High Performance Non Interest Income a High Performance Briefing by
High Performance Non Interest Income Non Interest Income (NII) has been an elusive metric for many years. Finding the secret formula that balances increased NII with customer acquisition has proven beyond taxing to bankers. Now, given the current challenges with loan growth, the need for enhanced NII is more pronounced than ever before. The community banking industry continues to seek an answer to the (literal) million dollar question, What combination of services and fees will land banks with the highest shareholder return and the happiest customers? Banking is a service business, and true quality is worth a price. The marketing shift to FREE only temporarily answered this question. Banks notoriously marketed many of their services, such as checking, as fee-free for the exchange of increased overdraft charges. New regulations have greatly hindered this strategy, however, and counting on overdrafts to largely boost NII has proven unsustainable in the new, and ever-changing, industry. Because of decreased fee income driven by regulatory changes and higher expenses, the typical free checking account currently loses over $150 every year. At the same time, constantly evolving, customer-driven technology has put expenses on the rise. Unfortunately, these costly new apps and electronic tools are not being adequately subsidized by increased fee income. As an example, many banks are still not sufficiently charging for remote deposit scanners. The imbalance between technology output and fee income certainly makes revenue growth difficult. In 2015 evaluating service offerings and related fees should be a top initiative for most community banks, as the average and underperforming banks undoubtedly need increased NII in order to survive and grow. A change in thinking, strategy, and marketing, is imperative for these banks to reach High Performance. In order to help banks plan and strategize, we have analyzed current and historical Non Interest Income data, mapped it against other metrics, and defined and studied the Resurgent Performance Non Interest Income High Performers. The Modified Universe of Banks As with all of our other High Performance briefings, we used the RPI modified universe to determine our data set. First, we divided banks with assets between $50 million and $10 billion into four asset bands. To eliminate extremes that could skew data, we removed all banks that were in the top or bottom 3% on any of the six metrics included in our study: Non Interest Income Non Interest Expense Net Interest Margin Return on Assets Return on Equity Efficiency Ratio For comparative purposes, we standardized our NII data by calculating a ratio for all banks included in the data set: [Non Interest Income / Total Assets]. We then defined our NII High Performers as banks that rank in the top 20 percentile for their respective asset band. 2
It is our philosophy that metric analyses and competitor comparisons are an essential aid in continuous improvement and should always be a high priority on executives task lists. High Performance is further broken down into two groups: A Players, or those who score in the 90-100th percentile, and B players, or those who score in the 80-89th percentile. Those banks that are below the line of High Performance should aim for the respectable, and achievable, B Player status in order to increase revenue and attain organic growth. High Performance Illustrated Comparing the NII High Performers to the average performers, not only on NII but on all key metrics, allows us to identify important correlations and determine trends in asset size performance. In previous papers we have found that true High Performance on one critical metric frequently lends itself to High Performance across the board. 2009 to 2014 Non Interest Income Each asset band graph shows that the relative High Performers consistently, and significantly, outperformed their average counterparts, and the disparity only increases with asset size. This size-dependent disparity is not surprising, as larger community banks typically have more sophisticated, automated systems that allow them to better realize and control broader fee income. In addition, larger organizations have more profitable wealth management and insurance offerings, which drive greater fees. Overall, however, the $1 billion to $3 billion dollar banks historically prove to be doing the best job at balancing their product offerings with expenses. The High Performance trend lines show NII to be on the decline following a spike in 2012, which was primarily related to exceptional mortgage fee income. As discussed earlier, more stringent regulations, which are not being balanced with new sources of fee income, is likely the culprit for the decline. 3
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2009 to 2014 Overall Revenue The $3 billion to $10 billion dollar banks reported the highest asset proportional revenue numbers over the last five years. However, these banks, along with the $1 billion to $3 billion dollar banks, have also experienced the most pronounced drop in revenue since 2012. The smaller banks, on the other hand, have better maintained their total revenue. This trend indicates that the True Local Community banks are producing more relative interest income, given that the larger banks have consistently outperformed them on NII. 5
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2014 Non Interest Income In line with the five year history, the $1 billion to $3 billion dollar banks show the best NII performance for the first three quarters of 2014, with the $3 billion to $10 billion banks not far behind. The larger banks continue to have a more significant gap between their high and average performers compared to the smaller banks. This illustrates the fact that asset size does matter due to the operating leverage it affords the bank. 2014 Non Interest Expense The highest performers on NII are also spending more money, as the Non Interest Expense graph illustrates. The reality is that various lines of business can be people-intensive and simultaneously less capital intensive. However, the net payoff from strategically chosen services can, of course, be significantly greater than revenue from net interest margin alone. 7
2014 Return on Assets The obvious correlation between higher fee income generation and Return on Assets is true across all segments. Furthermore, we believe this correlation will become even more pronounced as the industry becomes increasingly more dependent on NII. 2014 Return on Equity Return on Equity (ROE) is unsurprisingly comparable to the Return on Assets trends. While the difference is slight, the NII High Performers are consistently reporting higher ROE compared to the average performers. Given the array of services that are not capital dependent, we expect top NII banks to produce above historical average ROE results to a greater extent in 2015 than in prior years. 8
