The Future of Lock Box and How Banks Can Maximize Value

Bank Treasury Management Lock Box

It was in the 1930’s when in an attempt to stimulate lending to help post-depression economic growth, the U.S. government gave certain banks access to U.S. post office boxes so that they could collect their due loan repayments. Banks would enter their local post office after hours with their keys, open their PO box, grab the mail that was set to be delivered the next day, deposit the receipts and deliver the remittance document. It wasn’t until 1947 when the RCA Corporation, knowing about bank’s capabilities to intercept payments at the post office, approached First National Bank of Chicago and Bankers Trust to see about them collecting sponsor and affiliate payments for its fledgling National Broadcasting Company radio network.  RCA had a logistical problem of efficiently collecting payments from sea to shining sea from a variety of sources. Both banks agreed to collect payments centralized in Chicago and New York and the bank “lock box” product was born.

 

Treasury Management and Lock Box

 

 Ironically, long-term rates were at 1.75% back then, much where they are today, and banks wanted the lock box business to please a big corporate customer and to generate some fee income. Fast forward to 2016, rates are even lower, and now we process lock box items such as checks, ACH, debit, credit card and other remittance transactions for almost free. Why do we do it, should we do it and what will happen in the future to this product?

 

Looking At Profitability

 

The first step to answer these questions is to look at profitability. The cost of software, data processing, labor, management and direct overhead expenses comes to approximately $160 per year per account for the average bank depending on the amount of scale employed. On the revenue side, most accounts that are charged fees generate an average of $1,200 to $4,200 per year. However, banks usually waive these fees for a majority of their customers (something close to 70%). That leaves float.

 

Bank Lock Box Statestics

 

It wasn’t until the 1960’s that the lights came on at banks as they realized that lock box generated substantial float. Rising rates suddenly brought a new interest in lock box due to the substantial increase in profitability.

 

Small customers average approximately $25,000 in direct deposits while large accounts such as municipalities can generate millions. On average, the community bank customer generates approximately $45,000 in annual balances for approximately $293 of value per year in the current rate environment. Of course, some banks choose to pay interest on checking or allow their corporate customers to sweep into a money market account. This interest expense decreases profitability, on average, by a little bit more than a third for a net attribution of $180. Because balances increase as the economy improves and rates rise, the product is positively convexed. This extends out the product’s already high duration (interest rate sensitivity), thus presenting a low correlation to interest rates. In addition, lock box dramatically increases customer retention and increases the average life of the customer by several years.

 

Add this all together, include the capital and risk charge, and you get about a 35% risk-adjusted return on equity over the lifetime of the customer. Not great, but above most loan and interest bearing deposit products. Increase rates along the forward curve and the current expected lifetime value of your average lock box account jumps to above a 60% risk-adjusted ROE.

 

To enhance profitability, most banks can benefit from controlling costs, choosing the right customers, proactively managing the risks/profitability of those customers, limiting the amount of customization and by having a clear set of procedures on when to waive fees. While account types do fit into specific categories, no two are the same. The decision on what types of accounts you are going after is central to the most critical decision in lock box – outsource or not?

 

Outsource or Not Outsource?

 

One of the most vexing questions in lock box is, do you outsource the function or not? Some banks choose to bring in a third-party to handle all aspects of lock box, while most (see chart below) have it all in-house. Managing the platform in-house allows the bank to service a wider variety of customers and to provide more customized work. However, this level of service and customization comes at a significant cost, which is one reason why many bank lock box operations lose money.

 

The decision to build or buy largely depends on a bank’s goals, the desired service level, and their size. For CenterState, we have analyzed this question a number of ways and determined that a hybrid model works best. It allows us to provide a higher level of service and at a lower cost than either model. 

 

Outsourcing Lock Box

 

We needed some payment drop locations around our state, needed the ability to offer an integrated platform that consolidates wire, ACH, checks, imaged items, debit, credit and other forms of payments at the branch, at remote locations and via mobile. We also required the ability to run decisioning tools and advanced analytics, the data stream of which needs to be able to be ported to a variety of applications both bank and customer facing. To accomplish this, we private labeled a software as service application from CheckAlt / Klik Technologies. We then integrate our team of experts to provide the highest level of service to the customer.

 

Beyond Profitability

 

To understand the value of the model and how best to leverage it, we turn to our team of experts for answers. Jarrod Hurd (Treasury Management Director), Melissa Spatafora (heads up lock box to our general corporate clientele) and Karen Gorman (heads up lock box to our specialty clients) lead our team of nine people that are charged with doubling production over the next couple of years.  

 

Just as National Bank of Chicago and Bankers Trust used the concept of lock box to keep a major client, lock box is central to an integrated treasury management platform for some types of accounts. Any organization that collects a large number of payments is a prime candidate, the top eight of which are included below: 

 

Bank Lock Box Top Profitable Customers

 

Part of our success here at CenterState is making sure we target profitable customers, and can support the customer without too much customization. Homeowners associations, for instance, offer a significant number of items to be processed, decent sized balances, but are on every bank’s radar screen. As a result, competition is fierce. The same is true for municipalities. While these accounts typically offer the largest volume, they loath to pay fees, require higher than market rates of interest on their float and present the most operational risk. As a result, their risk-adjusted profitability while above average isn’t at the highest level.

