017 Phone: +1 212.953.4444 Sincerely, Fax: +1 212.972.4602 [email protected] www.novantas.com Dave Kaytes Rick Spitler Address changes and content Co-CEO Co-CEO questions can be directed to the contact information above.

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Offices Chicago New York San Francisco Sydney Toronto

3 | SUMMER 2020 Cover Story

DIGITAL will guide PROWESS success as COVID-19 Lingers BY RICK SPITLER AND GORDON GOETZMANN

he COVID-19 pandemic has pushed banks to act swiftly, a characteristic that is often rare in the industry. From closing branches to navigating the complexities of the Paycheck Protection Program, banks have demonstrat- ed admirable flexibility and focus in the first months of theT ongoing crisis. At this point, there is the possibility that the industry will emerge from the pandemic less harmed than after the 2008 recession. Banks are flush with deposits and they have much more capital to help sustain them. Still, earnings are under intense pressure and costs will be cut dramatically. Credit losses will be a big wildcard in coming months as banks curtail forbearance programs, landlords press tenants for rent and government benefits expire or change. At the same time, economies around the world will stay fragile as the pandemic ebbs and surges. It is tempting to slash costs as a way to bolster financial goals. But such strategies have repeatedly proven damaging to the core franchise. Forward-thinking banks have an oppor- tunity to preserve and grow the franchise by investing in core capabilities that cement customer relationships. It’s always good business to focus on the core franchise. It’s even more important to do so in a tough economic environment. Unlike previous economic upheavals, an abundance of real-time technology and data-driven insights can now help banks achieve these goals. This will be especially critical

4 | DIGITAL PROWESS WILL GUIDE SUCCESS AS COVID-19 LINGERS because some customers have likely the Harvard Business Review. In addition unable to meet the changing needs of changed their banking habits forever. to cutting costs and improving efficiency, their customers. Novantas believes the banks that use these successful companies “develop these capabilities to identify, attract and new business opportunities by making DEPOSITS SURGE retain the best customers will be in the significantly greater investments than At first blush, it may appear that banks strongest position to weather potential their rivals do in R&D and marketing,” the don’t need to worry about deposits. The credit problems and other fallout from authors wrote. Other companies that have industry is flush with liquidity, partly due the pandemic. emerged strong from an economic crisis to government programs that were creat- ed to prop up consumers and companies. A steep drop in consumer spend- ing has kept money in consumer bank accounts, leading to an estimated $1 trillion increase in deposits, according to Novantas research. (See Figures 1.) On the corporate side, companies that are con- cerned about liquidity have drawn down credit lines, causing coffers to swell more than 20% since the pandemic took hold in the U.S. But it’s unclear how long banks will hold onto those deposits even as interest rates hover near zero across the industry. For one thing, a contin- ued weak economy will trig- ger deposit drawdowns as consumers and companies struggle to pay bills. This will become more apparent if businesses stay shuttered and unemployment remains high when government stimulus programs expire. OTHER INDUSTRIES HAVE DONE IT by investing in technology and products Meanwhile, neobanks are luring con- The history books are filled with com- include Target, Apple and Warby Parker. sumers with distinctive features, driving panies that used technology to develop Banks can take a lesson from these efficient acquisition costs that are often new products and find opportunities in success stories by cutting costs surgically. less than $100 per account compared difficult and uncertain times. Preserving the core franchise is always the with more than three or four times that After the airline industry was dereg- goal during a crisis, but this time, future for “efficient” traditional banks. About ulated in the late 1970s, for example, growth won’t come from traditional sourc- 20% of people who switched their prima- carriers started investing in reservation es like new branches. Instead, banks need ry checking relationship in 2019 opened systems to better gauge demand and to invest in digitally-driven capabilities. with one of the neo-banks (largely with created frequent flier programs to build The challenge can’t be taken lightly. Chime or Varo), according to Novantas customer loyalty. The current crisis has already brought Shopper Research. That number is only But just 9% of 4,700 companies stud- a number of companies to their knees expected to continue rising. ied by professors at Harvard and North- because they didn’t anticipate changes Corporate deposits will also remain western flourished after an economic in customer behavior, didn’t adjust when volatile as the economic slowdown crimps downturn, according to a 2010 article in those changes became apparent or were revenues and hurts businesses of all sizes.

5 | SUMMER 2020 COVER STORY

FIGURE 1: U.S. DEPOSITS ARE ON PACE TO PEAK AT ROUGHLY $18.6 TRILLION, UP $3.3 TRILLION FROM PRE-COVID-19 LEVELS

U.S. Deposits

Base Corporate Draws Flight to Quality CARES | Corporate Loans CARES | Small Business Loans/Grants CARES | Individual Payments CARES | Local Government CARES | Other Fed Direct Lending

19000.00 $495 18000.00 $340 $329 17000.00 $604 $340 $329 $660 $604 16000.00 $250 $222 $222 $660 $449 $449 $111 15000.00 Total Deposits ($B) 14000.00 15,214 15,214 15,214 15,214 13000.00

12000.00 Pre-Covid (Q4 2019) Pre-CARES (3/25) Hypothesized Hypothesized Deposit Peak Deposit Stable

Consumer Savings | Savings / MMDA Growth

Acquisition Change to existing, net of switch Attrition Growth

70% 60% 50% 40%

30% 22% 20% 17% 12% 22% 10% 9% 3% 5% 2% 0% 1% -10% -5% -10% -10% -20% 1Q19 2Q19 3Q19 4Q19 2/1/20 2/8/20 3/7/20 4/4/20 5/2/20 5/9/20 6/6/20 2/15/20 2/22/20 2/29/20 3/14/20 3/21/20 3/28/20 4/11/20 4/18/20 4/25/20 5/16/20 5/23/20 5/30/20

Notes: CARES encompasses both the original CARES and PPP Enhancement Acts, Assumes only CARES — Corporate Loans will be repaid, and all other stimulus disbursements will be grants or forgiven | Assumed 50% disbursement for CARES — Corporate and 66% for Fed Main Street lending program Source: Novantas Comparative Deposit Analytics (CDA) Database, May ‘20 | Simple average used to protect participant anonymity | Federal Reserve H8 Data (April 15, 2020), CARES Act (March 27, 2020), and PPP Enhancement Act (April 23, 2020)

6 | DIGITAL PROWESS WILL GUIDE SUCCESS AS COVID-19 LINGERS

The key for banks, then, is to deter- of their best customers and then initiate return to branches once restrictions are mine how to identify and retain consum- strategies to keep them at the bank. fully lifted, according to a recent survey er and corporate deposits during a wave Once those characteristics are from FindABetterBank.com. (See Figure of liquidity and a period of ultra-low identified, banks need to redefine the 3.) That means banks will have to serve rates that can make all deposits look the way they engage with these customers. these customers from afar — either with same. Textured customer treatments and The industry is filled with bankers who outbound calling or monitoring of their precision customer-level management have never interacted with customers digital activity so that the banks can will be critical to protect relationships outside of the branch, as well as a whole provide assistance when needed. and demonstrate to the customers that generation of bankers whom have only their bank is on their side. These are the worked in the boom times. With branch- DIGITAL OPENINGS AND ONBOARDING: customers whose relationship with the es closed and many customers feeling A BIG OPPORTUNITY bank extends beyond the basic deposit financial distress, banks need to pivot One of the most important things that account, generating fee income and con- the way they connect. banks can do to engage with customers tributing stability in the credit portfolio. So far, banks seem to be falling is to improve the inadequate process of short — even when it comes to providing digital account opening and onboarding. CREATING CAPABILITIES simple services that customers want, While it is a priority during the pandemic, This is the time for banks to harness data such as balance updates via email or these capabilities will also be essential that create a holistic view of what cus- text. (See Figure 2.) for the future. Afterall, consumers are tomers want, how they act, where they These challenges are likely to interacting with brands like Zoom, Ama- spend and what they need. Metrics like remain even after the virus retreats. zon and Seamless more frequently than deposit stickiness, CD runoff and credit Fewer than half of people shopping for ever in their day-to-day lives and their risk can help the bank paint a portrait a checking account say they’re likely to sophisticated digital engagement with

FIGURE 2: BANKS AREN’T MEETING CUSTOMER NEEDS IN THE CRISIS

Bank Features: Most Useful vs. Implemented

Most Useful Implemented

35% 30% 25% 20% 21% 18% 18% 15% 13% 13% 12% 10% 10% 9% 7% 7% 5% 6% 3% 3% 3% 3% 0% 1% Dedicated Text/email Reimburse Budget Customer Regular Virtual Mortgage banker balance OD/insufficient optimizer support COVID-19 finance payment updates fund fees via text policy advice deferral updates

Sample: FABB shoppers week 16/17 (N=212) Source: Novantas Customer Knowledge | COVID Pulse Survey

