Early Contract Renewals: Trick, Treat or Trap?

Trading terms for cost in contract negotiations can be a win-win for bankers – if they’re smart about it.

In the spirit of Halloween, here’s a hypothetical question: You have a 5-year CD at a bank with two years left on its term. Your rate is below current rates. The bank offers you the option to renew for five years today at a rate higher than what you’re earning now but lower than the bank’s current new money rate. Should you do it?

Well, that depends on a few unknowns. The biggest one is this: What would the rate be when the current renewal date hits? If that were known, the answer would be easy. But without that piece of information, the answer is that maybe it would be a good idea and maybe it wouldn’t.

What is certain, however, is that the bank put a lot of data analysis, maybe AI, and thought into the offer, and it priced the offer at a rate that it is sure will work for the bank (i.e., not you).

Now, let’s apply the same logic to vendor contracts. Consider:

• Point #1: Every bank and credit union has one or more contracts that have not reached expiration but that may be one to three years from end of term.

• Point #2: Every – and we mean every – financial institution will be looking for ways to reduce non-interest expense in 2024.

• Point #3: An early renewal of a contract would, in fact, reduce 2024 non-interest expense.

• Point #4: Vendors may contact bankers to discuss an early renewal, and bankers may want to contact them to talk about it.

Is it a good idea? Like our hypothetical CD, it might be, or it might not be. An early contract renewal is fairly simple – in theory. It’s a matter of trading term for lower current costs. The vendor is trading current revenue for a longer, future revenue stream. Done well, it can be a win-win for both sides.

Now for the small print. If the institution is considering this strategy and starts a conversation with the vendor, it can be sure the vendor will use data, business intelligence and experience to make sure the deal is good for the vendor.

How do bank leaders do the same, and what should they consider or know to make sure the deal is as good as it can be on their side? Here are some thoughts and strategies we’d suggest:

• Understand your commitment to the product before starting the conversation. This may seem obvious, but some products are ones that you’re not likely to change often (e.g., document imaging) and some that you very well may change sooner rather than later (e.g., first online account opening solution).

• Understand commoditized vs. premium-priced products. Review your product set and determine those that are considered new or “novelty” versus those where pricing has commoditized, or that will in the next 18 months. Ensure these products are priced accordingly, i.e., you will receive the benefit of future price compression.

• Watch growth commitments. Make sure you understand future growth commitments, the line items of your pricing tied to that committed growth, and how your minimums are affected. Ensure that your pricing for these items is appropriate for your size and volume.

• Think through mergers and acquisitions. Be sure you understand (1) what will happen if you purchase an organization that does not use the same vendor, (2) what happens if they do use the same vendor, and (3) what happens if you are acquired. Given the contract terms you are probably discussing, one or more of these are likely to happen.

• Pay close attention to annual increases in the cost-of-living adjustment. Determine the contractual annual increase and verify that it is acceptable for the length of your term. What is appropriate for today may not be appropriate for the full term of your contract. More than one of you are feeling the pain of 2023/2024 COLA increases right now.

Next to people, technology is likely the biggest expense at a financial institution. Whether there are opportunities to reduce that expense through early renewals is a very fair 2024 planning question. Banks that pursue an early renewal strategy need to make sure they get their share of the win.

“What the big print giveth, the small print taketh away.”
-Mary Hunt

Kourtney Piepenburg is a senior director at Cornerstone Advisors. Follow her on LinkedIn. Terence Roche is a founder and partner at Cornerstone. Follow Terence on LinkedIn.