The banking industry has had a crazy ride over the last decade. Between the financial crisis, a regulatory overhaul, record low interest rates, and now technology disruptions coming from all directions, bankers feel they’ve been playing a game of whack-a-mole. Every time they survive one calamity, another industry-altering force pops up. With the focus so often about overcoming the next obstacles, the basics have gotten lost in the shuffle.
Among those basics is a concept as old as the banking business itself: cross-selling.
Bankers talk about the importance of cross-selling, especially for relationship managers who work with commercial customers. However, very few banks have dedicated the necessary resources to systematically and effectively cross-sell to their customers. They like the sound of being a “relationship bank,” but can it really be called that if little to no action is following the words?
Cross-selling has been overlooked and we think that’s a mistake. In this post we’ll give you three reasons why the time is right for more cross-selling, and then four keys to building deeper, more profitable relationships with your customers at scale.
But first, let's start by dispelling a common misconception.
The Liquidity Crunch Is Overblown
We have heard several banks complain about regulatory pressure, claiming that regulators are overly concerned about core deposit growth. They feel this is another classic example of regulators fighting the last war, and they are unfairly being asked to keep loan/deposit ratios below the optimal levels.
We’re sure there are individual examiners with unreasonable expectations, but the data and official regulatory communication don’t suggest that banks are facing a liquidity crunch that must be handled.
It is true that in recent years loan growth has outpaced core deposit growth. The chart below shows the ratio of loans to FDIC-insured deposits (which we’re using as a rough proxy for core deposits) for the entire domestic banking industry.
The chart begins in the first quarter of 2013, which was the first quarter after the temporary unlimited deposit insurance coverage was lifted. The trend is definitely up and to the right, but notice the scale on the vertical axis. It really isn’t that much of change.
The next two charts put it in a better perspective. The first is the same chart, but adds in the high and average levels for the last 30 years (since 1987).
The current levels are almost exactly at the 30-year average, and well below the highs reached in 2007.
The next one shows the exact same data over the last 30 years for full context.
The two big dips represent the two big banking crises of the period (the S&L crisis of the late 80s/early 90s and the 2008 housing crisis). But remember the latter is skewed by the temporary unlimited deposit insurance that greatly inflated the denominator of the ratio. The current levels are nowhere close to the highs from before the crisis, and are still well below the 30-year trend line.
Even though banks have been growing loans faster than deposits, they are largely still working through the excess liquidity that landed in the system following the financial crisis (remember all the surge deposits?). Regulators might be talking to your bank about growing core deposits, but that is not an across-the-board mandate. So, why is it a focus for you?
That leads to our second big reason why it makes sense to focus more on cross-selling.
Reason No. 1: Interest Rate Risk Needs to Be Balanced
A large swath of banks are taking on outsized interest rate risk. At first glance, this appears to be similar to the core deposits in that the overall industry is not showing unusual risk levels. But that industry total does not tell the full story.
The chart below shows the share of total loans that would be classified as “long-term assets,” which means their maturity or repricing date is more than 5 years away.
The overall industry level of longer-term loans is slightly higher, moving from 21% of total loans to 25%. The larger banks (those over $10 billion in assets) mirror that trend, which is no surprise since these largest banks make up the bulk of total industry assets. The majority of charters, though, fall in the smaller group with less than $10 billion in assets. Those banks started the period with a smaller portion of long-term loans (less than 17%) and currently sit at almost 31%. The asset base in community banks is significantly longer than it was a few years ago, and that extension took place during a period of record low interest rates.
There is a saying in banking that you can only be as good as your weakest competitor. In other words, once someone in your market is desperate, they can skew the market pricing levels. They will chase some of your best customers from a position of disadvantage. When your RMs come to you and say their customers are seeing aggressive fixed rate offers on loans, they are right. It only takes one bank to make this a reality in any given deal.