7 | SUMMER 2020 COVER STORY

FIGURE 3: LESS THAN HALF OF CONSUMERS SAY THEY ARE LIKELY TO RETURN TO BRANCHES ONCE COVID-19 RESTRICTIONS ARE LIFTED

Likelihood to Return to Branches Novantas estimates (week 1=3/30 to 4/5, week 18 = 7/27 to 8/2) current attrition Somewhat/Very likely Neither likely nor unlikely Somewhat/Very unlikely rates are above 50%

60% for accounts that 53% originate in the 51% 49% 50% 50% 48% 48% 50% 47% digital channel. 45% 46% 42% 43% 42% 41% 40% 40% 40% 37% these companies sets the bar in terms 36% 35% of expectations. Banks must raise that 32% 31% 31% bar quickly, especially when it comes to 30% 33% 30% 32% 33% 29% 29% 29% onboarding and personalization. 27% 28% 28% 29% 30% 26% Unfortunately, too many banks are 25% 31% 30% 28% still offering sub-par digital service. As 28% 28% 28% a result, Novantas estimates that current 26% 26% 25% 26%26% 20% 23% 24% 23% 23% attrition rates are above 50% for accounts 22% that originate in the digital channel. 19% 18% Furthermore, customers encounter far too many pain points during the process 10% — from application to account funding to setting up direct deposit. (See Figure 4.) Although these issues are difficult to 0% solve, customization and personalization can also help create a bond once the account is open. That may mean redi- recting billboard advertising into more Week 1 Week 2 Week 3 Week 4 Week 5 Week 6 Week 7 Week 8 Week 9

Week 10 Week 11 Week 12 Week 13 Week 14 Week 15 Week 16 Week 17 Week 18 personal experiences, such as sending emails directly from a dedicated banker Sample: FABB shoppers week 16/17 (N=212) to making exclusive online offers that Source: Novantas Customer Knowledge | COVID Pulse Survey can deepen the relationship. The upshot: corporate and retail customers have distinct communication preferences. It FIGURE 4: DIGITAL ACCOUNT OPENINGS ARE FULL OF JARGON AND OTHER PAIN POINTS is the bank’s job to identify those prefer- ences and meet them. Most Challenging Parts of Opening an Account Online There is little doubt that the next few months will be fraught with difficulties. The good news is that advances in AI and other technologies mean that banks 23% are in position to serve customers when 33% 26% Accessing the 13% they need help the most. Understanding Filling in It took a necessary personal financial jargon forms online long time information Rick Spitler Co-CEO, New York [email protected]

Kevin S. Travis Sample: FABB shoppers who opened an account digitally (N=205) EVP, Toronto/New York Source: Novantas Customer Knowledge | FABB DAO Survey [email protected]

8 | SITTING DOWN with Novantas: The Role of Marketing Mix Models

BY ROBIN SIDEL

9 | SUMMER 2020 MARKETING

Vijay Viswanathan knows that it isn’t enough to win customers with just great products and services. As an associate dean and associate professor at Northwestern University’s Medill School of Journalism, Media, Integrated Marketing Communications, Vijay studies how consumers make decisions and the corresponding implications for marketing strategies across a range of industries. He also helps companies move beyond traditional static marketing programs to ones that are dynamic and responsive to today’s customer demands. Those strategies will be even more important as banks navigate the ways in which customer behavior will change in a post-COVID-19 world. Furthermore, the need to optimize marketing spend will be critical in coming months as historically low interest rates intensify cost pressures. A vibrant and enhanced marketing mix model will help banks target the most valuable customers. Novantas recently sat down with Vijay to talk about the role of marketing mix models in banking today.

Q: What is the biggest value that Q: Are banks using this data to their marketing mix models can provide to advantage? companies today? A: The issue has been banks haven’t A: Marketing mix models have been Banks haven’t done a done a good job leveraging the power of around for more than three decades and good job leveraging their data. They tend to rely on marketing have extensively been used by retailers mix models that use highly-aggregated and consumer-goods companies. While the power of their data rather than understanding the huge strides have been made in devel- underlying motivations and preferences oping more sophisticated approaches of individual customers. They then use and methodologies along with greater data. these aggregated models to figure out the computing power and data availability, return on investment and how to allocate marketing mix modeling hasn’t changed resources. But when you sum everything much over time from a conceptual point has been difficult to appreciate the impor- across segments and markets, you suffer of view. At the core, these models help tance of data and the capabilities needed from aggregation bias. These aggregated managers decide where to allocate their to make use of that data. When you don’t models also do not help you respond to marketing resources to achieve their have sufficient expertise in-house to take changing consumer behaviors, especially business goals. the results from the analysis and translate when the marketplace is subject to signifi- them into action, then data is of little use. cant external shocks, like a pandemic. Q: Which industries are the most sophis- ticated in using marketing mix models Q: Where do banks rank? Q: What are the implications of that? for valuable insight? A: Banks have a great advantage over A: Look at what happened in retail, even A: The Amazons of the world are perhaps traditional consumer goods companies before COVID-19. Many retail giants the most sophisticated. Companies that in that they already have their customer, closed shop because they failed to lever- have a strong engineering and/or comput- or first party, data. On the other hand, if age the power of data to respond to their er-science base understand the power of I buy a soda from a convenience store, it customers’ changing needs and relevant data and technology. It is a part of their cul- is difficult for the soda company to know factors that influenced their purchase ture, whereas for most other companies, it that I am their customer. decisions and behaviors.

10 | SITTING DOWN WITH NOVANTAS: THE ROLE OF MARKETING MIX

Q: How does the transition to digital banking impact marketing mix models?

A: Well, digitization has now enabled If you’re not in front of the customers with many banks to deploy an omnichannel marketing strategy. Marketing mix mod- the right content when they are looking for a els can provide managers a good idea of product or service on their phone, which channels effectively drive individu- al consumer behaviors and, subsequently, different marketplace outcomes, such as sales, profitability, new customer acquisi- you have lost them. tion and customer retention across time and space. While marketing mix models can include digital marketing efforts, they A: We have now transitioned from dig- money on paid media. You need to can also include a whole range of custom- ital marketing to dynamic marketing. appear in front of the consumer like a er characteristics, such as demographic Here, you should have the capability to magic genie with your best content or psychographic variables, the firm’s assimilate continuous feedback from and service when the customer actually marketing efforts in offline channels and, the market so that you can finetune and needs you. While digital marketing was importantly, measures of brand equity. optimize your marketing operations about moving from share-of-voice to in almost real-time. You have to be so share-of-attention, dynamic marketing Q: What are some of the new types of much more agile and responsive. It’s is about moving from share-of-attention marketing capabilities that are valuable not enough to have a website with a to share-of-influence. to banks? ton of information or spend loads of Q: How does the domination of mobile devices change marketing strategies?

A: Mobile is the dominant platform for people to access and share information. You have to understand the context behind a human-mobile interaction first so that you can push out the right content. Compare it with stores and their shelves a decade ago. If you didn’t have a product on the shelf, you lost customers. In today’s world, if you’re not in front of the custom- ers with the right content when they are looking for a product or service on their phone, you have lost them.

Q: Let’s talk about your personal banking habits. When is the last time you went to a branch and what was it for?

A: I went to a drive-through ATM recently, but that’s really rare. It’s been many months since I walked into a branch. The last time I went to get a physical bank branch was to get a banker’s check. Today, I use my bank app for just about everything: depositing checks, transferring money, making invest- ments and contacting customer service.

Robin Sidel Director, New York [email protected]

11 | SUMMER 2020 Vijay Viswanathan | Associate Dean, Associate Professor at Northwestern University’s Medill School of Journalism, Media, Integrated Marketing Communications RETAIL BANKING

THE NEW BRANCH BAROMETER: Traffic Patterns BY BRANDON LARSON AND ANDREW HOVET

he scramble to overhaul the retail FIGURE 1: THE PANDEMIC HAS CHANGED TRAFFIC TRENDS SIGNIFICANTLY distribution network is forcing bank teams to consider branch Activity by Market Type* closures that were unthinkable just a few months ago. Con- Feeder Hybrid Work Center ventional wisdom about which branchesT are most efficient, productive 10% and profitable has been turned upside as Americans make radical changes in the 0% way they lead their lives. In many cases, the COVID-19 pan- demic has accelerated changes that -10% were already taking place. But those changes are far from over and they -20% aren’t one-time events. Novantas believes that an ongo- -30% ing analysis of consumer movement patterns can help banks as they enter -40% the next phase of branch closures. This analysis will also be valuable as some

Change in Weekly Visit s -50% Americans begin the long transition back to work from stay-at-home orders -60% while others wrestle with new surges in cases of COVID-19. Such data can be particularly helpful on an ongoing -70% basis as banks consider how to redis- tribute resources and make real-estate -80% decisions at a time when purse strings 3/9 4/6 5/4 6/1 6/8 7/6 8/3

are tight due to interest rates that are 3/1 6 3/2 3 3/3 0 4/1 3 4/2 0 4/2 7 5/1 1 5/1 8 5/2 5 6/1 5 6/2 2 6/2 9 7/1 3 7/2 0 7/2 7 hovering at zero and rising credit risk.

