Capturing Growth in U.S. Retail Banking: Building a Sustainable Right to Win

The retail banking industry faces significant growth challenges. In this highly competitive and difficult environment, banks that earn the right to win will be those that make a clear choice about their “way to play” and then develop a distinct, coherent capabilities system that supports it.

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Leading Research

Paul Hyde Ashish Jain Suzanne Girolami Brian Landau

Capturing Growth in U.S. Retail Banking Building a Sustainable Right to Win

This report was originally published before March 31, 2014, when Booz & Company became Strategy&, part of the PwC network of firms. For more information visit www.strategyand.pwc.com.

The retail banking industry faces significant growth challenges
Trends
1

Elevated unemployment (although lower than 2010 peak)

Implications Stagnant top-line revenue growth Declining profitability, particularly in mass-market segment Low return on equity High nonperforming assets Continued consolidation (driven by bank failures and strategic acquisitions) Increased competition, particularly for creditworthy customers More stringent risk management practices

Macroeconomic

Extended low-interest-rate environment (amid potential concerns of inflation) Slowly stabilizing home values

2

Reduced willingness to incur new debt

Consumer Behavior

Higher rate of savings and investment in simple financial products Deterioration in trust leading to erosion of bank loyalty

3

Regulatory

Heightened consumer protection laws focused on reducing fees and increasing transparency New regulatory oversight costs, increased capital requirements, and direct fees to cover federal intervention

Source: Booz & Company analysis

1

1 Macroeconomic

Macroeconomic headwinds remain, fueled by lingering uncertainty about when a full recovery will take root
Historical and Projected Unemployment Rate

Trends
Unemployment broadly impacts revenue streams and is not expected to return to pre-recession levels until 2012 or 2013 – Lack of job security and financial stability will continue to limit borrowing Interest rates will inevitably rise from record lows in response to GDP growth and inflationary pressures – The Fed is expected to raise rates by late 2010 or early 2011 in response to inflationary concerns – Yield curve is expected to flatten by 2013, putting pressure on net interest margins Home values will slowly improve starting in 2011, after falling precipitously from 2006 to 2009 – Home values have a direct impact on the mortgage industry and act as a leading indicator for other financial services

15% 10% 5% 0% ‘05 ‘06 ‘07 ‘08 ‘09 ‘10F ‘11F ‘12F ‘13F

Historical and Projected Long-Term Interest Rate
6% 4% 2% 0%

‘05

‘06

‘07

‘08

‘09

‘10F

‘11F

‘12F

‘13F

Source: Global Insight; Mortgage Bankers Association; Booz & Company analysis

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2 Consumer Behavior

Consumer and commercial clients are using fewer bank products, investing more conservatively, and exhibiting less loyalty to banks
Trends
Savings – Recent attentiveness to saving more and spending less should persist for several more years – Higher savings rates bode well for bank deposits and wealth management sector – Credit vehicles will have less appeal Risk aversion – Conservative investment strategies will dominate until real economic growth reduces market volatility in 2012 – Lower-risk, highly transparent, and less profitable investment products make up a larger percentage of assets under management than in previous years Deleveraging – Businesses will delay capital investments, and consumers will accelerate debt reduction until 2013 – Mortgage and credit facility revenues will continue to plummet in the short term and will grow very slowly even in the long term Customer loyalty – Existing banking relationships are being tested due to a general deterioration in trust 20% 10% 0% 2004 -10% -20%
Source: Federal Reserve; Booz & Company analysis

Consumer Savings Rate 6% 4% 2% 0% 2004

2005

2006

2007

2008

2009

Change in Revolving Credit Outstanding

2005

2006

2007

2008

2009

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3 Regulatory

New regulations are reshaping the banking landscape, reducing operating profits by ~US$200 billion over the next five years
Description
• Consumers must consent to overdraft service for ATM and debit card transactions • Limit on credit card fees; restrictions on rate changes and marketing to under-21 segment; clearer terms and conditions • Interchange rates on debit PIN and signature transactions are being cut by 25 to 75 percent • Early payments for 2010 through 2012 to rebuild FDIC insurance fund

