A Multidimensional Study of Banking Performance

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1 Banking & Financial Services White Paper A Multidimensional Study of Banking Performance What are North American and European Financial Institutions Focusing on, and Why?

2 About the Authors Sayantan Datta Sayantan Datta is a Research Analyst with the Corporate Research group, part of Corporate Marketing at Tata Consultancy Services (TCS). He specializes in global research for banking, financial services, and insurance industries. Datta has rich experience in developing industry and technology reports, especially on digital technologies and their impact on global players across the financial world. Himadri Pramanik Himadri Pramanik leads research and is part of Corporate Marketing at Tata Consultancy Services. He has worked with several global enterprises, primarily consulting in business process reengineering (BPR), adoption of macro quality models, balanced scorecard (BSC) strategy deployment, and Capability Maturity Model Integration (CMMI) benchmarking. Pramanik has anchored large project and program management assignments, as well as conducted primary research and analytics across industries. Moloy Sundar Ghosh Moloy Sundar Ghosh is a Research Analyst with TCS Corporate Research group. He specializes in global research for the banking and financial services industry and has rich experience in conducting organization, industry, and technologycentric research. Ghosh specializes in financial analysis of global organizations and assessing the impact of digital technologies on financial enterprises.

3 Abstract We conducted a study of 44 North American and European banking organizations across three dimensions: assetcapital space, profitability dynamics, and organizational strategy, to understand the trends in the industry and their resultant impact. This paper presents the findings of this study, which used publicly available data from annual reports and press release notes of the banking organizations studied. While the financial data spanned the period January 2013 to December 2014, business and environmental considerations covering the last three years were analyzed. This research highlights key changes in North American and European financial landscapes, and outlines the onground trends to help shape business plans. Some factors showed a secular trend with global impact, while others were regional in nature. Globally, banks faced considerable revenue pressures due to muted loan demand, even as they tried to expand their assets through alternative investments, and optimize costs by rationalizing branch portfolios and revamping branch operations with digital and selfservice channels. The majority of European banks showed a positive asset growth and increased risk response, but most of these organizations registered notable decrease in profitability. Most North American banks reduced nonperforming assets, showing signs of economic recovery in the market. However, the positive economic scenario was accompanied with an increased competition from nonbanking players in areas such as loan origination, especially in the US.

4 Contents Introduction 5 Research Methodology and Scope 5 Research Considerations 6 Trends Shaping the Global Banking Industry 6 Revenue pressures are here to stay 6 Seeking growth beyond loans 7 Multichannel banking and branch refurbishment are picking pace 8 In a nutshell 9 How North American Banks are Playing the Game 10 Improving loan asset quality 10 Focusing on new business areas to combat revenue pressures 10 Segmentwise performance of North American financial institutions 12 How European Banks are Responding to Industry Changes 13 Cautious risk management to drive benefits 13 Regionwise performance of European financial institutions 13 Conclusion 14

5 Introduction The banking and financial services industry is at a crossroads. Almost seven years after the financial crisis that practically shook the world, organizations are struggling to contain the volatility of key performance indicators (KPIs) like revenue, operating expense, number of employees, risk weighted assets, and so on, even as sweeping regulatory changes make the game tougher. As customer centricity gains prominence and competitive pressures remold industry dynamics, organizations worldwide are looking to leverage emerging technologies to develop robust survival strategies. In this context, we conducted a study to identify the key factors impacting the performance of major financial institutions in North America and Europe the twin hubs of the developed financial services market. Research Methodology and Scope We studied the public filings annual reports and press release notes of 44 North American and European financial institutions comprising universal banks, payment providers, and investment banks. To identify related factors, institutions were clustered into five segments based on geography, size, and specialization (see Table 1). Segment Definition Inclusion North American megabanks Large universal banks with assets of over $1 trillion Bank of America, Citibank, JPMorgan Chase & Co., and Wells Fargo North American midsize banks Banks with an asset size between $1 billion and $1 trillion, with considerable presence in retail and commercial banking Canada: Bank of Montreal (BMO), Canadian Imperial Bank of Commerce (CIBC), Royal Bank of Canada, Scotiabank, and TD Bank US: BB&T, Capital One, Fifth Third Bancorp, PNC Financial Services, Regions Financial, SunTrust Bank, and US Bancorp Investment banks that make 1520% of their total revenue solely from investment banking Goldman Sachs and Morgan Stanley Financial services firms that derive their revenue from cards and payment services Thirdparty processors like MasterCard, Visa, American Express, and Discover Financial Services Large universal banks with assets above $500 billion Barclays, HSBC, Lloyds Banking Group, Royal Bank of Scotland, and Standard Chartered Universal banks with assets above $500 billion France: BNP Paribas, Crédit Agricole, Groupe, BPCE, and Société Générale Germany: Commerz Bank and Deutsche Bank Italy: Intesa Sanpaolo and Uni Credit Nordics: Danske Bank and Nordea Bank Spain: Banco Santander and BBVA Switzerland: Crédit Suisse and UBS The Netherlands: ABN AMRO, ING, and Rabobank North American Niche Players UK universal banks Western European universal banks Note: FY 14 corresponds to November 2013 to October 2014 period for Canadian firms, and January 2014 to December 2014 period for others. Table 1: Segmentation of Financial Institutions for this Study 5