Note: Feeder — Primarily markets where people live, but commute to other markets for work; THE SUPPLY / DEMAND SWITCH Hybrid — Markets where large populations both live and work; Work Center — Places that The U.S. branch network has long been have a high working population, particularly during the day, but few people live there. Often a supply-driven business. Banks decid- downtown areas or central business districts ed where to build branches based on *Markets Included: Atlanta GA, Baltimore MD, Buffalo NY, Los Angeles CA, Memphis TN, market opportunity, traffic patterns and Minneapolis MN, New York NY, Portland OR, San Francisco CA competitive factors. In short, banking Source: Novantas Analysis, NovaLocation, PlaceIQ

12 | THE NEW BRANCH BAROMETER: TRAFFIC PATTERNS was a local scale game where physical convenience drove density of outlets. That was all changing even before the COVID-19 pandemic swept the U.S., where banks have been closing branches at a steady pace since the 2008 financial crisis. The first wave was largely focused on underperforming or “dead-on-arrival” branches that were often unprofitable. Accounts opened digitally Accounts opened in the Banks then turned their attention to low-performing or marginally-profitable have a first-year retention branch have a first-year re- locations characterized by lower deposit rate of tention rate as high as levels and lower sales. Many banks were still in this phase, which focused on low-growth commu- nity and rural markets, before the pan- demic hit the U.S. in March. It seemed to 50% 80% be working: banks experienced limited balance attrition and few lost new sales in this phase because customers were declines than others, for example. such as those with outdoor restaurants. already less dependent on branches The situation has been far differ- Others may be best-suited as limit- than they had been in the past. ent in work centers where traffic had ed-service, appointment-only centers. Novantas has long believed that the plunged by 70% as of late May. This is next round of network rationalization unlikely to return to near-normal levels needs to move beyond the low-risk any time soon since many companies DIGITAL DECISIONS closures of the past to high-deposit loca- have already said that they won’t be These traffic patterns can also play a role tions in densely-branched urban and headed back to the office until well after as banks make decisions about engaging suburban markets. Ultimately, branch the end of the summer — or even next consumers with digital capabilities. visits will be infrequent and focused on year. Furthermore, a growing number of After all, customers who have been advice and issue resolution — just like a companies have announced that they forced to stay home are now accustomed twice-yearly visit to the phone store. will permanently allow employees to to digital interactions with their bank. work remotely. But banks historically have a first-year TRAFFIC PATTERNS CAN DRIVE CURRENT Real-time tracking tools will be retention rate of just 50% for accounts AND FUTURE BRANCH DECISIONS increasingly important as markets that are opened digitally compared with Although banks have closed branches, remain dynamic; this isn’t a one-time as high as 80% for those that are opened changed hours and directed customers exercise. Banks that regularly monitor in a branch. to other channels during the pandemic, traffic patterns in these work centers Customers who live or work in areas many of the changes in branch traffic have can use them to make decisions about that aren’t seeing a resurgence in traffic been out of their control. Instead, it is the branches in those areas. Once-prized can be targeted for digital engagement customers who have driven these new locations may no longer be considered if the bank decides to close branches trends by following stay-at-home orders. viable. On the flip side, anticipated for good. Novantas has spent the past few declines in real-estate prices could create Banks can also enhance digital months analyzing consumer movements opportunities for banks that still want to onboarding capabilities — a typical across the country by plotting anony- have a presence in these locations. weak spot — for new customers who are mous cell-phone signals on a base map. The same will likely also be true for acquired through these channels and This dynamic data show where people retail centers — particularly shopping may no longer be driving to branch- are shopping, working and visiting. malls — as a wave of bankruptcies, store dense areas. As of mid-June, visits to bank branch- closings and liquidations pummel the es and other retail locations were down industry. In addition, many consumers Brandon Larson 30% from pre-pandemic levels, but off the have grown even more accustomed to EVP, New York April peak of nearly 50%. These figures online shopping during the pandemic [email protected] were highly variable, based on geography and may be unlikely to return to physi- and local market characteristics. Bank cal stores. Banks may be better off put- Andrew Hovet branches near retailers that were deemed ting branches in shopping areas that are Director, New York “essential” experienced fewer traffic expected to see a resurgence of traffic, [email protected]

13 | SUMMER 2020 Clipping the COVID-19 has rapidly accelerated the adoption of digital Branch banking and created widespread uncertainty about the future of the branch network. Banks have scrambled to close branches, redirect customers and add digital capabilities as sales volumes tumble. Most banks are still being very cautious about shutting branches permanently. That could certainly change if cost pressures intensify due to rising credit losses and a slow economic recovery. Faced with fewer opportunities for physical banking, consumers will continue the shift toward other BRANCH PROFILE FOR RESPONDENTS channels, underscoring the importance of digital account Fewer than 100 branches 22% openings and personalized outreach in a virtual world. 100-200 branches 26% Novantas is tracking these trends closely and conducting 200-500 branches 22% regular surveys about branch operations. The information 500-1,000 branches 17% below is based on a survey conducted in June that received 1,000-2,500 branches 13% responses from 46 financial institutions, representing roughly Novantas SalesScape Comparative Analytics Survey closed 6/12 18,000 branch locations.

PANDEMIC TRENDS

Teller transactions are down sharply from late 2019 as branches closed or reduced hours of operation, while digital sales are up sharply.

Decline in Teller Transactions Digital Sales

45% 40% 37% 41% 40% 35%

35% 32% 30% 26% 30% 25% 25% 20% 19% 20% 19% 15% 15% 11% % of Responses % of Responses 10% 10% 7% 5% 5% 3% 5% 0% 0% 0% More than 41% to 31% to 21% to 11% to 1% to 21% to 41% to 61% to 91% to +121% 51% 50% 40% 30% 20% 20% 40% 60% 90% 100%

56% of banks said teller volumes are 26% of banks saw digital sales increase by 14 down| by more than 31% from Q4 2019 more than 90% LOOKING TO THE FUTURE

Of the branches now closed, banks are being cautious about shutting them permanently, but many are considering accelerating branch consolidations or expect their network to be reduced notably within two years.

May Remain Closed / Consolidated Branch Consolidation Considerations by Branch Network Size

Over 1,000 500-1,000 200-500 100-200 Under 100 50% 42% 40% 5% 40% 35% 35% 9% 30% 30% 2% 23% 20% 25% 5% 12% 9% 20% % of Responses 10% 9% 15% 0% % of Responses 9% 10% 14% 2% 0% 1% to 9% 10% to 19% 5% 2% 7% 9% 2% 2% 0%

40% of banks said they were Delay No plans, Considering Expect per selection once than more answer could *Banks considering accelerating planned planned reviewing accelerating network branch consolidation / closures consolidations network plans will be reduced

Banks regret not having certain procedures in place WOULDA, COULDA, SHOULDA before the pandemic struck.

UNDER 100 BRANCHES 100-200 200-500 OVER 1,000 Better call-center technology More digital capability & Increased authority limits Phone & internet-based selling enablement Better outbound calling Instant issue at drive-thru Flexible staffing Cross training of branch staff Shared banker laptops Remapping of call center Verification of ID over the phone Chat, video conferencing lines into the branch Appointment setting Online appointment Plan to quickly move people Work-from-home capabilities banking to areas that match skill set Branch employees trained Mobile-acquisition programs to cover call center

How much smaller do you expect your branch network to be in two years?

Over 1,000 500-1,000 200-500 100-200 Under 100

50% 4% 7% 40% 4% 30% 7% 14% 20% 11% 4% 4% 4%

% of Responses 10% 7% 7% 7% 11% 4% 4% 4% 0% No Change 1% to 5% 6% to 10% 11% to 15% 16% to 20% Smaller Smaller Smaller Smaller 15 | SUMMER 2020

Source: Novantas SalesScape Comparative Analytics COMMERCIAL BANKING New Strategies TO MODERNIZE COMMERCIAL PRICING BY JACOB NYGREN AND MICHAEL RICE

Is a 40-year-old pricing structure really the best way to attract customers?

ommercial-banking operations have retained what Novantas believes is an outdated, labor-intensive pricing Cstructure that creates friction between bankers and clients. The inherent problems of a system that has more than 2,000 price points, combined with growing external competi- tion and a shift to digital transactions, means that banks need to consider new pricing approaches. Novantas estimates that an overhaul of commercial pricing represents a revenue opportunity of nearly $4 billion

16 | NEW STRATEGIES TO MODERNIZE COMMERCIAL PRICING to banks, but only for institutions that ture originally sought to balance bank NEW PRICING STRUCTURES have the foresight to embrace innova- profitability and market needs within the Novantas has identified at least four tive pricing before weaker economics regulatory limitations imposed by Reg Q. promising structures that can re-make take hold. Legislators repealed the rule 10 years ago, commercial pricing — just as they have but there has been very little change to done in other industries. Simplified DECAY OF THE STATUS QUO the status quo. package pricing and subscriptions are Today’s commercial-pricing structure has Indeed, the burdens of this legacy two that promote a simplified user expe- evolved from the framework of Regulation structure remain and are arguably as rience and streamline the sales process Q, the 1933 federal rule that prohibited cumbersome today as ever before, to promote deeper advisory-based client the payment of interest on commercial despite the many available alternatives. interactions. Banks can also consider deposits. At the time, bank-profitability Essentially, commercial pricing has customized pricing plans that use models relied on the revenue generated stagnated Essentially, commercial pric- algorithms or link pricing directly to the by these deposits to offset the costs of ing has stagnated due to inertia even as value it creates. transaction activity. digital advances create new opportuni- Under simplified package pricing, Earnings credit rates (ECR) took hold ties for an overhaul. legacy constructs such as ECR can PAIN POINTS

No matter what their size, com- panies grapple with a tangled web of data about their banking services. Here are some key num- Average pages of account Average number of unique Unique service line items bers, based on analysis of more analysis statements per service line items used managed by most banks than 10,000 bank statements that month across all bank were provided by nearly 200 relationships corporates and cover more than 60 banks.

