Technology Expense Management

High Performance

EXECUTIVE BRIEFING

For more information, contact 770-670-6717 or nataliebrooke@resurgentperformance.com

2014 Resurgent Performance Inc.

High Performance

Technology Expense Management

By L. T. (Tom) Hall, President & CEO and Dean Schumann, Senior Technology Advisor Resurgent Performance, Inc.

If you dont know where you are going, you might wind up someplace else. Yogi Berra
When it comes to understanding where your financial institution is headed with its technology, none of Yogi Berras witticisms is truer than this one. Managing the costand the cost effectivenessof technology is critical to your ability to having the financial resources to remain competitive. At Resurgent Performance, Inc. (RPI) we refer to this as High Performing Technology Expense Management. This methodology looks at the technology you invest in and how to control the cost, all while remaining competitive and meeting the changing needs in your marketplace.

Measuring the Cost

Utilizing RPIs proprietary methodology for charting high performance, we examined the RPI Modified Universe according to multiple parameters.1 The first measure that we considered was the most commonly known ratio of Total Non Interest Expense to Total Assets, determining the levels that both A Players (90 to 99 Percentile of RPI Modified Universe) and B Players (80 to 89 Percentile of RPI Modified Universe) regularly achieve in todays competitive environment of increasing technology requirements, growing salaries, and high cost of compliance.

Please see the Appendix on Analytical Methodology for further detail on the RPI Modified Universe.

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Within each expense management measure that we considered, asset size played a significant role, and in no measure was that more true than in Total Non Interest Expense to Total Assets. Given the economies of scale that they are able to achieve, the larger the bank, the lower its Total NIE to Assets. This differential was a result that we expected. In banks under $1 billion, however, we revealed an interesting result. The A Players actually report a higher Total Non Interest Expense than the B Players, indicating that in the smaller, more successful banks, executive teams have made decisions to invest in more technology, higher-salaried employees, and / or better equipment, even if it costs them a few basis points on NIE. It also suggests that the A Players achieve a significant benefit of scale for banks with assets over $1billion. With our focus specifically on Technology, we turned to the Other Non Interest Expense category to delve deeper. Within Other Non Interest Expense, we wanted to consider those categories that are mainly controllable by management, so the FDIC Assessments were removed from consideration, and we looked closely at the combination of Data Processing + Telecommunications as a percentage of Controllable Non Interest Expense. Dependent upon asset size, High Performance banks spent between 23.88% and 45.36% of their Controllable Non Interest Expense on a combination of Data Processing and Telecommunications.

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Asset Size Differentials for Controllable Non Interest Expense

For the asset size band between $50 and $300 million, the A Players spend only a slightly higher percentage of their controllable NIE on Data Processing and Telecommunications than do the B Players, again indicating that the higher performers have strategically invested in technology to drive profitability and efficiency. As you will see the overall spend for this asset band is significantly higher than the other bands because of the lack of scale and the fixed nature of a large portion of technology spending.

For mid-size community banks between $300 million and $1 billion, the A players spend about 1.5% less on Data Processing + Telecommunications than their B Player counterparts.

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For community and small regional / super community banks between $1B and $3B in assets, we see the lowest spend of any asset size band in the top 20% of performers, suggesting that this group of banks has found ways to both achieve economies of scale and negotiate contracts successfully, yet without having invested in the larger infrastructure required by banks above $3B in assets. This asset band, which utilizes technology extensively and has broad service offerings, has achieved the optimal balance of scale / volume of activity and cost / technology investment management.

For banks between $3B and $10B in assets, the A Players spend a significant 6% less on data processing and telecommunications than do the B Players of the same size, suggesting that they are much more highly efficient at managing contracts and other data processing expenses.

2014 Resurgent Performance Inc.

What Do These Numbers Mean for My Bank?

As a community bank, calculate your organizations data processing and telecommunications expense, and look to stay near the percentage of spend achieved by the highest performing organizations in your asset size band. Because there are differences in how almost every organization classifies their individual expenses for rollup into call report data, consider a margin of error of + / - 5% as within a desirable range. If you find that your organization is more than 5% away from the high performance numbers, consider where your spend is too high, determine why that is, and consider the following strategies to lower it.