6 Research Considerations We analyzed public filings and disclosures of the 44 institutions that were studied, along with respective press release notes, to assess their organizational performance with regard to the following three dimensions: Assetcapital space: An overview of the financial position of an organization through the analysis of its balance sheet, assets and liability statement, financial ratios, capital and liquidity positions, and credit risks. Profitability dynamics: A study of the statement of income along with factors affecting the statement, avenues of income generation, cost levels, and profitability. This helped us gauge the financial aspects of organizational operations. Organizational strategy: An analysis of the organizational performance and growth model across business lines and geographies. This was done through an indepth review of geographic and businesscentric growth strategies like branch and channel expansion, mergers and acquisitions, divestments, and so on. We examined the different lines of business (LOBs) of financial organizations including retail or consumer banking, commercial or institutional banking, trading or investment banking, payment processing, and asset and wealth management. Trends Shaping the Global Banking Industry Revenue pressures are here to stay Banks the world over are facing intense pressure to grow their business across regions. One of the probable byproducts of this drive is the current trend of growing deposits and lagging loan growth. The annual FY 14 filings of banking majors like Wells Fargo, BBVA, RBS, and ABN AMRO clearly exemplify this. BBVA posted a moderate growth of 5% in loans and advances to customers, which lagged behind its customer deposit growth of 6%, while Wells Fargo posted loan and deposit growth of four and 8%, respectively. Figure 1 shows the yearonyear (yoy) change in loandeposit ratios among the banks studied during the FY Banks with falling Loandeposit ratio yoy Banks with rising loandeposit ratio yoy North American Banks European Banks Note: This covers organizations with relevant data disclosures (does not include nondeposit taking institutions) Figure 1: Change in LoanDeposit Ratios in FY 14 (Source: TCS research) [1] Annual filings of North American and European financial institutions for FY 14 (April 2015), accessed in April

7 Growing deposits lead to banks expending more toward interest expenses amid relatively muted loan growth. This in turn leads to lesser income generation due to reduced interest amounts. With falling net interest income, banks are cutting down on operating costs to maintain profitability. Some measures being undertaken in this regard include optimization of branches and the workforce. As per the annual reports studied, 17 out of 22 European banks reduced the size of their workforce, while 11 banks reduced the number of branches. In North America, 18 out of the 22 banks studied reduced their headcount to cut costs. Banks are also working toward adopting innovative ways to generate income and enhance operational efficiency. ING, BBVA, and Bank of America for instance, are investing in alternative banking channels as they reduce their workforce to optimize costs and improve efficiency. Seeking growth beyond loans The banks studied have shown a decided shift in terms of asset growth. While loan portfolio remains a key contributor to asset formation, we have observed that asset growth cannot be explained by loan growth alone (see Figure 2). Two cases in point include Santander in the UK that grew its asset base by 12% in FY 14, but had a customer loan growth of just 7.3% for the same time period; and Danske, whose corresponding figures were 7% and 3%, respectively. Banks are leveraging other means like alternate investments to drive asset growth. This shift points toward investments in trading assets, derivatives, and holding of liquid assets. For example, Standard Chartered s liquid asset to total asset ratio grew from 29.8% in FY 13 to 32.2% in FY 14. Its derivatives and investment assets grew by 4.9% in absolute terms, while loans and advances to customers reduced over the same period by about 3%. 14% 19% 86% 81% Banks in North America Banks in Europe % of banks with asset growth equal to or less than loan growth yoy % of banks with asset growth more than loan growth yoy Note: Figure covers organizations with relevant data disclosures Figure 2: Change in Asset Growth vs. Loan Growth in FY 14 (Source: TCS research) 7