Source: Novantas NDepth bank fee analysis data

as interest rates soared in the 1970s and Corporates and bankers alike feel be shelved in favor of direct interest. 1980s and banks gradually began adding the pain points associated with com- Complicated and cumbersome service more transaction fees and services. mercial banking pricing. In some cases, line item pricing can yield to fixed-fee Pricing schemes became more complex, companies struggle to digest thousands package pricing or all-in product pric- required more time to manage and nego- of pages of account analysis each month. ing. By collapsing service line items tiated relationship pricing became the A simple goal to consolidate monthly into a single package, banks can shift rule rather than the exception. fees paid, compare monthly changes and the perception of “nickel-and-diming” This ever-expanding complexity understand how pricing compares across customers into one that offers standard introduced increased friction within banks becomes a herculean task for the features “free of charge.” With package the sales process that continues to exist typical treasury group that operates pricing in place, banks can still selec- today. In fact, a typical bank relationship without intelligent fee-analysis software. tively offer value-based add-on features manager (RM) now spends an estimated On top of all that, near-zero interest like enhanced reporting or industry-spe- 225 hours per year on lengthy price rates and corporate belt-tightening tied cific specialty offerings. negotiations, addressing billing errors, to the global pandemic are leading to The “banking as a service” concept describing the minutia of service line increased scrutiny over bank fees. Disin- draws on the pricing model used by item pricing and evaluating how pricing termediation by fintech organizations and many software companies to better compares (or more often, doesn’t direct- slow growth in new treasury management reflect value and promote deeper client ly compare) with competitor banks. fees and services further exacerbate the integration. This model helps shift the The current cost-based pricing struc- headwinds faced by commercial banks. relationship dynamics from being purely

17 | SUMMER 2020 COMMERCIAL BANKING CREATIVE

PRICING BUNDLE/PACKAGE SUBSCRIPTION CONTINGENT PERSONALIZED ACROSS PRICING MODEL PRICING* ALGORITHMIC PRICING Non-bank: Non-bank: Non-bank: Non-bank: INDUSTRIES New-car option Amazon Prime Investment Car insurance Banks have been slow to packages banking fees modernize commercial-pric- Bank: Bank: ing structures, but they can Bank: Tiered online Bank: Broad and complex embrace new methods by Cash banking platform Receivables relationships examining how other indus- management for (bronze, silver, management tries have embraced creative importer gold) pricing models. BENEFIT: BENEFIT: BENEFIT: BENEFIT: Simplifies Simplifies Based on real or Customized and purchase purchase anticipated value unique

*based on proactive role in billings and collections based on defined success criteria

transactional to one that delivers more ship data (risk, attrition, scoring) and tioned to benefit as the industry expands value-based analytics, data and advice. market benchmarks (pricing, penetration beyond its historical domain of trans- Under this model, banks can put them- to establish optimal, client-level pricing). action execution into the value-added selves in the enviable position of being realms of data, analytics and advisory a transactional, informational, analyt- THE ARGUMENT FOR MORE services. Improved pricing schemes will ical and advisory hub for their clients. EFFICIENT PRICING encourage deeper client relationships The contingent pricing concept By shrugging off the yoke of the past and supporting technology will unlock seeks to directly tie pricing to value. Fees and adopting modern commercial pric- additional capacity, empowering a more are calculated based on measurable real ing schemes, banks can introduce struc- effective sales force. or expected benefits to the client. For tures that more clearly reflect the value Ultimately, these changes will herald a example, accelerated receivables can of the business for the client. This type new era in commercial banking as friction produce a measurable improvement in of overhaul can simplify sales efforts, in existing pricing schemes is reduced, days-sales-outstanding (DSO), which promote efficient pricing and profit- yielding greater operational efficiencies leads to quantifiable working capital ability and offer a client experience that and a restoration of economic equilibrium. benefits for the client. Or customers can rivals fintech competitors. And in the long run, banks will be share in the revenue benefits that come Sales personnel, now freed from the compensated for the value delivered with commercial-card performance, such shackles of complex price negotiations, and transparency in pricing will effec- as customer penetration, higher average can pivot to truly become advisory tively restore bankers as collaborative spend or reduced fraud. This can cement partners. Client interactions that were business partners rather than potentially the banker as an advisory partner invest- once centered around nitpicking line perceived as exploitative vendors. ed in clients’ success. items can evolve into conversations of Finally, banks can use intelligent how consolidating volumes can improve Jacob Nygren algorithmic pricing models to provide pricing through economies of scale, how Principal, Chicago unique client-specific pricing that can be new products benefit their organization [email protected] used for the entire book of business. This and/or advisory discussions on process personalized approach to pricing uses vast optimization. Mike Rice amounts of client behavior data (channel, Financial institutions that revamp Managing Director, New York customer-service engagement), relation- pricing structures will be well-posi- [email protected]

18 | Surge Deposits: How to Manage the Balance Sheet in a COVID-19 World

BY MIKE JIWANI AND PETE GILCHRIST

ore than $2 trillion of deposits myriad scenarios that could develop in A prudent approach can help main- have flowed into U.S. banks coming months and years. At the heart tain balance sheet stability through since early March, represent- of this strategy is the need for banks to the cycle. This involves determining Ming an unprecedented surge. understand the potential behavior of financial objectives and constraints, Spurred by government programs and a these surge deposits, dictating how they planning for multiple potential sce- strong desire for liquidity by companies could be put to use on the asset side. narios, developing a coordinated and and consumers alike, banks are now This should involve developing centralized action plan and developing awash in deposits. The trend is drawing detailed surge-deposit analytics to proj- appropriate monitoring and gover- attention from regulators and bankers, ect structural and stressed liquidity, as nance to make course corrections creating new questions about balance well as customer-level analytics to make as necessary. sheet management as old Treasury informed estimates of balance behavior Taking these steps now can help models essentially become obsolete. based on a vast array of data points prevent the need for a panicked and Banks need to develop strategies about the customer’s past holdings, likely expensive overcorrection down for managing the balance sheet under current position and likely future path. the line.

19 | SUMMER 2020 TREASURY

FIGURE 1: TOTAL U.S. DOMESTIC DEPOSITS — Q4 2019 A LONG LIST OF UNKNOWNS The months of uncertainty around Consumer | $6.9T Commercial | $3.6T Wealth | $2.5T COVID-19 are unlikely to retreat any- Small Business | $1.2T Public Funds | $1.0T time soon. Before the virus hit earlier this year, the banking industry had been experiencing a relatively stable deposit 7% environment. The Fed had signaled it planned to keep rates flat for the fore- 8% seeable future, and while the deposit market was still active with accelerated money in motion, trends had become somewhat predictable. (See Figure 1.) But the industry has been anything 16% Deposits by Segment 45% but stable since early March when a (% of Total Deposits) large influx of liquidity started to enter the system. The Fed cut rates by 150 basis points to zero in a matter of two weeks and companies planned for the worst by drawing down credit lines to shore up liquidity. These actions, com- bined with government programs such 24% as the Payment Protection Program and stimulus payments, have fueled the surge in deposits. (See Figure 2.) Furthermore, the ongoing pandemic Source: Novantas Analysis, FDIC SOD report; Z1; Includes commercial and savings banks, has significantly, and perhaps perma- savings / lending associations, and credit unions nently, changed the way in which people and businesses conduct themselves in FIGURE 2: U.S. DEPOSIT BASE seemingly every facet of life — a devel- opment that has turned past assump- Total U.S. Domestic Deposits tions about deposit behavior on its head. The future behavior of these depos- Baseline Deposits Surge Deposits its is now at the heart of critical ques- $18 tions banks are asking themselves. How quickly will these surge deposits burn $17 down? What is the worst-case scenario? How can a bank make the distinction $16 between high- and low-quality deposits, given there are limited differences in product and cost between them in an $15 ultra-low rate environment? Sensitivity to rates will also be a major $14 factor. How will these deposits react when rates finally rise again? If rates go nega- tive, what actions should the bank take

Total U.S. Domestic Deposits ($T) $13 with respect to product design, pricing and marketing? Is it wise to be the first $12 mover or is it better to wait for others to act? How will deposit customers respond? Finally, banks will need to consider Jan-19 Jun-19Jul-19 Jan-20 Jun-20Jul-20 Dec-18 Feb-19Mar-1Apr-199 May-19 Aug-19Sep-19Oct-1Nov-199 Dec-19 Feb-20Mar-2Apr-200 May-20 changes to models underlying asset/ Note: Total H8 deposits grossed up to equal total U.S. domestic deposits, which includes liability management, funds transfer deposits from commercial and savings banks, savings & loan associations and shares from pricing and stressed liquidity, as well as credit unions the overall impact on the institution’s Source: Novantas Analysis; H8 Report asset strategy.