Impact
• Estimated loss of $7.3 billion in 2010 and $34.3 billion through 2014, about 19 percent of total nonsufficient funds/overdraft (NSF/OD) fees • $5.5 billion in lost revenue in 2010 and more than $50 billion through 2015

Regulation E

Lost Revenue

CARD Act

Interchange Fee

• Revenues for banks that issue debit cards could fall by an estimated $5 billion

FDIC Prepayment Additional Expenses

• $45 billion in prepaid insurance from the fourth quarter of 2009 to the end of 2012

TARP Tax

• 15-basis-point tax on liabilities, focused on wholesale funding, for banks with more than $50 billion in assets • Creates consumer protection authority • Ends “too big to fail” moral hazard

• Proposed fee expected to raise $90 billion over the next 10 years

Financial Reform

• $50 billion to $150 billion liquidity fund paid for by large banks

Source: Press releases and news articles; annual reports; FDIC; Bretton Woods; websites of Senator Christopher Dodd and Congressman Barney Frank; Booz & Company analysis

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Revenue and operating profit growth in many product segments will stagnate over the next five years
Operating Profit Margin2 70% 60% 50% 40% 30% 20% 10% 0% $10 $20 $30 $40 $50 $60 $70 $80 $90 $100 $110 $120 $130 $140 $150
1) Excludes insurance (life, property and casualty, etc.) and capital markets. Revenue (in billions) 2) Excludes loan loss provisions, nonrecurring gains or losses, and income taxes. 3) Excludes commercial real estate. 4) Includes home equity lines of credit, auto loans, student financing, and other consumer lending products; excludes mortgage and credit cards. 5) Includes originations, holdings, and servicing of multifamily, commercial, and farm mortgages; excludes securitization. 6) Includes originations, holdings, and servicing of 1- to 4-unit residential mortgages; excludes securitization. 7) Includes interchange fees from credit and debit card transactions, in addition to fees from cash management, online payment processing, global trade, and wire transfers. Source: Federal Reserve; FDIC; Nilson Report; Mortgage Bankers Association; 2010 Financial Services Fact Book; analyst reports; industry newsletters; news articles; annual reports; Booz & Company analysis

2014F 2009

U.S. Product Revenue & Operating Profit Pools1
2009-2014
Bubble Size = Operating Profit

Commercial Mortgage5

= $25B = $5B

= $50B

Commercial Loans3

Credit Cards Wealth Payments7 Residential Mortgage6 Deposits

Consumer Loans4
Revenue Growth (CAGR) 2004-2009 2009-2014F 4.8% 1.2% Profit Growth (CAGR) 2004-2009 2009-2014F 3.8% -1.1%

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Capturing available profit pools will require banks to clearly align their distinctive capabilities with market opportunity
Traditional Approach to Growth Most banks have historically used expansion to fuel growth: – Branch expansion – Bank acquisitions – New products (mortgage, real estate lending, etc.) They have over-invested in these so-called adjacencies (i.e., in related businesses where they perceive they have a “right to win”); such strategies often produce shortterm gain but long-term pain Coherent Approach In a low-growth environment, banks will need a much more surgical approach; they cannot afford to invest across the board Banks need to first understand what they excel at, channel scarce resources toward building these capabilities further to make them best in class, and then identify market opportunities that leverage those capabilities This distinctiveness will give them a right to win in a highly competitive environment

Source: Booz & Company analysis

6

Leading banks have successfully earned a right to win by asking three fundamental questions
Establishing a Coherent Strategy
A

How are we going to face the market?
What is our “way to play”? Do the executives, managers, and employees at every level understand the way the company creates value for customers?
Right to Win B

What capabilities do we have and what do we need?
What do we do well that customers value and competitors can’t beat? How do these capabilities work together in a system?

C

What are we going to sell and to whom?
Is every product and service offering aligned with the capabilities system and the way to play?
Source: Booz & Company analysis

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A

How are we going to face the market?

