after the crash: the future of finance the future of ... · 10/16/2009 · – the crisis shaping...

NYC-MOWAM1MKT-068

Alan McIntyre

Michael Zeltkevic

Financial Services

After The Crash: The Future of Finance

The Future of Commercial Banking

October 16, 2009

1NYC-MOWAM1MKT-068© 2009 Oliver Wyman www.oliverwyman.com

Defining the topic

A US focused analysis

– FDIC universe used as the core data set

– Balance sheet, regulatory and competitive issues vary greatly

by country

Focus on traditional commercial banking economics

– Assets

– Liabilities

– Treasury management

– Non-balance sheet fee income

A future that is 2-4 years out

– Current wave of credit losses through the system

– New regulation in place

– Macro-economic conditions that are currently priced into the

market


Structure of the next 60 minutes

How did we get here?

– The long history

– The golden decade of 1993-2003

– The crisis

Shaping the future of US commercial banking

– Macroeconomics

– Regulation

– Competition

Three plausible future scenarios

The distribution of returns – what will define the outperformers?

Discussion

NYC-MOWAM1MKT-068

How did we get here?

Section 1


The economics of the US commercial banking industry since the

Great Depression can be defined by five key eras

US Commercial Banking Post-tax ROTE

Source: FDIC Historical Data

Stagflation

2

S&L

crisis3

“Golden

Era”4

Financial

crisis5

Average

ROE

11.1%

10.1%

-8%

-4%

Post-Great

Depression recovery1

0%

4%

8%

12%

16%

1936 1942 1948 1954 1960 1966 1972 1978 1984 1990 1996 2002 2008

RO

TE

(%

)


A confluence of macro factors lifted the performance of the

industry during the golden era of 1993 to 2003

Good treasury

profit contribution

High banking

profits

Capacity to

borrowAbility to lend

High origination

volumes

Very low

credit losses

High lending

profits

Falling rates

Net long

treasury

positions

Steep

yield curve

Strong

home price

appreciation

Secondary

market

liquidity

Strong

deposit

growth

High barriers

to entry

in deposits

Favorable

conditions

Positive

secondary

effects

High profits

Higher

fee income

High profits for

branch based

deposits

Low competitive

intensity and high

pricing power

Sustained high

employment


This perfect storm lifted industry profitability to

unprecedented levels

Pre-tax net operating income

Commercial banking as a % of all US Corporations

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

1934

1937

1940

1943

1946

1949

1952

1955

1958

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

5.73%

12.3%

Source: FDIC Historical Data, SNL


Unlike investment banking this wasn’t a leverage story

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%

1983 1987 1991 1995 1999 2003 2007

Source: FDIC Historical Data

Note: Tangible common equity calculated as total capital – intangibles – perpetual preferred

Tangible common equity/

Total assets

0%

2%

4%

6%

8%

10%

12%

14%

16%

19

34

19

38

19

42

19

46

19

50

19

54

19

58

19

62

19

66

19

70

19

74

19

78

19

82

19

86

19

90

19

94

19

98

20

02

20

06

Equity capital to total assets


The party should have ended in 2004 as rates bottomed out and

the yield curve flattened and then inverted

Sources: Bloomberg

3 Year Swap Rate – 3 Month LIBOR

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Ja

n-0

4

Ma

r-0

4

Ma

y-0

4

Ju

l-0

4

Se

p-0

4

No

v-0

4

Ja

n-0

5

Ma

r-0

5

Ma

y-0

5

Ju

l-0

5

Se

p-0

5

No

v-0

5

Ja

n-0

6

Ma

r-0

6

Ma

y-0

6

Ju

l-0

6

Se

p-0

6

No

v-0

6

Ja

n-0

7

Ma

r-0

7

Ma

y-0

7

Ju

l-0

7

Se

p-0

7

No

v-0

7


Instead, to compensate for lower spreads and to utilize fixed cost

infrastructure, asset growth became the priority

$0

$200

$400

$600

$800

$1,000

$1,200

20

01

20

02

20

03

20

04

20

05

20

06

Su

bp

rim

e +

Alt

-A o

rig

ina

tio

n $

BN

0%

5%

10%

15%

20%

25%

30%

35%

40%

% o

f tota

l orig

ina

tion

Alt-A Subprime

Sources: Fed Flow of Funds, MBA, Company reports

Sub-prime and Alt A mortgage

originations 2004-2007

0

5,000

10,000

15,000

20,000

25,000

Q1

-20

02

Q4

-20

02

Q3

-20

03

Q2

-20

04

Q1

-20

05

Q4

-20

05

Q3

-20

06

Q2

-20

07

Q1

-20

08

Q4

-20

08

$B

N

Household Liabilities

Non-Financial Business Liabilities

US Credit Liabilities 2002-2009

1Q

20

07

An

nu

aliz

ed


The end result was the current banking crisis

Heavy write-downs on structured credit portfolios

Investors and banks exposed to insolvent

banks incur heavy losses

3

Lack of

liquidity

Inter-bank

markets freezeBanks can’t

unwind positions

Illiquidity depresses

prices and further

erodes capital

Regulatory gaps in the shadow-banking sector

“This time is different mentality”

