As seen in the COVER STORY. By Rick Spitler

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1 A new era is unfolding where in-depth customer analytics will have a direct impact on shareholder returns. The hunt is on for specific applications to drive performance. Customer Analytics:

2 COVER STORY As seen in the Unlocking Growth By Rick Spitler A continuing challenge in the post-recession economy is that while the banking industry in many ways has recovered, market demand has not. At this point in prior economic recoveries, loans were growing up to four times as fast. The issue has gained renewed urgency now that the second of two major coping mechanisms has run its course. With the recent uptick in loan-loss provisions, banks will no longer be able to prop up earnings by recapturing reserves. And institutions have already cut costs as much as they dare. This leaves banks to scour the market for growth, even subtle opportunities to improve sales and/or margins. In this unforgiving environment, the advantage increasingly will go to players that excel in customer analytics, statistically-based behavioral analysis that allows banks to target their outreach to major customer groups. This is the key to growth in an overall slow environment. Applied correctly, it allows successful banks to unlock pockets of revenue and margin, and outperform competitors. 2

3 Given the complexities and especially the performance implications, excellence in customer analytics is now a C-level priority requiring careful thought on what to develop and when. Customer analytics will help in a number of ways, including: price realization for both loans and deposits; relationship expansion with core customers; and crosschannel marketing and sales, bridging the divide between digital and branch banking. There are tangible applications in all these areas. Yet there are many challenges in taking advantage of the opportunities. Most banks do not have adequate systems and talent to support customer analytics. Many struggle with the question of which capabilities to build internally, and which to outsource. New levels of coordination and cooperation are needed among various internal functional silos. Given the complexities, and especially the performance implications, excellence in customer analytics is now a C-level priority requiring careful thought on what to develop and when. Each bank will need to identify a series of pragmatic, incremental steps, staying focused on key applications that will support revenue growth. Critical Path To be sure, the field of customer analytics would still be gaining momentum even if the industry did not have a growth problem. Drivers include improved technology, increased availability of transaction-level data and a heavier reliance on information-based marketing at a time when more shopping is done via remote channels. If anything, the banking industry (besides credit card) is late to the party relative to other customer-facing industries. Two factors put this trend on a critical path for banks. Figure 1: Growth Deficit Compared with other major loan expansions over the last 20 years, the current economic recovery has not delivered the growth that banks hoped for. Growth in Total Loan Balances for the U.S. Banking Industry 15% 3Q91 to 3Q95 10% Annualized Growth Rate 5% 0% 1Q02 to 1Q06 4Q09 to 4Q13-5% -10% Trough Yr 2 Yr 3 Yr 4 Quarterly Progress from Cyclical Trough Yr 5 Source: Novantas analysis of FDIC data. 3

4 One is a pressing need for revenue growth (Figure 1: Growth Deficit). The second is the need to improve marketing effectiveness as more shopping shifts online. Demand and margins. Commercial lending has delivered much-needed growth following the Great Recession, but now margins are beginning to slip even as the parent banks clamor for more growth to offset shortfalls elsewhere. This raises the question of how to improve returns in a business model heavily influenced by the decisions of individual relationship managers. Here, part of the answer lies in better understanding how much RMs may be leaving on the table that is not required by the market. The retail side is an even bigger challenge. Including residential, home equity and consumer loans, householdrelated borrowings fell by 4.1% during the three years ending December 31, 2013, as measured by the Federal Deposit Insurance Corp. Home equity lending, a roaring engine of growth for years prior to the housing collapse, is a shadow of its former self. Residential first mortgages through the details and look directly at marketing and sales. Particularly on the retail side, a lot of new banking business is now won or lost in the course of online shopping. Banks need to learn a lot more about the deciding factors building customer awareness; presenting the right products; eliciting serious consideration; and finding a way to close and fulfill the sale (increasingly online but today primarily in the branch). This is not to say that old-school paradigm of local marketing, branch presence and over-the-counter sales is paradise lost but it was a reasonably well-oiled machine that had the advantage of in-depth customer interaction. Banks could count on branch traffic to get to know the customer, engage the customer, and convince the customer to bring product needs to the bank. Needs-based selling, if you will. Now face-to-face contact is rapidly diminishing as customers shift more of their everyday banking to the virtual space. Either the bank learns to compensate for this loss of face time via an electronically-enhanced understanding and management of the marketing and sales process, or it will risk losing Growth is underway in some lending categories and at least re-started in others, but there is not enough to lift the overall industry out of its earnings challenges. This implies that there will be winners and losers. The winners will figure out how to identify and target important segments of demand. hold promise, but the ebb of the great mortgage refinancing wave has taken its toll on division performance. Auto lending is strong but cannot take up all the slack in residential, plus it is likely at its peak. And any credit card growth primarily will help the large monoline card banks. Also as we have mentioned, the industry will no longer have the option of right-sizing loan-loss provisions as an increment to earnings. The industry piled up huge reserves immediately following the housing collapse and has been siphoning the excess back into earnings for several years. That cushion is now fully exhausted, and the quarterly provision is now rising for most banks. If banks are to grow and maintain margins, they will have to become more skilled at finding and exploiting market opportunities. Growth is underway in some lending categories and at least re-started in others, but there is not enough to lift the overall industry out of its earnings challenges. This implies that there will be winners and losers. The winners will figure out how to identify and target important segments of demand. Marketing and sales. The customer online migration in banking is a complicated topic, but it is necessary to cut increasing amounts of business to other competitors that succeed in reaching the next level of online effectiveness. For both of these major challenges tapping market demand and bridging the online divide customer analytics can provide crucial answers. Specific Applications One of the great information-based initiatives of the 1990s, customer relationship management, got off to a rocky start as many banks invested heavily in technology infrastructure before tangible and profitable CRM applications came into view. The same risk is present with customer analytics, but we believe there are logical areas of focus that can yield real performance traction. Price realization. This is a skill that cuts two ways, helping to enhance loan yields and also helping to control deposit funding costs. For skilled practitioners with customer analytics, both can be done in a way that upholds core customer relationships. On the commercial loan side, a systematic analysis of loan pricing and negotiations can provide new management context and a valuable supplement to relationship managers 4