Banks are increasingly competing in one of four ways to play
Way to Play Distribution Giants Competitive Characteristics Extensive branch network and broad channel access Competitive pricing and convenience Broadest range of products Dense branch network coupled with reliance on other channels (e.g., online, mobile) Focus on product innovation, features, and packages Use of M&A to expand footprint and product abilities Trusted brand in the community Deep relationships through local leadership and decision making Traditional product set Branch-centric delivery Targeting defined segment(s) and/or product(s) Deep client and industry expertise and product knowledge Specialized product sets and custom solutions

Product Innovators

Community Banks

Segment Specialists
Source: Booz & Company analysis

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B

What capabilities do we have and what do we need?

Winning banks have developed a distinct and coherent capabilities system that supports their way to play
Examples of Capabilities Systems for Select Banks
Way to Play Examples of Winning Banks*
Client Experience Client Insights and Analytics Product Development and Innovation Distribution Management Acquisition and Integration Risk and Capital Management Human Capital

Distribution Giants Chase
• Siloed measurement and response, channel-driven • Analytics embedded in product silos • Lean product manufacturing, broad product capability set • Pervasive footprint, rapid channel innovation • Defined M&A process for acquiring outside footprint • Foundational risk management within product silos • Centralized talent management, basic training

Product Innovators PNC
• Institutionalized measurement and response • Some noninstitutionalized insights • Rapid product innovation driven by deep client insights • Strong branch density, growing other channels

Community Banks BB&T
• Embedded in the value proposition with local focus • Local insights, limited institutionally • Traditional product offering

Segment Specialists USAA
• Relationship- and value-based customized experience • Local insights on target segments • Custom products for targeted segments • Average branch density, focus on alternative channels • M&A discipline with focus on enhancing customer value • Prudent risk management, focus on diversifying earnings • Centralized, knowledge of industry and segments Distinctive Foundational

• Largely branch-based model with local delivery

• Real-time market intelligence on • Expertise in acquiring small innovations and technology banks in micropolitan areas • Prudent risk management, local decisions on relationships • Centralized talent management, linked metrics and behaviors • Prudent risk management, local decisions on relationships • Localized talent management, long-tenured employees

* Winning banks can compete with different capabilities systems. This exhibit shows, at a high level, the capabilities for select banks, not for the broader categories in which they are classified. Source: Booz & Company analysis

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C

What are we going to sell and to whom?

Banks use their capabilities in different ways to determine the products they sell and the customers they target
Examples of Product and Service Portfolios for Select Banks
Way to Play Examples of Winning Banks*

Distribution Giants Chase
• Broad array of core products and services manufactured in-house • Focus on product bundles and crossselling across multiple points of sale • All customer segments, from mass market to ultrahigh net worth • All businesses and institutions

Product Innovators PNC
• Emphasis on innovative products and features that leverage technology, customer insights, and analytics • Products that generate fee income • A targeted set of customer profiles and early adopters • Low-cost channels

Community Banks BB&T
• Traditional set of products (deposits, credit cards, mortgages, etc.) augmented by meaningful customer relationships

Segment Specialists USAA
• Deep set of products across core categories • Personalized and masscustomized solutions, depending on particular needs

What are we going to sell …

… and to whom?

• Customers who have a preference for local banking relationships • Small and middle-market businesses based in the community

• Select customers within traditional (e.g., mass affluent) and nontraditional (e.g., military) segments

* Winning banks can compete with different capabilities systems. This exhibit shows, at a high level, the capabilities for select banks, not for the broader categories in which they are classified. Source: Booz & Company analysis

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For example, Chase uses its coast-to-coast distribution network to deliver a consistent set of products to each segment
CASE STUDY