 

According to our lock box team, here are our ten ideas for turning in above-average performance when it comes to lock box:

 

Part of our success here at CenterState is making sure we target profitable customers, and can support the customer without too much customization. Homeowners associations, for instance, offer a significant number of items to be processed, decent sized balances, but are on every bank’s radar screen. As a result, competition is fierce. The same is true for municipalities. While these accounts typically offer the largest volume, they loath to pay fees, require higher than market rates of interest on their float and present the most operational risk. As a result, their risk-adjusted profitability while above average isn’t at the highest level.

According to our lock box team, here are our ten ideas for turning in above-average performance when it comes to lock box:

 

  1. Having expertise – The critical factor when it comes to selling lock box is understanding both treasury management and lock box. Having in-house expertise allows the bank to better understand the customer, their needs, and the solutions.
  2. Positioning service – When competing against lock box services, and often large banks with expertise only available via phone, it is important for the community bank to educate the customer between the differences of a lock box processor and lock box expertise. This point often gets lost. While every competitor can process, having on-call expertise will make the difference.
  3. Easy and accurate technology – A great lock box offering not only has memorable service but has a strong technology backbone that is easy to use, posts quickly and is accurate. Make sure your bank has the basics right and then expand.
  4. Having the ability to handle different payment streams – Banks should develop a solution that integrates multiple payment types into a consolidated payment stream. End customers should be able to mail checks, bring in checks to the branch or deliver ACH or credit card transactions all to one place and with ease.
  5. Provide customer self-help tools – Giving customers the ability to research items and archive for at least seven years has proven essential to winning larger accounts.  
  6. Provide lock box image capture – Full imaging capabilities (different than remote deposit capture) should be available so the customer can not only handle items in their office (such as an HOA) but mail or bring checks into the branch. A superior lock box program will not only handle this but provide the required analytics and reporting for the customer.
  7. Local mail boxes – Some customers, particularly municipalities, still require mail drops within their county. Having the ability to have multiple mail boxes in different zip codes can be important if your bank covers customers across different counties or even different states. While this is getting less important, this capability has been crucial to winning some profitable customers.
  8. Customer training – End customer employees consistently turn over so having a quality training program to train the customer in the finer points of treasury management and provide ongoing training is a key distinguishing factor. In this day and age, leveraging videos, webinars, remote screen shares and online/mobile chat is becoming the standard.
  9. Create multiple deposit options – Interest bearing checking, NOW account sweeps, repo and/or reciprocal sweep to FDIC insured funds are important particularly for larger, more sophisticated accounts that are either counterparty risk or interest earning sensitive.
  10. Pricing position and bundles – Having well-thought out and designed solution bundles will make it easier for accounts to understand treasury management pricing structures and provide more certainty in pricing. Banks should be clear with the client on when, and how, fees get to be waived. Waiving fees certainly makes sense for some accounts, but not for others. Banks should consider putting product packages together allowing a set number of specially handled items but be more disciplined on who gets their fees waived. Further, these packages should be based on segment type and then by volume in order to demonstrate expertise in specific industries.

 

The Future

 

The big question is what will happen to lock box in the future? Paper items will continue to decline and soon the cost to process will make them prohibitively expensive for banks to continue to support. The same is true for branch networks over the next 20 years. These trends bode well for the future and underscore the need for this product. In the next five years, profitability on this product will increase as paper items continue to drop. Where we had 90% in paper items back in 2010, we are now less than 75% (graph below). 

 

Virtual lock boxes

 

The pace of this change will accelerate even more in the future, and smart banks will be positioned accordingly. This will bode well for banks in the short-term. In the long-term, lock box will all go digital, which will decrease the barrier to entry for many competitors and more non-banks will offer the service supported by virtual banks with a lower cost structure. 

 

In addition, new payment methods, such as digital currencies and all mobile payments (payments not on the backbone of credit or debit cards) will need to be accommodated.

 

We also look for non-banks to force banks into real-time processing. Because U.S. businesses will want to be leaner, they will push banks for real-time availability. This instant availability will only come once banks have a core that can process in a real-time environment instead of our current batch structure.

 

More intelligent analytics, alerts, corporate financial management dashboards and a better risk interface covering both fraud and credit are on the horizon. Credit products will be integrated into payment platforms adding another dimension to lock box.  Banks that build their systems now and make an ongoing investment will find that they will be able to bank a highly profitable customer almost anywhere in the world. Lock box, in our opinion, is one of the most critical products a bank can have as the industry redefines what “community” means.

 

Instead of being constrained to a region, a flexible treasury management platform, to include lock box, will allow a bank to add scale in banking which will result in greater profit and better customer service. The future of banking looks bright because, in part, of the future of payment products like lock box.

 

Lock box was born out of the need for innovation, and it is innovation in this product that will be important to corporations, non-profits and municipalities for the next 50 years.