20 | SURGE DEPOSITS: HOW TO MANAGE THE BALANCE SHEET IN A COVID-19 WORLD

Because they don’t know how these type when the rate cycle turns. Banks surge deposits will behave, most bankers will need to reevaluate their Treasury have invested these funds in short-term, models and apply new assumptions and low-yielding assets. While longer-term overlays to account for the recent surge assets provide limited incremental value in deposits. at the moment, yield curves could steep- Next, banks should evaluate margin- en as the economy stabilizes. That means al initiatives to affect the balance sheet. banks could leave valuable net interest These initiatives should be evaluated margin on the table if they don’t optimize centrally so that they can be compared their balance sheets. The impact could across lines of business and relative be significant: Novantas has found that Keeping a relatively to Treasury actions. This will help the balance sheet optimization can be worth stable balance bank determine things like the need as much as 50 bp in return on equity or and capacity for incremental funding two percentage points of earnings per sheet position that and which funding sources (customer or share growth — all while staying within non-customer) are most efficient. the bank’s risk appetite. optimizes through the Of course, things rarely go as cycle is ideal. planned, so banks must be prepared HOW BANKS HAVE BEEN REACTING to pivot as necessary. Banks should Banks are already pursuing different monitor performance and the economic strategies to manage these surge depos- environment closely, developing early its. Some bankers are happy to have warning indicators that suggest when them because they provide much-need- changes are needed. Additionally, the ed liquidity relief. Others are worried bank should install an appropriate these surge deposits will crimp NIM as The key to success is around prepar- governance structure to ensure it is loan growth slows and there isn’t a pro- ing for multiple potential scenarios and in a position to make course correc- ductive place to put these excess depos- being nimble enough to pivot as needed. tions as necessary. This will limit any its to use. Some are even worried these “whiplash” a bank may incur as it tries deposits will affect capital and liquidity STRATEGIES TO MANAGE THE to manage its balance sheet through a ratios, believing they may be forced to BALANCE SHEET tumultuous environment. raise capital at an expensive time. This Novantas believes that banks can best The uncertainty gripping the is driving some banks to move deposits manage these uncertain times by first industry today requires that banks take off balance sheet and/or make more identifying their financial objectives. a thoughtful approach and prepare aggressive rate cuts to reduce balances. What is the bank looking to optimize? It for a range of scenarios to manage the Additionally, banks are beginning may be earnings growth, return on equi- current surge in liquidity. Proper prepa- to question the near-term value of low- ty and/or some other goal and it likely ration can ensure banks aren’t left in a cost core deposits if rates stay low for an involves optimizing in the near-term sub-optimal balance sheet position for extended period. Others are willing to while not sacrificing long-term success. whatever lies ahead. invest in the key capabilities required to The bank must do this while continuing Advanced institutions already are win core customers, betting the deposits to operate within its risk appetite, with analyzing deposit behavior at the custom- and associated fees will put them in a a particular focus on capital, leverage, er level for both retail and commercial better position if and when the economy liquidity and interest-rate risk. lines of business, enabling banks to be returns to some sort of normal state and Once the goal is identified, the bank more surgical about pricing and targeting rates begin to rise. needs to prepare for a number of poten- decisions. For example, which products Whatever strategy a bank is taking, tial scenarios. Novantas recommends and customers would have the lowest the last thing a bank should do is take that these scenarios include a V- and/ balance impact from reducing rates? drastic actions only to overcorrect down or U-shaped recovery, a prolonged In other words, the more granular, the line. Keeping a relatively stable low-rate environment — such as 0% for the better. balance sheet position that optimizes the next three years — and a period of through the cycle is ideal. Uncertainty negative rates. Mike Jiwani in the future has only made this task Each scenario should include projec- Director, New York more challenging: without a clear sense tions of funding needs (based on expect- [email protected] of what will happen in the future, it is ed loan growth and credit performance) hard to project how the balance sheet and how deposits will behave. This Pete Gilchrist will react and what actions are needed should include estimates of burndown EVP, New York to optimize. rates and analysis of betas by deposit [email protected]

21 | SUMMER 2020 THE CD CYCLE: Managing Runoff with Customer Treatments

With rates hovering at zero, how do you keep customers who have been getting more than 150 basis points on their deposits for the past year?

More importantly, do you want to?

22 | THE CD CYCLE: MANAGING RUNOFF WITH CUSTOMER TREATMENTS

CD portfolios are on pace to run off 40% of balances over the course of a year. That would be modestly higher than levels seen in 2007-2009. The runoff is driven by low rates and the desire of customers to switch from term deposits to liquid savings. This proprietary snapshot from Novantas’ Comparative Deposit Analytics (CDA) platform shows the trend.

Annualized CD Growth | All Terms

Annualized Growth 4-Week Rolling Average

20%

10%

0%

-10%

-20%

-30%

-40%

-50%

Quarterly Weekly -60% CDA data CDA data 1Q19 2Q19 3Q19 4Q19 4-Jul-20 6-Jun-20 1-Feb-20 8-Feb-20 4-Apr-20 11-Jul-20 18-Jul-20 25-Jul-20 1-Aug-20 7-Mar-20 13-Jun-20 20-Jun-20 27-Jun-20 2-May-20 9-May-20 15-Feb-20 22-Feb-20 29-Feb-20 11-Apr-20 18-Apr-20 25-Apr-20 14-Mar-20 21-Mar-20 28-Mar-20 16-May-20 23-May-20 30-May-20

Source: Novantas Comparative Deposit Analytics (CDA) Database, July ‘20 | Simple average used to protect participant anonymity

In the past, banks that sought to reprice these time deposits as quickly as possible — for as little as possible — later discovered that strategy didn’t work. Not only did they see large outflows, but they later had to pay more to re-acquire these deposits when rates rose. Banks that can retain these deposits now when they are inexpensive (but not the cheapest in the market) can reap the benefits over the longer-term.

23 | SUMMER 2020 RETAIL BANKING

More than 60% of current CDs are priced above 1.5%, according to Novantas research. Many of those customers will feel “sticker shock” when they consider choices for those maturing funds. Banks need to consider multiple strategies for these customers.

STANDARD RATE DISCIPLINE SHIFT TO MMDA SLOW PLAY EXCEPTIONS Lower rate sheet rates in line Consider proactive shifting of Customers with prior exceptions with competitors promo CDs into MMDA/Savings have self-identified (sometimes to lean into market trends and with banker assistance) as rate Avoid ‘area of indifference’ — customer preferences sensitive worst place to be is ‘not the best, not the worst’ Short-duration offers can help These clients are at highest risk shift deposits while improving for near-term attrition, but Acquisition rates dampened for retention, delivered on a back depending on other now but likely to return as excess pocket or proactive basis characteristics may be long-term liquidity flows out and branch persistent traffic rebounds Cashable CDs provide similar outcomes if available

Since not all CD customers are alike, banks need to assess their anticipated behavior before the CDs mature.

Term Renewal Segmentation

Term Auto-Renewal Likely Not Likely Low EXPECTED BEHAVIOR Likely to auto-renew at go-to rate/term Not likely to auto-renew, likely to respond to term switch offer

Not likely to auto-renew or respond to term switch offer

ILLUSTRATIVE TREATMENT No additional treatment Price Sensitivity Provide term offer with higher rate than current on-sale Provide savings offer to retain balances in the bank High

Source: Novantas Comparative Deposit Analytics (CDA) Database, July ‘20 | Simple average used to protect participant anonymity

24 | 25 | SUMMER 2020 CHECKLIST FOR EFFICIENT CONSUMER DEPOSIT GROWTH

The value of core, relationship-based sticky consumer deposits can’t be underestimated in today’s banking environment. Still, many banks aren’t taking advantage of analytics that can help avoid costly errors and improve their mix of high-value deposits as they navigate this unprecedented period. This checklist for efficient deposit growth can go a long way in guiding banks to make the most of their valuable deposits.