Chase: A Distribution Giant
A

Way to Play

• Branch density in major metropolitan areas attracts customers who value the proximity of the branch • Serves needs of all customers, but mostly focused on affluent segment in urban markets • Uses branches to facilitate cross-selling (e.g., placing loan officers in branches) Coast-to-coast branch network: • Proprietary data and analytics used to optimize existing branch network • Well-defined M&A and post-merger integration process designed to identify, acquire, and absorb large retail banks outside JPMorgan Chase footprint Broad product set: • Leverages economies of scale by developing, deploying, and managing products in-house • Extensive set of products distributed through coast-to-coast branch network serving the needs of most customer segments and businesses

Chase’s Branch Network

B

Capabilities System

Measured Progress (as of 1/2010)
5,100 retail branches and 15,400 ATMs across 23 states (mostly in highly populated areas) – Covers 42 percent of U.S. population and 46 percent of U.S. businesses – Deposit share leader: first in Chicago and New York, second in Los Angeles, third in Miami and San Francisco

C

Segment/ Product Alignment

Source: Company website; annual reports; investor presentations; press releases; SNL Financial; Booz & Company analysis

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PNC’s Virtual Wallet uses product innovation to target Gen Y and other Internet-savvy customers in a unique way
CASE STUDY

PNC Financial: A Product Innovator
A

Way to Play

• Has increased focus on product innovation to accelerate customer acquisition in select segments • Leverages technology to develop virtual products that cater to non-branch customers • Diversifies revenue streams through fee-based products Product innovations linked to targeted segments: • Ability to leverage technology, customer insights, and client analytics to develop innovative products • Ability to expand the use of innovations to different customer profiles (e.g., students and parents) Nontraditional delivery channels: • Adept use of nontraditional marketing and distribution channels (e.g., YouTube, mobile apps)

Notable Features of Virtual Wallet
Calendar: Know when you need to pay your bills and when you get paid Alert: Know when you are at risk of overdrawing your account Wish List: Monitor how much money you have set aside for wish-list items Chart: Know how much you are spending on utilities, groceries, and other items

B

Capabilities System

Measured Progress (as of 1/2010)
150,000 PNC customers use Virtual Wallet, representing a 14 percent increase in the bank’s Gen Y customer base Investment cost about $15 million, with a two-year breakeven period (one year less than a de novo branch)

C

Segment/ Product Alignment

• Innovative products servicing the needs of specific target segments (e.g., Gen Y, early adopters) • Used as a means to increase wallet share, acquire new customers, and reduce distribution costs

Source: Company website; annual reports; investor presentations; press releases; SNL Financial; Booz & Company analysis

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BB&T’s high branch density in small communities outside major cities caters to local clientele and small businesses
CASE STUDY

BB&T: A Community Bank
A

Way to Play

• High branch density in homogenous markets (aims to achieve top-five position in each market) • Caters to local clients (e.g., small businesses) that value branch convenience and hometown experience • Core consumer products augmented by valueadded, fee-based services (e.g., insurance) Strong presence in micropolitan areas: • Disciplined approach to market positioning: Focus on micropolitan areas, where few large players exist Local decision making: • Optimal balance between local and centralized decision making in order to leverage scale while remaining close to clients

BB&T’s Branch Network
Kentucky Ranked #3 Alabama Ranked #5 (up from #55) Georgia Ranked #5 W. Virginia Ranked #1 Virginia Ranked #3 S. Carolina Ranked #3 Florida Ranked #5 (up from #11)

B

Capabilities System

BB&T Branches Colonial Branches*

Measured Progress (as of 1/2010)
Diversified product and service portfolio supports bank during trying economic times – Fee income is about 40 percent of total revenue Leading positions in key markets and businesses – Seventh largest insurance agency in the U.S. – Top-five retail bank in about 70 percent of micropolitan areas 13

C

Segment/ Product Alignment

• Core savings, lending, and investment products augmented by deep client relationships and a focus on local clientele

* BB&T acquired Colonial in August 2009. Source: Company website; annual reports; investor presentations; press releases; SNL Financial; Booz & Company analysis

USAA is a segment specialist targeting military personnel with products and services that align with their needs
CASE STUDY