Tight-coupled architecture of the financial

system

Failures of top-level risk governance

Originate to sell model led to over-reliance on

external credit ratings who became the de-factor

regulators

Short-term funding structures

1

Credit

losses

2

Lack of

capital

Weak

regulation

Insufficient

risk

management

NYC-MOWAM1MKT-068

Shaping the future

Section 2


1,049

316

1,109

337250

200

793

340

4,394

0

1,000

2,000

3,000

4,000

5,000

US UK Rest of

Europe

Australia/

Asia

US GSEs US

pensions

Other

investors

Bank

losses on

emerging

market

assets

Ultimate credit crisis writedowns

By type of institutions bearing losses

Source: Ultimate writedowns from IMF; losses to date from Bloomberg

Not broken out geographicallyBanks and insurers

(hedge funds,

non-US

pensions,

etc.)% ultimate

losses

recognized

to date

77% 43% 30% 12%

The immediate future will be dominated by further credit losses

74%

CRE

C&I

Prime Consumer


Beyond that three sets of forces will shape the industry

Regulatory

Capital levels

– Regulatory

minimums and

composition

– Market

expectations and

de facto minimums

Consumer protection-

deposits

– Overdraft changes

– Other fee income

Consumer protection

– CPFA

Competitive

Deposit competition

Consolidation

Lending business

model

– Secondary markets

– Competitive

intensity

Interest rate

environment

– Trajectory of rates

– Shape of the curve

GDP growth

Employment

Home prices

Savings rate

Macroeconomic


Modeling future industry returns

Drivers

Second order

effects

Input metrics

(% of assets) Output metrics

Macroeconomic

Regulatory

Competitive

Credit losses

Asset growth

Deposit growth

Bank failures

Net interest

margin (NIM)

Non-interest

income (NII)

Non-interest

expense (NIE)

Provisions

Tangible common

equity (TCE)