8 Figure 2 also depicts a similar trend at North American banks, big banks like JPMorgan Chase, growing its total assets twice as fast as its loan assets in FY 14 (6% asset growth versus 3% loan growth). State and municipal bond markets have been a particular focus area for new investments in JPMorgan Chase. Canadian banks showed a healthy loan growth. Yet, for most of them, asset growth was faster. For example, Royal Bank of Canada showed 6% loan growth in FY 14 while its assets grew by 9%, due to increased trading asset investments. Multichannel banking and branch refurbishment are picking pace Continuous fall in branch transaction volumes and concurrent rise in mobile banking are indicators of increasing adoption of alternate banking channels. A study of the strategic focus statements of annual reports show that almost all banks have recognized these trends as vital and are making investments to develop their digital channels further, to engage better with their customers. Examples are BBVA s tabletbased retail banking and JPMorgan Chase s mobile corporate banking initiatives. While digital channels will help banks reduce operational costs (like in the selfservice channels of the innovative Capital One 360 Café format branches), the digital concept will also drive innovationled differentiation in customer service and product design. US Bancorp, for instance, changed its website design thrice in 18 months to improve customer selfservice experience. As shown in Figure 3, majority banks across regions exhibited a movement toward optimization of their branch assets. Banks are consolidating the number of branches they operate and are opening smaller selfservice outlets. Examples are, Bank of America that continued its branch rationalization exercise in 2014, and PNC that reduced costs by creating popup branches by modifying shipping containers. These branches come up in places with heavy crowd concentration like fairs, festivals, concerts, or specific localities for a few days, in line with the ideology of being close to your customers. Similar trends have also been observed in Europe, as evidenced by Nordea and Unicredit, both of which optimized their branch numbers. # of banks with less branches yoy # of banks with more branches yoy # of banks with undeclared branch data yoy Banks in North America Banks in Europe Note: Covers organizations with relevant data disclosures; nonretail banking institutions not included Figure 3: Changes in the Number of Bank Branches in FY 14 (Source: TCS research) 8

9 In a nutshell Our study revealed that while the aforementioned trends are observed across most global institutions, regional variations do gain precedence in some cases, thereby implying that the impact of global trends is not uniform across submarkets. Aside of asset growth, multichannel banking was the only common phenomenon observed. Other trends varied due to regional factors like macroeconomic conditions, industry risk appetite, and business sentiment. For example, we observed that for German banks, the growth of Risk Weighted Assets (RWAs) was higher than the asset growth. Though the growth in North America was comparable, in most other regions of Europe, asset growth outpaced RWA growth. Table 2 indicates geographic relevance of these global trends. Explaining the relevant context for the variations seen here, however, requires a detailed exploration of each, which is beyond the scope of this study. USA Canada UK The Netherlands Iberia France Germany Nordics Revenue growth Profit growth Asset growth RWA growth slower than asset growth Deposit growth more than loan growth Loan growth slower than asset growth Investments in digital multichannel banking Trend Legend: prevalent Not prevalent, Mixed trend (inconclusive) Table 2: How each Geography Fares on the Outlined Global Trends (Source: TCS research) Banks with different Lines of Businesses across geographies responded to these global factors in a similar fashion. However, it is to be noted that these responses are based on expansive observations and may vary for different banks. Retail banking: Almost all banks are focusing on customercentricity and alternate banking channels to improve customer engagement. Commercial or business banking: With growing focus on advisory services to increase income, banks are exploring new methods to leverage opportunities. Asset or wealth management: Asset and wealth management driven revenues have grown across most banks in North America and Europe observed indicator towards increasing focus on this business segment to offset subdued growth in retail banking. 9