USAA: A Segment Specialist
A

Awards and Accolades
2009-10
Ranked #1 2009 Customer Service Hall of Fame MSN Money Ranked #1 USAA Brokerage Customer Satisfaction AAII Journal Top Financial Strength Ratings A.M. Best, Moody’s, Standard & Poor’s 19th Ranked #2 Customer Service Champs Business Week Ward’s 50 Top Performers in Insurance Ward’s Consecutive Year for Property/ Casualty 16th Year for Life

Way to Play

• Focuses on serving complete financial needs of military personnel and their families • Uses life insurance to gain client’s trust, then cross-sells based on client analytics High-end customer service: • Ability to consistently deliver a superior client experience that resonates with targeted audience Segment-specific products: • Ability to develop and market segment-specific products (e.g., youth and college banking) Online delivery: • Adept at leveraging and customizing mobile technology to support needs of military personnel stationed overseas

B

Capabilities System

Measured Progress (as of 1/2010)
High level of customer satisfaction and retention – 98 percent member retention – 97 percent customer satisfaction Growing customer base with 6 percent customer acquisition in 2009 (420,000 new members) Effective cross-selling: Customers average 4.2 USAA products

C

Segment/ Product Alignment

• Top-notch products and services that cater to a specific (nontraditional) customer segment (e.g., military personnel and their families)

Source: Company website; annual reports; press releases; Booz & Company analysis

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Employing a coherent strategy results in superior performance; on average, leading banks had positive growth in share price
The Coherence Premium
Average Return on Equity (ROE) and Change in Stock Price, 2004-09 Change in Stock Price1 20% 10% 0% -10% -20% -30% -40% -50% -60% -70% -80%
1) The cumulative change in the stock price, adjusted for dividends and splits, from January 1, 2004, to December 31, 2009. 2) The average return on equity from 2004 to 2009. 3) Does not include USAA, which is a private company. 4) The Dow Jones U.S. Financial Services Index is a proxy for the change in stock price of the average U.S. bank; return on average equity of all FDIC-insured institutions represents the industry ROE. 5) Actual ROE and stock price data from prominent U.S. banks that lack a coherent strategy. Source: FDIC; SNL Financial; Booz & Company analysis

Chase

PNC

Discussion
Investing in distinctive capabilities has enabled leading banks to maintain momentum, even through the recent crisis Banks with coherent strategies perform better than their peers and generate greater shareholder return – Average return on equity is 3.4 percent higher than industry benchmark – Significant growth in share price relative to industry (industry decline of about 45 percent)

Banks with High Coherence3 0% 5% 10%

BB&T 15% 20%

Return on Equity2

Industry

Average4

Banks with Low Coherence5

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Getting started: Evaluate your internal capabilities in the context of the external market to determine what gives you the right to win
A B C

How are we going to face the market?
• Are we clear about how we choose to create value in the marketplace?

What capabilities do we have and what do we need?
• Can we articulate the three to six capabilities that describe what we do better than anyone else? • Have we defined how they work together in a system?

What are we going to sell and to whom?
• Have we specified our product and service “sweet spot”? • Do we understand how to leverage the capabilities system in new or unexpected ways?

Evaluating Internal Capabilities

Assessing the External Market

• What external trends impact our business? What is the outlook? • How much regulatory exposure do we have? • Can we draw parallels from other industries or historical market cycles?

• What are the barriers to entry in the market? • How has the value chain been impacted by the market? • What strategies are competitors using? Where do they have a right to win?

• Who are our customers? How engaged are they with this category? How have their expectations changed? • How is technology impacting our products, channels, and segments?

Coherence can help align your M&A strategy to your capabilities system and eliminate non-core activities and expenses
Source: Booz & Company analysis

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Contact Information
Atlanta Daniel O’Keefe Partner +1-404-581-3489 [email protected] Chicago Ashish Jain Principal +1-312-578-4753 [email protected] New York Paul Hyde Partner +1-212-551-6069 [email protected] San Francisco Tracie Redd Partner +1-415-281-5034 [email protected]

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