The economic down turn of 2009 – 2012 is behind us. We have started to see economic growth and increased loan demand, and charge-offs have returned to normal levels. These are all positive trends for banks and credit unions. The next big challenge bankers face is fighting the trend against margin compression. For the banking industry over the past five years we have seen overall NIM decline by 19bp (3.02% - 2.83% - see Chart 1).
The low margin is partly affected by a very low return on the investment portion of the balance sheet. However, we have also seen decrease spread on loan and deposit rates over the past five years, with a dramatic compression from 2010 to 2012 (Chart 2). In 2010 the spread between loan and deposit rates was 4.85% (5.54% - .83%) and in 2013 it had dropped to 4.44% (4.92% - .48%). This 39bp drop in spread is very concerning since margin is the “lion share” of banking revenues. In 2013, margin accounts for 62% of overall revenues with fees accounting for the other 38%.
The best way to combat this compression trend is understanding and using relationship profitability data. Relationship profitability allows bankers to understand which clients contribute most significantly to the organization’s profit. We find that up to 180% of the organization’s profitability is concentrated in the hands of the top 20% of clients. The first step is to build a process to systematically determine and distribute profitability data to the front-line so they can effectively interact with clients and fight the compression trend.
Key uses for Profitability Data
- Effectively Pricing New Transactions – Existing business already has a locked in margin, but using profitability data in pricing “the next transaction” can be very powerful in improving profit margins. First, we must understand the client’s existing profitability, then determine the profit associated with adding a new loan/deposit or service. It is important to understand the account level profitability and also give your bankers the ability to modify pricing parameters (rates, balances, fees, and terms) to see the impact of these changes on pricing.
- Client Relationship Management – With well over 100% of your organization’s profit concentrated in the top 10% of your clients it is essential to know who these “key clients” are! Empowered with this data, banks are using the information in officer assignments, outbound calling campaigns, and fee waiver decisions with the ultimate goal of reducing your “key client attrition” rate.
- Feeding Profitability Data into Marketing Systems – Profitability is an important factor many bankers use in marketing additional products and services to their clients. As a factor in marketing campaigns, we find that special campaigns or offers may be built for your most valuable clients.
- Evaluating and Rewarding Officers for Profit Improvements – Do you reward officers based the size of their portfolio? If so, you aren’t alone, but what do you really want from a commercial banking officer? Most banks say they want improved profit from their portfolio. Account profitability data aggregated by loan officer can provide you insights into the value of each officer’s portfolio. Then over time you can start rewarding officers for profit improvement, which more closely aligns to most banks goals.
Our bank and credit union clients that actively analyze and use customer profitability information generally drive NIM that is 10 basis points or more above their competition.