5 in the field. RMs will continue in their leadership role, yet overall performance will improve as obvious inconsistencies are addressed and new context becomes available on client price elasticity and the competitive frame of reference. With retail deposit portfolios, banks now need to prepare pricing strategies to attract and retain lasting balances as market interest rates begin to rise. Much will depend on an analytical ability to discern between core customers and pure rate shoppers, better enabling banks to offer promotional pricing where it is best justified. Relationship expansion. Adding new-to-bank customers is clearly important. But customer migration among banks has slowed down quite a bit following the recession. And the economics of customer acquisition cost vs. the near-term contribution to profitability increasingly are out of whack. Novantas estimates that only about 5% 7% of customers are in the market for a new bank. And up to 2% are younger customers who are relatively new to the workforce important as a contribution to overhead and a future source of profitability, but with limited near-term profit potential. Thus in retail and small business banking, the most significant growth potential lies with current customers, either those who have recently opened an initial checking or card account, or more established customers who may be receptive to cross-sell based on their needs and rapport with the bank. This kind of selling increasingly depends on analytically guided targeting. Multi-channel marketing and sales. Person-to-person touch points are still important, especially with key segments of the retail franchise. But the exploitation of digital channels to support overall customer objectives is the new measure of success. This marks a major industry shift. No longer a branchdominated business model that strictly relies upon street corner presence and trained customer representatives, retail banking is moving to more of a hybrid marketing and sales model that enlists all channels, especially digital, to engage the customer in the most effective manner. The new model incorporates some of the critical elements that drive the likes of American Express and Amazon.com. Customers are engaged in the virtual space. They are understood based on those interactions. They are presented with compelling propositions that fit their needs, and rewarded in those same channels for loyalty. All players face the challenges of modernizing data structures and coping with shortages in seasoned analytic talent. Improved systems and teams will be needed to meet the challenges of multi-channel marketing and sales. Banks will need these same skills and capabilities to engage customers in the virtual space to understand their interactions with the bank; and to take advantage of the now digital opportunities to counsel and sell products that consolidate their wallets. At the same time, they need to nurture the branch role in completing online-instigated shopping behavior, a revenue-critical sales path that needs a lot more attention. Here again, success will be influenced by competitive capability with data and analytics. In the prior business model, customer knowledge would reside substantially with the front line associates. With most interactions taking place virtually, there is no option but to invest in analytics. And since there will now be much greater volume of information available digitally, a bank must invest in its analytics infrastructure. Arms Race Regional banks may find it harder to compete in the arena of customer analytics. The costs and benefits will extend across fewer households, compared with the very largest institutions. Also there are widespread uncertainties about how to develop capabilities, building internally versus outsourcing. More broadly, all players face the challenges of modernizing data structures and coping with shortages in seasoned analytic talent. Improved systems and teams will be needed to meet the challenges of multi-channel marketing and sales. There are limits to what any bank can invest and the amount of change it can manage, calling for strategic discipline with customer analytics. To succeed in the long run, banks must understand the shifting plane of competition, invest in differentiating capabilities, and learn to acquire other applications externally. More immediately, the hunt is on for specific applications that will help to improve near-term performance. This introduces an era when customer analytics will have a direct impact on shareholder returns. Fortunately, a variety of specific possibilities are in sight, but it is up to executive management to lead the charge. Rick Spitler is Co-CEO and Managing Director at Novantas, Inc., a management consultancy based in New York City. He can be reached at rspitler@novantas.com. 5