The flip side of this is that those banks are starting to feel the pressure. Rates are rising (more on that in a bit), and a lot of the fixed rate loans booked between 2011 and early 2016 are looking ugly with the higher funding costs. It has become a treadmill, as those banks need higher yields to offset margin compression, and the easiest path to get there is by continuing to move out on the curve. They also must find a way to balance the interest rate risk. The easiest path here is DDA balances, as they offer the best of both worlds: a long duration and no interest expense. Expect even more of this in the coming quarters, as these banks will continue to chase borrowers that can bring DDA balances along with their loans.
Reason No. 2: Deposit Profitability Is Rising
In a rising rate environment, deposit accounts become more profitable. This is especially true of DDA accounts, since the 0% rate can be invested at a higher earning asset rate. But it is also true of interest-bearing deposits. The beta on these accounts (the amount their rates change compared to market rates) can be high in some markets, but is less than 100%. Every move up in rates makes core deposits proportionally more valuable.
The profitability of deposit accounts was suppressed by several factors following the crisis. Record low rates at nearly all points on the yield curve were the biggest factor, but rising overhead (more regulations and higher insurance costs) and declining fee income (from new restrictions on overdrafts and interchange income) played big roles, as well. Banks have responded with cost cuts, and are using technology and process to reduce cost and optimize fee income where possible. Both are worse than pre-crisis, but have stabilized. That leaves interest rates.
To illustrate this phenomenon, we used PrecisionLender to measure the profitability of a $100,000 DDA account over the last several years. We used our demo account, which we configure using benchmark data so that it will be as close to “typical” as we can make it. We use the FHLB curve for FTP rates (funds transfer pricing), a 60-month assumed duration, and our standard overhead costs that we get from The Kafafian Group.
The chart below shows the FTP rate for these accounts since the beginning of 2016.
While the rate change may not seem all that drastic, it has a huge impact on the profitability of our hypothetical $100,000 DDA account. The chart below shows the annualized net income in August of 2016 versus August of 2017.
The increase from $705 per year to $1,076 per year translates to a 53% improvement. If you cherry pick from the lowest point in 2016, that number grows to 86%.
There is another way to consider the value of this account. If you pair it with a typical $1 million loan (priced as a 5-year balloon on a 20-year amortization), the $100,000 DDA would have allowed you to lower the rate on the loan by 12 basis points in 2016 and still have the same profitability for your full opportunity. In 2017, the same combination allows you to lower the rate by 18 basis points, or a difference of 6 basis points. And who couldn’t use another 6 basis points of wiggle room on their loan pricing?
Here’s one more angle to consider: The rising FTP rates also change the balance at which the account becomes profitable. In July of 2016, the breakeven balance on a DDA account (again using our standard configuration) was around $29,000. In August of 2017, that breakeven level dropped to $19,000. How many accounts at your bank have turned from red to black just because of rising rates?
Reason No. 3: Fee Income Is Also Rising
For brevity’s sake, I only pulled data on deposit accounts for this post. However, many of the same trends can be found around fee income. With all the new capital standards being phased in, capital has become the big constraint for almost every banking organization in the world.
Being able to generate fee income, which requires little to no capital support, has become a much more efficient way of generating returns than the usual tricks performed to squeeze a couple more basis points of spread out of your borrowers. Nearly all the top performing banks far outpace their peers in generating fee income.
Keys to Better Cross-Selling
Cross-Selling Key No. 1: Visibility
As stated early in the post, few bankers would dispute that cross-selling is a good thing. It’s not that high performing banks are not necessarily more fervent believers in the value of cross-selling; rather, they are simply more effective at the execution of cross-selling. What are these banks doing differently?
For starters, we have learned that cross-selling is not something that can be oversimplified. The Wells Fargo cross-selling scandal should serve as a reminder. Even before the fraud issues surfaced, the bank’s “8 is great” motto was fundamentally flawed. Incentivizing staff in a giant organization to open as many accounts as possible without regard to need or profitability does not create value. As catchy as the “8 is great” phrase might have been, the outcome was not a surprise. Instead, effective cross-selling needs to be mindful of both customer needs and bank profitability. And that means your bankers need visibility into both.