10 Investment banking: Investment banks are also looking at clientcentric advisory services to stabilize revenue volatility. The growing prominence of alternate asset investments indicates increased focus on trading and investment operations. How North American Banks are Playing the Game Improving loan asset quality A majority of the North American banks showed a decline in their nonperforming assets (NPAs). For instance, BB&T bank witnessed a fall of nearly 40% in NPAs, showing a general improvement in asset quality. Figure 4 shows that the shift is visible across all subsegments of North American banks. The low NPA is an indicator of the recovering economic scenario in the US. Lesser NPAs lead to banks lowering their provisions thereby improving profitability. However, there is a point of concern: in an environment of low loandeposit ratio and falling NPA, some banks may again adopt aggressive lending practices that may lead to an undesirable turn of events. The 23% growth in subprime auto loans in 2014 is a case in point North American Megabanks Midsized US banks # of banks with recorded growth of NPAs yoy Midsized Canadian banks # of banks with recorded fall in NPAs yoy Note: Covers organizations with relevant data disclosures Figure 4: Change in Loan Asset quality in FY 14 (Source: TCS research) Focusing on new business areas to combat revenue pressures Stricter regulations and discerning customers have created different challenges for various industry segments, notably affecting the growth momentum. Financial services organizations have responded by devising strategies to expand the customer base and increase their wallet share from existing customers. For instance, U.S. Bancorp is looking to improve business financial advisory services and project it as a key offering. This has resulted in organizations moving into each other s areas of play, for example, Wells Fargo is expanding its asset management customer base by crossselling to its retail bank customers. The new mortgage origination market has shrunk considerably, with over 40% fall in new loans in 2014, compared to Moreover, North American megabanks are losing their market share. Figure 5 shows this drop in market share from 2012 to Large financial institutions like JP Morgan Chase and Wells Fargo have reported a decrease in their new mortgage business of close to 50% in the same period. 10

11 % 36.0% 29.7% Total new mortgage origination in the US market (in $ million) Market share of North American megabanks in new US mortgage originations Figure 5: Changes in new US Mortgage Origination Volumes and Market Share of Megabanks (Source: TCS research) Though the low interest rate environment and fall in new loan origination impacted net interest income of large US banks, figures show that Canadian banks have managed to overcome the challenge with market expansion. They have continued to expand in overseas markets (like the US and Latin America) through both organic and inorganic growth strategies. Canadian banks are using their cash reserves to fund these growth initiatives. Figure 6 clearly shows a fall in the Year on Year (YoY) Net Interest Incomes (NIIs) for a majority of the US banks that were studied, while also depicting Canadian banks shift in the opposite direction. # of banks whose net interest income has fallen in 2014 yoy # of banks whose net interest income has risen in 2014 yoy Big Four Universal banksnorth America 3 Midsized banks USA 2 2 Midsized banks Canada Note: Figure covers organizations with relevant data disclosures Figure 6: Change in Net Interest Income (NII) of North American Banks in FY 14 (Source: TCS research) 11

12 Midsized banks in the US have offset this revenue decline considerably better, by raising noninterest income (see Figure 7) # of banks whose non interest income has risen in 2014 yoy # of banks whose non interest income has fallen in 2014 yoy Note: Covers organizations with relevant data disclosures Figure 7: Change in Noninterest Incomes of North American Banks in FY 14 (Source: TCS research) Summarizing the segmentwise performance of North American financial institutions in Table 3. Segment Highlights North American megabanks Decline in revenues; rising deposits; increased focus on asset management Still struggling to grow revenues, with both interest and noninterest income down for three out of the Big Four banks (see Figures 6 and 7) Positive deposit growth a good sign, indicative of their regaining customer trust; now focusing on utilizing this extra cash to improve asset management business (three out of the Big Four show a rise in revenue from asset management) Increasing market shares in asset management, for example, Wells Fargo exhibited a 7% YoY growth in asset management revenue in 2014 Canadian midsized banks Varying success in new market expansion; growing revenues Some banks more successful than others in growing revenues (see Figure 6) Banks with positive revenue growth have increased their interest and noninterest income through growth in other geographies US midsized banks Growing noninterest incomes; flat overall revenue; rising profitability Divergent trends in loandeposit ratio Noninterest income growing faster than interest income (see Figures 6 and 7), giving an alternate avenue to raise revenues Payment organizations Rising revenues and profitability Growth in business as digital payments and volume of payments grow fast across the globe, for example, Mastercard had an 8% revenue growth in 2014 Investment banks Growing revenues but non uniform business segment performance Pure play investment banks exhibited revenue growth Morgan Stanley grew by five and Goldman Sachs by 10% YoY growth in FY 14 Underlying units show a variation in performance with institutional client services growing fast, as investing operations show a sharp decline Table 3: Performance Shifts across Different Industry BFS Segments in North America (Source: TCS research) 12