Budgeting for High Performance Technology Expense Management

In order to manage your cost related to technology, your budgeting process should be defined in three major categories: 1. Fixed cost that you have already committed 2. Variable cost that is dependent on volume 3. Strategic investments initiatives to keep you competitive and growing

Fixed Costs
The items in this category are likely the easiest to quantify because the decisions to commit to them were made some time ago, and you are obligated to continue licensing, taking depreciation, or paying maintenance for a defined period of time. You may be committed to continue to pay for facilities, communication lines, staff, and other items in support of the products and services you provide. Even if the cost is already committed, you should still continuously look for ways to improve processes around them or to renegotiate contracts when possible. Increasing volume or business activity levels to optimize your return on fixed costs requires study, as fixed costs have limited functional capacity. Also, outsourcing various aspects of your technology is a consideration to avoid excessive additional fixed costs.

Variable Costs
Variable cost items may include those that are volume-driven, such as debit card and ATM transaction fees, image item processing fees, the number of e-bill customers or bills paid, etc. Volume-driven pricing should be reviewed frequently, especially if your bank is growing organically or through acquisition. More volume is a good thing, but having the right pricing on your variable costs is a great thing.

Strategic Investment Costs

Items that fall into this category are both new initiatives, such as implementing mobile banking or replacing old systems like an aging internet banking site, or buying new desktops, tablets, or other technology. Funding for these initiatives may to a large degree depend on how well the other two cost categories are managed. In an economy that is increasingly dependent on new technology, you cannot afford to sit on the sidelines too long before your customers leave for an organization with newer technology. Aligning technology investments with your Strategic Plan is of critical importance, especially today as the rate and speed of change in banking technologies is increasing at its fastest ever pace.

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Managing Technology Expense for High Performance Banks

High Performance Technology Expense Management is a continuous process and takes a different approach within each of these three categories.

Managing Fixed Cost Process Improvement

Given historically low industry-wide margins and expectations of continued slow growth, a new normal is evolving that includes driving technology to deliver new and old services and products to particular customer segments or niches on a more cost effective and more favorable service basis. Challenging your business line managers to continuously look at their operations and processes usually yields significant cost reduction opportunities as well as service level enhancements. These reviews reduce the time to complete individual tasks (or potentially eliminate them) and shorten the time to make better decisions, with and without technology. Many times processes can be improved using the existing technology. Banks historically have not used more than half of the features and functionality available through their existing systems. Applying new technology to the same old process is not likely going to provide the kind of improvements in the overall productivity that produce Best in Class results. We believe changing processes and then applying the appropriate technology will consistently yield the best outcome. Buying new technology is not always the answer.

Replace Aging Technology

On the other hand, delaying the replacement of aging technology can cause inefficiencies and processing delays throughout the organization. New software releases often place higher requirements on servers, data communications, and on individual workstations. Adding time to completing individual steps in a process due to older or dated technology adds time to everyones day and has an exponential effect on the overall time to complete a process, not to mention the sub-par customer experience.

Outsourcing
We have seen a significant shift in the last several years toward outsourcingwhether for core and item processing, statement printing, telecom management or other services. Outsourcing may or may not be the best answer for any and all areas of IT, but it should be a consideration that provides a good comparison for cost. Before making the final decision to outsource, it is important to understand all aspects of the service levels you will receive, the costs involved, and your ability to service your customer. As many banks transform into customer advice centers and develop new services, managing technology and operations should be reviewed not just from a cost perspective, but from a core capabilities and strategic focus as well.

Renegotiate Vendor Agreements

One assumption that many financial institutions have is that the expense for most of the items in this category cannot be reduced until the current contract comes to term. Not true. Vendor contracts typically run for a period of 3 to 7 years and include built-in increases that effectively drive the cost higher in the later years, even when the overall cost of technology in our industry continues to drop. Consider

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negotiating vendor agreements at mid-term or at least prior to the last 18 to 24 months of expiration. Services that include transaction fees such as EFT, bill payment, and core processing are excellent candidates for re-negotiation prior to full term. Technology vendors have a vested interest in maintaining their revenue stream through long-term agreements. That means they have an interest in keeping you from looking at the competition. Approaching a vendor suggests that you want to retain your contract, but that you also need to lower the cost, and it provides an opportunity for the vendor to extend the contract for a longer period of time in exchange for lowering their fees. It should be a win for both the vendor and for you. Since pricing is complex and is constantly changing, you may need help to determine if you are in fact realizing the best deal possible.

Managing Variable Cost Renegotiate Vendor Agreements

The largest gain in managing variable cost is through contract re-negotiation which we discussed in the section on Managing Fixed Cost. Other approaches that RPI have proven effective are as follows.