26 | Determine segments with favorable, higher-value CHOOSE retention profiles Identify long-term sticky deposits Calculate duration analytics for portfolio products and segments

Analyze primary DDA relationships and core deposit TRACK growth versus single-service hot money Assess loyalty versus hot money Leverage flow-of-funds level detail to spot new versus existing money and attrition risk

Analyze weekly rate position and understand true market clearing rates across acquisition and portfolio COMPARE balances by peer set and industry totals Align results to timely peer data Explain variances to core industry metrics, providing executives a clear picture into key bank performance versus the market

DEEPEN Monitor customer cross-sell behavior over time and retention impact Measure cross-sell activity, including new-to-bank Analyze the effectiveness of promotional campaigns, households including marginal cost of funds

Efficiently target new money without cannibalizing the OFFER existing book Define offers to deepen relationships, gather and Pinpoint the best market and product to launch a maintain deposits campaign, tracking key competitor and market reference rates across both direct and branch channels

27 | SUMMER 2020 M&A Distressed M&A: Underpriced Gem or Empty Franchise?

BY MIKE JIWANI, BOB WARNOCK AND BRYAN MOORE

OVID-19 has thrown bank merger we looked at the change in funding non-government assisted transactions. and acquisitions into disarray, quality leading up to the transaction, (See Figure 1.) In normal transactions, we triggering the collapse of several followed by the post-deal deposit runoff. see no material changes to mix or cost planned transactions and creating (While not every stressed deal is govern- in the two years leading up to the deal a cloudy future for deal-making. ment-assisted, we felt it represented the announcement, with behavior largely CNovantas expects some clarity to emerge easiest and cleanest proxy.) tracking the industry during the entire over time, however, creating potential The upshot? On average, deposit timeframe. Failed banks, however, had acquisition opportunities for value-hunt- quality deteriorated significantly before material run-up in time deposits relative ing buyers later this year and into 2021. government-assisted transactions, lead- to the industry, with a corresponding While evaluating credit quality is ing to materially-higher deposit runoff increase in deposit costs of more than critical to any bank acquisition, evalu- after those deals. There was a wide range 30 basis points. ating deposit quality is of heightened of outcomes: some deposits accelerated This phenomenon is not surprising importance during this unsettled time. after the transactions, while others expe- since stressed banks try to bolster their The deposit book is typically evaluated rienced runoff of more than 30%. liquidity position with the only tool they based on a set of traditional bench- For potential acquirors, this under- have: price. As a result, these banks marks, but Novantas has found that scores the need to pay attention to the materially shift their customer base it is also valuable to examine deposit quality of a target bank’s deposits when towards a much more price-sensitive management on a historical basis in pursuing M&A, especially as we enter a mix right before being acquired. order to help determine how deposits more stressed environment. Not doing may behave in the future. so could be the difference between DEPOSIT RUNOFF POST-CLOSE acquiring an underpriced gem and an Banks that make stressed acquisitions A LOOK AT PAST DEALS empty franchise. where the target’s deposit portfolio has Novantas recently analyzed more than deteriorated are left with two undesir- 300 deals from the past 15 years, includ- FUNDING QUALITY PRE-CLOSE able options when these time deposits ing the largest non-government-assisted The analysis revealed notable differ- mature: either maintain the above-mar- deals and all government-assisted deals ences in the changes to pre-acquisition ket rate offered to these price-sensitive that were above $1 billion. Specifically, funding mix of government-assisted and customers or drop the rate and expect

28 | DISTRESSED M&A: UNDERPRICED GEM OR EMPTY FRANCHISE?

FIGURE 1: PRE-ACQUISITION FUNDING MIX & COSTS Time Deposits As % of Total Funding Government-Assisted Transactions Non-Government Assisted Transactions

50% 30 25 40% 20 30% 15 10 20% 5 of Total Funding Relative to Industry 10% 0 Median Cost of Deposits Median Time Deposits as % 0% -5 Pre 8Q Pre 7Q Pre 6Q Pre 5Q Pre 4Q Pre 3Q Pre 2Q Pre 1Q Pre 8Q Pre 7Q Pre 6Q Pre 5Q Pre 4Q Pre 3Q Pre 2Q Pre 1Q

Source: Novantas analysis of call report data and M&A transaction material deposit runoff. The effect of this tial year post-close (See Figure 2.) had initial deposit runoff above 15%, can be seen by tracking deposits in leg- Not all stressed deals are alike, with continued runoff thereafter. (See acy seller branches post-close. The typ- however. Breaking down govern- Figure 3.) It’s often only through a ical failed-bank deal sees initial deposit ment-assisted transactions further, we comprehensive assessment of the target runoff of eight percentage points higher see that some acquiring institutions bank’s customer base that acquirers can than regular transactions. In many cases, actually accelerated growth in legacy understand what the expected range of that runoff persists well beyond the ini- seller branches post-close, while others runoff will be.

FIGURE 2: DEPOSIT GROWTH PRE- VS. POST-DEAL

Seller Branch Deposits (Overlap Markets) Seller Branch Deposits (Legacy Seller Market Only) 5% 3.5% 3.4% 2.5% 2% 2.1%

0% -0.2% -0.6% -0.5% -0.3% -2% -1.1% Deposit CAGR -5% -3.4% Percentage Change in -5.2% -10% -8.2%

3-Years Close to 1 Year 1 to 4 Years 3-Years Close to 1 Year 1 to 4 Years Pre-Close Post-Close Post-Close Pre-Close Post-Close Post-Close

Non-Government Assisted Transactions Government-Assisted Transactions

Source: Novantas analysis of FDIC Summary of Deposits report

29 | SUMMER 2020 M&A

FIGURE 3: CHANGE IN DEPOSIT GROWTH CAGR PRE-CLOSE VS. POST-CLOSE (GOVERNMENT-ASSISTED TRANSACTIONS ONLY)

Seller Branch Deposits (Overlap Markets) Seller Branch Deposits (Legacy Seller Market Only) 10%

5% 4.1 1.9 2.7 0.6 0.6 0% -0.9 -5% -4.9 -6.7 -6.7 -10% -9.4 Deposit CAGR -15% -14.1

Percentage Point Change in -20% -18.9

3-Years Pre-Close 3-Years Pre-Close 3-Years Pre-Close 3-Years Pre-Close vs. vs. vs. vs. 1 Year Post-Close 1 to 4 Years Post-Close 1 Year Post-Close 1 to 4 Years Post-Close

25th Percentile Median 75th Percentile

Note: Deal Close is defined as the date at which the sale is completed (e.g., 1-4 years post-close includes performance from the date one-year after deal close, to the date four years after close) Source: Novantas analysis of FDIC Summary of Deposits report

PROCEED WITH CAUTION quality and fit with acquirer’s network. deposit due diligence for any major bank Periods of stress can create attractive Interested acquirers also need to acquisition, but it’s even more critical in acquisition opportunities for oppor- estimate the impact of potential inte- stressed transactions where acquirers tunistic buyers, but it is critical to gration decisions to determine what must separate out hot money to filter understand the quality of the deposit will happen if the acquiring institution down to the true remaining underlying franchise before making an acquisition. drops rates on legacy customers of value of the franchise. Too often, acquir- Novantas has identified high-level the target bank after the acquisition ers have paid what they thought was a actions that can be taken during due is completed. While a buyer may want discounted price for a distressed bank, diligence to help uncover any potential to run off “hot” money, it is critical to only to find limited or no underlying val- warning signs. understand how much runoff will occur ue. Enhanced deposit due diligence in the First, the target bank’s deposit fran- from that decision, as well as minimize current strained environment can help chise must be diagnosed thoroughly by any unwanted runoff through sound buyers pay the right price for gems that analyzing the drivers of growth leading integration decisions. can drive the transformation they need. up to the acquisition. This includes While there are many moving understanding the degree to which pieces that go into the pricing of Mike Jiwani growth comes from existing versus stressed-bank transactions (and in Director, New York new customers and how much is driven particular, failed bank transactions [email protected] using rate and/or marketing versus where loss-share agreements come into other factors. Other areas for analysis play), ultimately the underlying value Bob Warnock include an assessment of the quality of the target institution largely falls in Director, Chicago of the underlying customer base by the deposit franchise. Incorporating [email protected] evaluating metrics such as customer detailed deposit assumptions into bank depth, tenure and activity levels and an valuation models ensures acquirers pay Bryan Moore assessment of the quality of the bank’s the right price for the transaction. Manager, New York distribution network, including location Novantas recommends rigorous [email protected]