ROA

Efficiency ratio

Post-tax ROTE

NYC-MOWAM1MKT-068

Three future scenarios

Section 3


Our baseline has the industry returning to the long-run average of

~10% ROTE

Macroeconomics

Steep curve with 10 year

at 4%

Unemployment at 8-9%

Subdued inflation of 1-2%

U-shaped recovery with

2-3% growth afterwards

Savings elevated at 7-8%

through deleveraging

Credit volumes flat and

deposits at GDP growth

Defaults remain high but

recoveries improve

Regulatory

CFPA-light for high

margin lending products

Minimum capital

increased, especially for

Tier I institutions

Opt-out overdraft

legislation plus other

fee restrictions

Competitive

Wholesale lending volumes

rise but pricing remains

elevated

Securitization returns for

jumbo mortgage and card

Increased deposit competition

from branch and non-branch

competitors

Consolidation driven by

failures in 2011 and 2012

Some additional

roll-up deals

Inputs

NIM 2.9%

NII 1.9%

NIE 3.1%

Provisions 0.6%

TCE 7.1%

Outputs

ROA 1.1%

Efficiency ratio 65%

Post-tax ROTE 10%


A plausible malign scenario would make US commercial banking

a breakeven business . . but this would almost certainly drive

industry restructuring

Macroeconomics

Flat curve with 10 year at

3% or lower

Unemployment at 9%+

Inflation at 0-1%

Double dip recession with

1% growth afterwards

Savings at 8-10%

Sustained losses in CRE,

C&I and prime consumer

Credit contraction with

deposit growth at GDP

Regulatory

Capital levels rise for all

institutions

Multiple fee income

restrictions imposed

Full CFPA implementation

Competitive

Wholesale lending

market tight with limited

asset growth

Limited deposit

competition given

sustained low rates

Consolidation is failure

driven and peaks in 2011

with 600-1,000 total

failures

Inputs

NIM 2.6%

NII 1.6%

NIE 3.4%

Provisions 0.7%

TCE 7.5%

Outputs

ROA 0.1%


Post-tax ROTE 0.9%

High hygiene costs for

compliance


A benign, but also plausible scenario, would see industry returns

back at golden-era levels

Macroeconomics

Steep curve with 10 year

at 5%

Unemployment at 6-8%

Inflation at 2-3%

U-shaped recovery with

3% growth afterwards

Savings at 5-7%

Credit losses back to

normal cycle

Credit expands at GDP

and deposits at GDP+

Regulatory

Capital levels don’t rise

from current levels

Limited fee regulation on

deposits or quick

substitution of other fees

Limited lending regulation

except card and mortgage

disclosures already

passed

Competitive

Availability of credit high

with rates at pre-crisis levels

Secondary markets except

sub-prime return

Limited competition from non-

branch banks for deposits

Some merger of equals

consolidation

Failures peak in 2010 and

then drop steeply and are

<500 overall

Sustained cost control

Inputs

NIM 3.1%

NII 2.2%

NIE 3%

Provisions 0.5%

TCE 6.8%

Outputs

ROA 1.8%


Post-tax ROTE 17%

NYC-MOWAM1MKT-068

The distribution of returns –

who will outperform?

Section 4


Banking has become less of a sector play over the last decade

with a wider distribution of returns

Return on average equity distribution

All publicly traded commercial banks & thrifts (1997-98 vs. 2007-2008)

Source: SNL, Oliver Wyman analysis

’97-’98 industry

median

0%

5%

10%

15%

20%

25%

30%

< -10% -5% 0% 5% 10% 15% 20% 25%

ROAE (%)

% o

f re

gu

late

d d

ep

os

ito

rie

s

2007-2008 1997-1998

2

1

’07-’08 industry

median


Outperformance will result from the combination of positioning

and performance

Structural Performance

Market outlook Capabilities

Economic climate

Demographic

trends

Regulatory

environment

Operations

Culture

Analytics

Performance

management

Business model

selection

Outperform rivals

Lines of business

Segments

Products

Geographies

Efficiency

Productivity

Incentives

Positioning Execution


0

50

100

150

200

250

300

350

MSA

MS

A q

ua

lity

sc

ore

Geography will matter

Distribution of MSAs by MSA quality index1

1. Quality index is a deposit profit per branch index that incorporates average balances, balance composition, estimated income and expense assumptions

Honolulu

Las Vegas

Cleveland

Nashville

Kansas City


48

11

13

2

39

0

20

40

60

80

100

120

Households

Ho

us

eh

old

s (

MM

)Segment focus will matter as well – particularly in deposits

US consumer households

23% of

households

4.0 5.5

19

7.5

3.0

7.5

6.5

7.0

10.01.5

5.5

0

5

10

15

20

25

30

35

40

45

50

Lending Deposits

Ne

t in

co

me

($

BN

)

56%

of the

profits

70% of

profits

US consumer banking profit pools 2007

High net worth

Small business

ownersMass affluent

Mass

Below mass

High net

worth

Small

business

owners

Mass

affluent

Mass

Below

mass

Small

business

Source: Survey of Consumer Finances, Oliver Wyman analysis


Business mix will determine the impact of regulatory and

NIM changes

Non-interest income revenue contribution and mix

Largest regional banks (2007-2008)

Sources: Bank analyst reports; SEC filings; Oliver Wyman analysis

0%

10%

20%

30%

40%

50%

60%

Regional

Bank

Average

PNC US Bank TCF Fifth Third Key Wells

Fargo

BB&T SunTrust RBS-

Citizens

Comerica

No

n-i

nte

res

t in

co

me

% o

f to

tal re

ve

nu

e

Deposit service charges Mortgage banking Trust and Investments Other

25%

3%

14%

57%

10%

90%

62%

20%

4%

14%

55%

43%

2%57%

14%

6%

23%

57%

26%

18%

55%

18%

8%

19%

66%

7%

22%

5%

50%

23%

26%

47%

4%

28%

21%

42%

52%51%

47%45% 44% 42%

41%

31%

39%

45%

5%2%

48%

34%


Cost control will be a hygiene factor, not a strong driver

of outperformance, except in a malign scenario

-50

-30

-10

10

30

50

70

0 20 40 60 80 100 120 140

Efficiency Ratio

RO

AE

%

Efficiency Ratio Versus ROAE (Q2 2006) R2 = 0.29


Common characteristics of the future outperformers

Advantageous positioning and business mix

– Good markets and customer segments

– Robust non-balance sheet fee income businesses

Reintegrating the balance sheet at the customer level to improve

risk management, asset growth and pricing

A clearer focus on the value and management of deposits including

deposit related fees

The ability to take advantage of disruption through advantaged

M&A

Balance sheet and risk management discipline

– Credit risk

– Funding and liquidity management

– Continuous stress testing of capital


The new normal for US commercial banking

A simpler business with more regulation and more transparency

– Balanced balance sheets

– More customer than transaction driven

A Beta 1 business more closely tied to the macro economy, but still

above hurdle rates of return

But also a business where the dispersion of returns will continue to

increase with clearer winners and losers than in the past

after the crash: the future of finance the future of ... · 10/16/2009 · – the crisis shaping...

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