When structuring and pricing deals, most banks still negotiate in a vacuum. Their systems are not integrated with a CRM, which would allow them a holistic view of their customer relationship. This view would include prior sales activity, and analytics around likely product fits. Without this context, bankers are left to blindly plug additional business into a disconnected model to see if it clears hurdle rates. These tools can’t be used to meet customer needs; instead they are trial-and-error plugs in a spreadsheet to hit an internal bank requirement.
These structure decisions are also generally made without clear visibility into bank needs. How important is that deposit account? Does the bank need the liquidity, or is it trying to mitigate a growing interest rate risk position? If so, that changes the appetite, and should change the pricing. It sounds like basic common sense, and yet very few banks offer this insight to their bankers who are actually dealing with customers.
Cross-Selling Keys No. 2 & 3: Clear Targets & Combined Targets
To solve this problem, each account type should have a clear target level of profitability. Bankers can then have something tangible to aim for when negotiating, and can be incented to add the right kind of accounts instead of simply any account they can convince the customer to open. The key to making this work, though, is that you also need a separate opportunity target. This is the combined targets of all the accounts being discussed.
For example, if you are discussing a term real estate loan, an operating line of credit, and a deposit account with treasury management services with a customer, each account should have an individual profitability target. But the entire bundle should get a target, as well. That way “excess” profitability on some portions of the bundle can be used to win other, more competitive pieces.
The usual scenario is that convincing a customer to bring new deposits will allow you to price their loan with a lower rate. However, it should be noted that this usual circumstance is changing for many banks. At one large regional bank on the east coast, certain markets are almost entirely driven by deposit and fee income. In one large metro market, the market president told us that 70% of their income came from these sources. In many cases, they view the loan as a “foot in the door.” It serves as their version of the milk in a grocery store; offer it cheaper than the competition, and then put it in the back of the store so you make up the margins on everything else you sell. That is the opposite approach of most banks, and has allowed them to grow quickly and profitability in a brutally competitive market.
Cross-Selling Key No. 4: Accountability
The final ingredient to effective cross-selling is the one that tends to be the most difficult: accountability. Management teams often tell us they have big fears around offering discounts based on cross-selling. How can they be sure those accounts will ever show up? And, how can they keep their bankers from “re-using” existing deposits over and over to justify below-target pricing?
We’ve spent a lot of time thinking about how to solve this problem, and we believe we have finally cracked it in our pricing platform. There are two essential elements.
First, we track and maintain opportunities that are priced separately from the existing accounts at the bank. In other words, first you price an opportunity, and then we later see that same account show up in the data feeds once you book it. Keeping two records allows us to do a comparison. Was the loan priced with the assumption that new deposit balances were coming? And, did they actually show up? You must have a way of matching these two versions (“as priced” and “as booked”) to find discrepancies.
Second is the accountability. You must have a way of notifying bankers (and eventually customers) to remind them of these promised new accounts. It can’t simply sit in a giant report that no one reads. It has to be presented in an actionable way.
In PrecisionLender, we have built this functionality into Andi®, our virtual pricing analyst. Andi can monitor your portfolio, and let you know when you are still owed products that were a part of the original negotiation. Even if you don’t have our Andi, you should have some sort of mechanism for triggering follow-through.
Cross-selling isn’t easy. We work with enough banks to know that everyone struggles with executing it in a way that is beneficial to the customer and the bank. But it is also vital to your success, and it’s getting more important every day. For those who want to get better, we have some suggested homework.
- Find simple ways to provide your bankers with more visibility into the strategy and profitability of your types of accounts.
- Give your bankers more autonomy to be flexible, as long as they are still meeting the overall opportunity target.
- Hold your bankers and your customers accountable for these promises and trade-offs.
You don’t have to be perfect. If you can simply get better at all three, you will see immediate and tangible results. Your customers will be happier, they will be more profitable, and they will stick around longer. With those three trends as a wind at your back, you can withstand whatever pops up next in this ongoing game of whack-a-mole.
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