30 | From Fintech to Full Service: How Fintechs Can Enter Everyday Banking

BY BRYAN MOORE, BOB WARNOCK AND MIKE JIWANI

hile the early innings of the fintech revolution A GOOD STARTING POINT focused on attacking specific niches of the finan- The COVID-19 pandemic is accelerating the move by fintechs cial value chain, some fintechs are now looking to to expand into traditional banking, particularly as digital adop- leverage superior customer-acquisition-and-expe- tion rates have quickened in recent months while states were rience engines to springboard into direct banking on lockdown. This trend, which Novantas expects to continue Wproducts and services like deposits and cash management. even as the economy reopens, has benefited neobanks like Developments within the broker-dealer, payment and Chime and Varo considerably. Additionally, certain fintech lending verticals have made it clear that many fintechs view players are experiencing wholesale funding stress for the first traditional banking products as a way to acquire customers, time in their existence, an issue that stable deposit funding deepen customer relationships through a broader suite of would remedy — at least in part. financial products, diversify revenue and potentially access The expansion of the fintech ecosystem has given rise lower-cost, more stable funding. Case in point: Varo Money to “banking-as-a-service” (BaaS) providers that enable non- just became the first fintech to receive a national bank charter. banks to offer regulatorily-compliant, FDIC-insured deposit Fintechs that want to offer traditional banking must make accounts. Novantas believes that these partnerships are a good a key choice: enter the market via partnership or pursue a way for fintechs to get their foot in the banking door, although charter, either by applying for one or buying an existing bank. they likely aren’t sustainable long term. There are challenges, advantages and implications for each Partnership models allow fintechs to manage the customer option, but Novantas increasingly sees partnerships as just a relationship while the banking partner holds the deposits first step on the path to becoming a bank. on balance sheet. Fintechs can either enter into an exclusive

31 | SUMMER 2020 JULY 2017 JUNE 2017 Varo applies for a national banking charter Social Finance (SoFi) applies for an ILC banking charter

FEBRUARY 2020 FDIC grants Varo Money deposit insurance moving OCTOBER 2017 Varo to the final stage of the application process Withdraws its application for an ILC charter due to changes in the leadership team

JULY 2020 OCC and FDIC grants Varo full regulatory ap- JULY 2020 proval to open Varo Bank, N.A. to end a 3 year Files an application for a NBC with the OCC application process

arrangement with one bank, as in the utility without a large investment. It is The value created by these deposits case of N26 and Axos Bank, or choose also a good training ground to refine the must be divided between the banking multiple banking partners as Chime business case and determine the viabili- partner and the fintech through margin has done through deposit partnerships ty of a deposits business. and interchange splits. Partnership with Stride Bank, N.A., and The Bancorp negotiations set the terms for which Bank. The latter is becoming more com- LIMITS OF PARTNERSHIPS party must cover costs such as over- mon as a growing number of banks open On the flip side, shared-product econom- draft, ATM fees and call-center support. their doors to BaaS services. ics can reduce profitability for the fintech Fintechs that want to provide superior Market entry through partnership and limit options for product design. In customer experience with features such is a flexible, low-cost alternative to addition, banks and fintechs may have as free ATM access, flexible overdraft pursuing a banking charter. The BaaS different corporate objectives, creating and 24-hour customer service will often ecosystem has brought down entry the potential for an unstable relationship. end up bearing these costs. These costs, costs to as little as $500,000, according Part of the economic challenge is along with customer-acquisition costs to QED Investors, a venture-capital firm that the deposits generated via these like marketing, can dwarf the revenue that focused on fintech. partnerships are treated as brokered, that is generated. Partnership models allow fintechs which have limited value for banks. Novantas analysis suggests that to avoid expensive infrastructure Furthermore, brokered rates are particu- typical deal structure can result in investments by leveraging an existing larly low in today’s environment, leading negative account-level economics to the bank’s systems. Launch times are large- banks to prefer to use their limited tune of roughly $5 per customer/month ly limited by contract negotiation and brokered deposit capacity on funding for checking products. While negative preparation of front-end technology, sources that are cheaper than the rates product economics may be an accept- creating a significant advantage over many fintechs must offer to acquire new able tradeoff for some fintechs that the regulatory hurdles required by the customers. The FDIC has proposed want to capture a broader relationship, charter option. This option can be use- changing these rules, but there has been the costs more often than not outweigh ful for fintechs that want to offer extra no formal action. potential benefits.

32 | SEPTEMBER 2017 JUNE 2018 Square applies for an ILC banking charter Nelnet applies for an ILC banking charter

JULY 2018 SEPTEMBER 2018 Withdraws its ILC application in order to improve Withdraws its application for an ILC charter to aspects of its filing before resubmitting improve aspects of its filing before resubmitting

DECEMBER 2018 NOVEMBER 2019 Resubmits its application for an ILC charter Resubmits its application for an ILC charter

MARCH 2020 MARCH 2020 Receives conditional approval for an ILC from the Receives conditional approval for an ILC from FDIC the FDIC

CHOOSING THE RIGHT PATH relationships, whether on balance sheet ulators. Early engagement with deposit Once a fintech understands the benefits or off, will go a long way in helping experts, both externally and in the and challenges of each approach, it must assess whether it is worthwhile to enter form of experienced banking hires, can consider a number of issues to help the market. provide fintech leadership teams with decide if it wants to begin its transfor- If the partnership path seems necessary education on deposits. This mation with a bank partnership or jump appealing, the fintech must identify the additional knowledge can also be valu- right to becoming a bank. main goals in pursuing a partnership able in communicating with investors First, the fintech must determine and the economic challenges associated and customers. how its business model would benefit with these tie-ups. A deep understand- There is no question that more from everyday banking, whether it is ing of the underlying economics of each fintechs will seek to enter traditional through attracting more customers or component of traditional banking will banking. In all cases, the outcome of deepening ties with their existing base, provide a great baseline for contract these efforts will be based on pursuing and then determine if there is added val- negotiations with a banking partner. the right market entry approach and ue in holding deposits on balance sheet. The fintech should also set a timeframe taking the appropriate steps to prepare While deposit funding provides clear for the partnership that lays out an ulti- for the challenges to come. value for some key players, fintechs mate path for either seeking a charter or should develop a well-executed busi- buying a bank. BECOMING A BANK ness case to understand the true costs If a fintech decides that a partnership There is a long list of fintechs that are and benefits. The includes analyzing doesn’t go far enough toward achieving in line after Varo. LendingClub (through deposit pools, determining the realistic its goals, it can pursue a charter or seek its acquisition of Radius Bank), Square costs to acquire these deposits (both to obtain one by buying a bank. In either and Nelnet (through bank charter operating expense and interest rate) and case, prudent preparation, targeted applications) are all going through the the prospects for additional sources of investment and experienced leadership regulatory process and other players cross-selling. Being able to quantify the can help fintechs clearly communicate aren’t far behind. While the acquisition realistic benefits of acquiring deposit their understanding of deposits to reg- of a charter gives fintechs full license to

33 | SUMMER 2020 APRIL 2019 JULY 2019 Robinhood applies for a national banking charter Rakuten (formerly known as Ebates) applies for an ILC banking charter

NOVEMBER 2019 Withdraws application for a national banking MARCH 2020 charter citing difficulties in the process Withdraws ILC application in order to improve aspects of its filing before resubmitting

MAY 2020 Resubmits its application for an ILC charter

JULY 2020 Withdraws ILC application

FEBRURARY 2020 APRIL 2020 LendingClub agrees to buy Radius Bank for $185M, Monzo applies for a national banking charter securing access to Radius Bank’s banking charter

Source: S&P Global, Company Websites NBC=national bank charter, ILC=industrial loan company operate as a bank, the charter process margin while optimizing their investment ital levels that are higher than typical has its own distinct challenges. strategies. And those that aren’t in the FDIC-insured banks. Acquiring a bank A bank charter enables fintechs to lending business need an asset strategy. may speed up the process slightly, hold customer deposits on balance sheet Still, the process of acquiring a however, regulators will demand sim- — a transformative profitability lever for bank charter isn’t for the faint of heart. ilar requirements before approving companies that previously relied on Indeed, it took Varo three years to win the deal. wholesale funding. Retail deposit fund- a national charter. FDIC and OCC reg- ing has clear advantages over alterna- ulators hold charter applicants to a high Bryan Moore tive funding sources: it is low-cost, long bar, resulting in a challenging approval Manager, New York duration and generally counter cyclical. path for previous applicants. Applicants [email protected] Deposits can reduce funding costs by 10 must demonstrate clear knowledge of to 30 basis points below wholesale rates core banking concepts and an ability Bob Warnock — an even larger advantage in times of to effectively manage deposits — skills Director, Chicago stress and higher rates. Fintechs that that are often outside of fintechs’ core [email protected] have a clear understanding of deposit capabilities. Regulator skepticism can behavioral life can invest funding in impose additional post-approval costs, Mike Jiwani longer-term, higher-rate investments as evidenced by the FDIC’s requirement Director, New York with greater certainty, increasing for Square and Nelnet to maintain cap- [email protected]