13 How European Banks are Responding to Industry Changes Cautious risk management to drive benefits In line with global banking trends, banks across Europe are showing notable growth in terms of overall asset formation. As can be seen in Figure 8, both asset and RWA of European banks have exhibited growth, with the rate of asset formation comparatively higher than that of RWAs. For example, ABN AMRO s assets grew by around 4% in FY 14, while the RWA grew by 0.6%; and Danske Bank s asset growth outpaced RWA growth by 5%. This shows the likely effectiveness of risk management policies being adopted by banks. With the possible exception of German banks, this emerging trend also points toward risk aversion towards growing loan portfolio as well as the overall business strategy. 19% RWA grew less than asset growth 81% Others Note: Covers organizations with relevant data disclosures Figure 8: Change in Asset Growth vs. RWA Growth in FY 14 (Source: TCS research) Regionwise performance of European financial institutions One notable observation for European banks is a strong local influence on the growth roadmap (see Table 4). This has been evidenced by the variation in the performance of German banks with regard to their UK counterparts. We believe that this trend will encourage institutions to develop localized organizational strategies to respond optimally to global and regional developments. Region Highlights UK & Ireland (UK&I) Dwindling income; risk averse asset growth Income declined for major banks Loan portfolios declined; four out of five banks posted better performance in deposit growth as compared to loan growth Barring HSBC, the other four banks were able to grow their asset base while RWA performances showed a mixed movement Contd.. 13

14 Region Highlights The Netherlands Muted business growth; asset growth outpacing RWA growth Muted performance in business growth. For example, ING's loans and advances to customers grew by 2% and, customer deposits and other funds on deposits grew by a modest 3% Moderate asset growth a positive factor. An example is Rabobank that recorded a 1.8% growth in its assets Asset growth outpaced RWA growth a movement toward prudent risk management. For example, ABN AMRO's assets grew by 4% while RWA growth was about 0.6% Iberia Improved profitability Improved profitability showed the effectiveness of focused cost control measures on profit. An example is BBVA group's net attributable profit growth of 17.5% while operational expenditure declined by 6% France Challenge to maintain profitability; positive bullish asset growth Banks facing challenges to maintain profitability profitability declined for three out of four major banks In line with the movement across the continent, French banks posted growth in their assets in FY 14 BNP Paribas' assets, for example, grew by a robust 15% in FY 14 Germany Aggressive loan growth; worrying growth of risky assets Nordics Lagging deposit performance and increasing loan performance; low RWAs RWA growth outpaced asset growth and banks are already well positioned to meet regulatory requirements. For instance, Commerz Bank's posted asset growth was 8%, while the growth in RWA for the bank was 13% As a deviation from the general trend, German banks posted relatively better performance on their loan portfolio in comparison to their deposit portfolio performance. For example, Deutsche Bank posted a growth in customer loan and deposit portfolio of 8% and 1%, respectively Pressure remained on the deposit side, as loan side performances remained comparatively stronger than deposit performances. For example, in Nordea, deposits and borrowings from public declined by 2%, while loans to the public grew by 2% Lower RWA growth in comparison with asset growth indicated a tendency to take fewer risks. The recorded improvements in the Common Equity Tier I (CET1) ratio corroborate the same. Danske, for example, grew its assets by 7%, while recording an RWA growth of 2% Table 4: Highlights of Regionwise Variance in Performance among European Banks (Source: TCS research) Conclusion Our research shows distinct global and regional trends that are playing a key role in how banks and financial institutions chart their way forward. Globally, banks are facing challenges to grow their business and maintain profitability. Though there is significant growth in deposit portfolios, loan portfolio growth remains rather muted. This is creating pressure on banks Net Interest Incomes (NII). However, the robust asset growth, in spite of the slow loan growth, remains positive and is indicative of growing trading and investment assets. Banks are also trying to optimize their resources and operational costs by streamlining their workforce and branches moving toward a multichannel and selfservice environment aided by digital technologies. In North America, banks are witnessing improved loan quality. As NPAs fall, the banks are looking to expand their loan portfolios. However, increasing competition from specialist lenders and niche players has reduced the mortgage origination market share for banks, especially in the US. This fall in loan originations combined with low 14

15 interest rates have affected NII growth of US banks. Canadian banks however, have managed to grow revenues through expansion into new regions. US banks indicate a likely shift of focus to noninterest incomes, targeting business advisory and asset management fees, a shift that midsized banks seem to be doing better than their bigger peers. In Europe, banks are treading on more cautious risk management strategies as evident from their asset and RWA growths. For most banks, asset growth outpaced RWA growth indicating their preparedness for the upcoming regulatory changes. Notably, the European banks demonstrate regional differences. For example, while Iberian banks showed growth in both loan and deposits, Nordic banks differed with growing loans and declining deposits. Additional regional differences show Netherland s banks recording muted loan growth while German banks showed positive loan growth of 8%. These differences indicate that strong local factors sometimes trump the impact of global factors in specific markets. Future performance of banks the world over will depend entirely on how they manage these global and local factors to their advantage. 15

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