Alternative Delivery Channels

Do you have back office processes that could potentially become customer-facing alternative delivery channels? Remote Deposit Capture (RDC)Too often we see clients with very low volume using RDC when they should be using mobile capture. If you have not already done so, you should establish policies on which customers are offered RDC, and then price it to make it a revenue generator based on the benefits to the customer. The time and expense that customers spend preparing the deposit and making the trip to your branch has to make sense for both the customer and the bank. Cash Management Services Cost savings that your commercial customers can enjoy by performing ACH, wires, generating positive pay files, and other similar processes can be significant. If you are offering these services today the question is: Are you getting the acceptance from your customer base you should be, and are you making it a competitive advantage to do business with you? Automated Decisioning It can cost your financial institution significant business if you are not able to make decisions on loans faster than your competition without diminishing credit quality. In order to achieve this speed, you need to have the appropriate processes and procedures in place, including the appropriate technology. Online Applications Like the decisioning speed discussed above, providing the ability to take new loan applications online can both provide competitive advantage and lower cost per application. For some consumer loans you may consider auto-decisioning; however, for commercial loans you likely will begin the application process with an online application and save their time in coming to your branch. Once the application and other required documents have been received, it is important to make the decision as quickly as possible. Small business lending is going this way too.

Managing Strategic Investment Cost

Investing in new technology is an ongoing process. Banks typically have had to increase their year-over-year technology spend due to changes in regulations, increased security risks, and enhancements to existing systems.
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Determining which technology initiatives to invest in is accomplished in different ways. We recommend that the departments requesting new technology be held accountable for the outcome, beginning with providing a detailed cost / benefit analysis for the initiative. Some updates or new technology initiatives are driven by regulation and cannot be cost justified, other than to mitigate risk. We also recommend that once the new initiative is in place, the requesting department is held accountable for the results. For example if the cost justification for a new lending platform was based on increasing the efficiency, was that level of efficiency achieved, and are loans being processed faster with fewer FTEs? Or, if mobile banking was going to increase the number of customers for the financial institution, was the goal achieved? Many times we have seen technology implemented with the justification being all our competitors are doing it. This defensive strategy may be reason enough to implement a new technology, but it should not go unmeasured in terms of attracting and retaining customers.

Conclusion
Technology has become and will remain a significant portion of every banks Non Interest Expense. Technology not only drives efficiency, but it can make or break the customer experience and thus customer loyalty. Setting overall expectations for managing technology expense to high performance levels provides a real financial goal from which technology budgeting and expense management strategies should follow. Because of the high rate of change in technology today, we recognize that the need to balance growth, efficiency, service, and cost management is more challenging than it has ever been. But not balancing these critical aspects, and not aligning technology spending with well conceived strategies, and not producing results from technology initiatives is a guaranteed prescription for lower-than-High Performance Banking. n

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Appendix Background / Analytical Methodology

Charting the Numbers
Earlier this year, RPI released its Executive Briefing on High Performance, which considered key financial ratios of High Performing banks and how those numbers can be used to take the pulse of the banks financial performance. In this paper, we have taken a closer look at one of those ratios Non Interest Expense and consider how banks can drill down into Non Interest Expense to better manage technology costs. Its a well-known fact that no two banks account for and report their technology costs in exactly the same way. Banks that outsource their core data processing will have numbers sometimes widely different from those that process in house. Some organizations report the depreciating assets of hardware and software under Premises and Equipment, while others report them under Other Non Interest Expense. Some banks report telephone, internet, and VOIP as part of Telecommunications, and others report it as part of the larger Data Processing expense. The list of variations is long. Consequently, the numbers contained in this briefing are more useful as guidelines than as specific targets, and your bank can track toward a + / - 5% margin of error toward these High Performance numbers and still consider itself successful. The Modified Universe for RPIs analysis on High Performing Technology Expense Management developed as follows: Banks from $50 million to $10 billion were divided into four asset size bands Within each asset band, the extreme performers (3% from both high and low) of ROE and ROA were removed Banks that did not report Data Processing Expense were removed from consideration These normalizations resulted in the following size groups:

The banks in each asset size band were ranked according to the RPI Performance Formula, which encompasses both ROA and ROE. A Player High Performance banks are those that ranked from the 90th to 99th percentile of the RPI Performance Formula. B Players are those ranked from the 80th to 89th percentile.

For more information, contact 770-670-6717 or nataliebrooke@resurgentperformance.com

2014 Resurgent Performance Inc.