34 | FOR TREASURY MANAGEMENT TEAMS, a Chance to Help Stressed Clients

BY RYAN SCHULZ AND JEFF DIORIO

ompanies around the country are place in 2019 and the third spot in 2018. than before and increasing the need for struggling, providing an opportu- (See Figure 1.) Furthermore, a majority of good data on a timely basis. nity for bankers to step in and help organizations indicated they were “less The shutdowns and quarantines by deferring loan payments and than satisfied” with their cash forecasting have also caused an unprecedented dis- setting new pricing structures. processes and forecast accuracy. ruption to businesses’ working-capital CThis is also a unique time for banks to COVID-19 has only amplified this cycles. Careful management of liquidity build loyalty by stretching beyond the need. Many companies are now forecast- is the top priority for companies, but traditional lending-deposit relationship. ing cash needs on a daily basis instead they often struggle to optimize working For bank treasury management of weekly or monthly. The pandemic has capital (See Figure 2.) While many busi- teams, it is a chance to help corporate created a structural break in historical nesses saw payments volume decrease at clients solve financial problems in models, making them far less reliable the start of the crisis, March fund transfer ways that go beyond providing routine transaction services. These efforts can improve the client’s financial position FIGURE 1: TOP PRIORITIES FOR COMPANY TREASURERS and deepen customer relationships. Three ways to accomplish this are by encouraging digital adoption, simpli- RANK RANK RANK fying pricing and, of course, providing 2020 2019 2018 business advice. Cash Forecasting 1 2 3 IDENTIFYING WHERE CLIENTS NEED HELP Best Practices 2 11 9 Even before the pandemic swept the Bank-Relationship Management 3 4 5 country, company treasurers were hungry Working-Capital Management 4 1 – for better forecasting capabilities. A survey of corporate treasurers conducted early Operational Efficiency 5 13 7 this year by Treasury Strategies Inc., a division of Novantas, found that improved forecasting capabilities were the top pri- Note: Dash indicates no prior ranking available. ority for 2020. That was up from second Source: 2020 State of the Treasury Profession Survey

35 | SUMMER 2020 COMMERCIAL BANKING

FIGURE 2: BIGGEST CHALLENGE IN OPTIMIZING WORKING CAPITAL

26% 18% 42% Accurately predicting Quality data inputs Reconciling direct (Trea- 13% It took a payments from from people sury) vs indirect (FP&A) long time customers and systems cash forecasts

Source: 2020 State of the Treasury Profession Survey volumes were up 56% among corporate SIMPLIFIED PRICING need to understand how these issues clients as companies consolidated liquid- Pricing for corporate services has always will impact individual clients. ity. Volumes decreased after the initial been complicated and complex. (See New Digital Adoption As noted above, surge, but April transfer volumes were Strategies to Modernize Commercial the adoption of digital processes still 24% higher than April 2019. Novantas Pricing.) Yet, it is one of the quickest and should be one of the most important expects companies to continue this focus most effective levers banks can pull to help capabilities in a bank’s wheelhouse, on cash concentration, deployment and their clients through this crisis. Beyond the providing benefits for both the bank liquidity information reporting. obvious fee waivers and discounts, banks and its clients. Banks that don’t already The pandemic has forced many can get more creative to help stressed have digital documentation capabilities businesses to modernize overnight. For clients and win customer loyalty. should make this a top priority since it years, payments have been steadily mov- The crisis is an opportunity to test is quickly becoming table stakes in a ing from physical to digital; checks shift- new approaches to pricing. Simplifica- world where clients are working remote- ed from 57% of total non-cash payments tion of treasury management pricing ly. Banks that can’t open accounts digi- in 2000 to 16% in 2012 and only 8% in has been on bank wish lists for years, but tally will lose corporate business. 2018, according to the Federal Reserve. implementation success has been limit- Banks can help corporate clients Companies that still rely on paper are ed. By offering customers a lower flat-rate navigate the problems they face when facing even more challenges during this fee for treasury services (potentially tied their vendors don’t accept electronic pay- pandemic because many businesses can to past usage), banks can help customers ments. The creation of approved vendors no longer support a physical location. plan cash flows better, provide additional networks, for example, can also boost Novantas expects this shift to accel- fee relief and test a new pricing approach electronic payments and counteract com- erate further, with an increased focus for middle-market clients. mon sources of fraud. These programs on electronic payments, remote deposit can be enhanced with proactive vendor capture and digital documentation OFFERING ADVICE outreach on behalf of clients, much like such as e-signatures. Banks can provide Banks also can’t underestimate the val- banks already do for commercial cards. discounts to encourage companies to ue of providing timely advice to clients Companies often re-evaluate their adopt lower-cost digital services, such about how to manage their business. A banking relationships during times of as remote deposit capture. 2018 survey by Novantas showed that stress. Banks that prove to be good part- This digital acceleration also has 82% of companies consider it important ners over the coming months will exit created new opportunities to take for their primary bank to provide busi- the pandemic with a stronger brand and advantage of process weaknesses, ness advice. With all the uncertainty in deeper client relationships. By focus- prompting bad actors to jump at the the industry, this is more important than ing on pain points, banks can ensure chance to flood businesses with fraud- ever. Banks need to arm their bankers clients are getting the most value from ulent activity. A recent survey by the with the right tools and information to these partnerships. Association of Financial Professionals be effective advisors to their clients. found that 40% of respondents said This requires relationship managers Ryan Schulz they have already started working with to be well-versed in the changing finan- Director, New York banks and vendors to mitigate fraud cial and regulatory environment that [email protected] attempts during the pandemic; another relates to clients. Relationship managers 15% plan to do so. Banks can help in this need to know the bank’s perspective on Jeff Diorio area by offering trial periods of fraud important economic issues, such as the Director, Chicago protection services. potential for negative rates. They also [email protected]

36 | AT THE PODIUM WITH NOVANTAS Although in-person events aren’t on many calendars right now, Novantas experts have been busy hosting and participating in virtual events. Please reach out to the session leaders if you missed any of these online events and would like to know more about the content that was presented.

Director Hank Israel and Principal Zak Executive Vice President Darryl Demos Jeff Diorio, a director in Novantas’ Trea- Kaplan hosted a CBA Webinar called and Directors Sarah Welch and Andrew sury Strategies division, led a June 24 “Why Broad-Based Campaigns Are Hovet hosted a Consumer Bankers As- webinar called “Adapting to New Pay- Hurting Your Deposit Portfolio” on sociation webinar called “Transitioning ment Types and Interfaces While Balanc- March 3. They were joined by execu- Field-based Sales into the Digital Age” ing the ‘Need for Speed’ and Security.” tives from People’s United and CIT. The on April 28. The session focused on He was joined by Andrew O’Garro, se- webinar explored how granular acqui- how branch-based workforces, retail net- nior vice president at AxleTree Solutions, sition strategies can be more effective works and marketing can be re-tooled to and Larry Mills, vice president and assis- for deposit acquisition and retention adjust to COVID-19 and beyond. tant treasurer at Travelers. than a broad approach. Brandon Larson, managing director, On June 25, directors Hank Israel and Director Paul LaRock of the Novantas discussed the impact of COVID-19 on Adam Stockton led a Consumer Bankers Treasury Strategies division, and Vice branch transformation with members Association webinar called “Managing President Steve Wiley held a webinar of the Consumer Bankers Association Your CD Maturity Bulge: Getting Ahead on March 30 for company treasurers. on May 21. The session, which was with Scoring, Strategy and Execution.” “Navigating COVID-19: Immediate part of a CBA membership call, exam- They were joined by Linda Williams, re- Steps for Treasurers” served as a guide ined how changing traffic patterns as tail deposit pricing and portfolio man- to how treasurers could manage liquid- states re-open can be used to guide ager at M&T Bank. ity forecasting and working capital in branch plans. the early days of the pandemic. Managing director Brandon Larson pro- Jeff Diorio, a director in Novantas’ vided an update on branch networks Paul LaRock, a director in Novantas’ Treasury Strategies division, and Trac- to members of the Consumer Bankers Treasury Strategies division, and David ey Knight from High Radius hosted a Association on Aug. 5. Robertson of Deluxe Corp. led an April June 3 webinar called “Using Tech- 16 webinar called “The Check is Not in nology to Eliminate Cash Forecasting Director Sarah Welch discussed how finan- the Mail: Managing Financial Transaction Roadblocks.” It focused on how com- cial-services marketers are preparing for Processing Risk During the Pandemic.” The panies are using new technologies to the demise of the third-party cookie in an webinar examined strategies for remote address challenges when developing ADARA webinar on Aug. 12 that is part of check issuance, in-house lockbox process- forecasts in a COVID-19, work-from- a series called “Mission Possible: Cracking ing and migration to digital methods. home environment. the Code of Customer Data and Identity.”

37 | SUMMER 2020 Novantas Review is published quarterly by Novantas, Inc., 485 Lexington Avenue, New York, NY 10017. © 2020 Novantas, Inc. All rights reserved. “Novantas Review” and “Novantas” are trademarks of Novantas, Inc. No reproduction is permitted in whole or part without written permission from Novantas, Inc.