2014 Efficiency Ratio Interestingly enough, NII High Performers are outperformed by the average banks on Efficiency. This is partially due to the fact that in 2014 mortgage banking was especially challenging relative to net profitability. Among other factors impacting 2014 performance, many banks made investments/expenditures into increased lending capabilities. Some of these investments will produce benefits in 2015. The 2014 Efficiency of NII High Performers will not be sustained; increased application of technology will absolutely drive higher levels of productivity and more opportunities for fee income. Furthermore, as the industry hastens its pace of consolidation, we will see even greater efficiency levels in the magnitude of 10% to 20% improvement. 9
Determining where your bank currently stands is an essential part of the improvement process. In order to define a path to High Performance, you must take a critical look at your bank s products, pricing, markets, policies, and procedures. Your bank is in the position to provide the answers and cross-sell in the process. The Play Book First Things First: Optimize Your Current Fees Are your bank s current fee structures and service levels in line with your High Performing competition? Is your bank realizing all potential service fee income? Does your bank have clearly defined NII targets and goals? Is acceptable branch performance partly based on Non Interest Income goals? Do employees understand the importance of fee income? Are your service features and product offerings specifically aligned to your customers needs? If you can t solidly answer these questions with yes, it s time to engage in a Non Interest Income study. Realizing current fee potential could produce huge gains, and potentially even High Performance status. From our experience, the incremental lift will be in the range of 7 to 18 basis points on assets on average. For some banks, the lift will be much higher. The study can be bank-led, or outside advisory can be hired to assist with research, evaluation, and implementation. Either way, the study will work to do the following: Evaluate real improvement opportunity for revenue and service levels Set fee realization targets by product, lines of business, and / or position Create reporting tools for effective short-term growth and long-term continuous improvement Determine whether NII product-related technology is being used to its fullest capacity Evaluate product systems set ups for revenue leakage Create and distribute a clear and concise fee exception policy Link fee income to compensation and performance reviews Make Non Interest Income an integral part of all scorecards Align the depth and breadth of offerings with customer profiles Be The Trusted Advisor Wealth management is no longer solely for older adults and the affluent. There are ways to profitably extend money managing services to all clientele. The industry is shifting to a model where Wealth Consultants and Trusted Advisors are replacing transactional bankers, and customers can now largely take care of their transactions on their phone, computer, or ATM. In fact, younger customers prefer to do so. Consequently, when they do take the time to enter the bank, they are looking for something more. Clearly convenience and expert advice are part of the new solution needed. Simply put, customers and business owners want applicable money advice. They want to know how to save, how to invest, what to invest in, how to pay off debt, when to take out a loan, how to save for college, and even the basics of setting up a budget. Of course, your niche markets will determine what kind of advisory services you offer. If you serve the under-banked, perhaps your bank should offer one-on-one budget creation help. Or, if you serve a college town, consider offering classes regarding paying off student debt. Retirement savings workshops would of course be useful to a middle-aged client base. Small to mid size business owners also have specialized needs. Figure out what your customers want to know and give them the answers; become their Trusted Advisor. 10
While the margin may be small, workshops, classes, and consulting-like services can be a pathway to gaining customers and selling related services. If they trust you, they will bank with you, and there s no better way of gaining trust than providing helpful, specialized advice. What s Trending in 2015? Innovative Fees As technology continues to evolve, and customer profiles and demands continue to change, banks have an opportunity to be truly innovative, and differentiate themselves, with their service offerings. Peer to Peer Transactional Payment Service Customers want the ability to instantly transfer money to their college kids, best friends, church, Girl Scout Troop, and more. Small businesses also seek out payment solutions. Phone Application, Website, and ATM Advertisements There s money in selling electronic advertising space, and it s a great way to offset free services and marginally profitable business lines provided to the customer Debit and Credit Card Personalization Personalization, especially with younger adults, is very popular. Your bank can certainly capitalize on this trend by letting customers adorn their banking card with their initials, favorite sports team, or pictures of their kids. There is no magic bullet. The key is tailoring your services to your bank customers specific needs and executing them with superior service. Partnering with Local Businesses Similar to the ever-popular Groupon and Scoutmob, offering customers exclusive local dining and shopping deals via your bank s phone application is a novel idea. Customers win with deals, businesses win with increased traffic, and the bank wins with advertisement fees. Creative, uncommon, and non-conventional service offerings will work to increase income, satisfy customers, and serve as fantastic marketing tools. Put Someone in Charge Banks should consider implementing an in-bank committee in charge of service and fee income innovation. Outside of brainstorming creative and market-relevant offerings, the team can dually serve to define and track NII goals. That committee head should be a new officer primarily tasked with building non interest income. When it s someone s job, the job gets done. The Prescription Simply stated, a deep and thorough analysis of your bank s current NII practices and related service levels are critically important to your bank s long term survival and share value growth. Peak performance requires understanding, and persistently tracking, your competitors services and fees. It requires listening to your customers to determine what they want from their bank s Trusted Advisors. It requires truly exceptional, and regularly measured, customer service. It requires thoughtful innovation and a fresh mindset. While it may not be quick, or pain free, the pay off and long term gains will be significant. The industry is changing, and to keep up, your bank must change too. Forget your old practices, forget your old philosophies, and steer clear of operating under the, This is the way it s always be done attitude. Start 2015 with renewed perspective and the motivation to be, and deliver, more than the average bank. Your customers, and shareholders, will thank you. 11