Succeeding with Growth - BCG – Global Management … WITH GROWTH TABLE OF CONTENTS PREFACE 3...

Succeeding with Growth

Creating Value in Banking 2005


Creating Value in Banking 2005 Creating Value in Banking 2005


BCG│REPORT

SUCCEEDING WITH GROWTH

TABLE OF CONTENTS

PREFACE 3

EXECUTIVE SUMMARY 5

I. THE STATE OF THE BANKING INDUSTRY 6 Outstanding Profitability Drove Value Creation 6 The Consolidation Process Continues 8 Mortgage Finance Has the Highest Segment Returns and the Lowest Risk 9 Canada Is Best-Performing Region over the Long Term—Japan Is Recovering 10 Top-Performing Banks 11

II. TURNING PROFITABILITY INTO PROFITABLE GROWTH 13 Profitability Improvement Is the Key but It Has Limits 13 Top Performers Go for Growth 14 Break through Growth Barriers with Acquisitions 17 Don’t Sit on Your Capital, Manage It Actively 19

III. RANKINGS OF TOP PERFORMERS 21 Large-Cap Companies 21 Mid-Cap Companies 22 Segment Ranking 23 Country Ranking 24

APPENDIX: SAMPLE AND METHODOLOGY 25 Sample and Data 25 Definitions and Methodology 26

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PREFACE Building competitive advantage and creating superior value must form management’s top two goals. Since our founding more than 40 years ago, The Boston Consulting Group (BCG) has analyzed the drivers of value creation for clients across industries. In recent years, we have published annual stud-ies that analyze the world’s top-performing companies in order to build an understanding of leading players. Succeeding with Growth: Creating Value in Banking 2005, our third annual study of large banks, analyzes shareholder value creation in banking, including universal banks and specialist fi-nancial-services companies. This report covers almost all the banks listed on stock exchanges worldwide and encompasses more than 90 percent of the global banking market’s capitalization. It takes an international investor’s per-spective by calculating all data in U.S. dollars and ensures high comparability of company perform-ances across different countries, adjusting for currency and risk effects, as well as market influence. We combined a long-term capital-market view with management and banking-segment perspectives by measuring shareholder returns and fundamental data over five years to identify top-performing companies from a value-creation perspective. We retrospectively analyzed best-performing compa-nies to draw key strategic and management insights. For details of this report’s approach, please see the appendix, which specifies our sample and meth-odology. Authors Walter Sinn is a vice president and director in BCG’s Frankfurt office. Ranu Dayal is a vice president and director in the New York office. David Pitman is a vice president and director in the Sydney of-fice. Lars-Uwe Luther is a vice president and director in the Berlin office. Gerold Grasshoff is a manager in the Berlin office. Thomas Herbeck is a manager in the Frankfurt office. Acknowledgments We’d like to thank the people who were involved in preparing this report—including many individu-als from the Financial Services and Corporate Finance and Strategy practice areas, as well as those from the Graduate School of Management (HHL) in Leipzig. In particular, the authors would like to thank BCG’s Christian Bailly, Jasper Masemann and Peter Truell.

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For Further Information For further information on the report and to learn more about BCG’s value-management capabilities in financial services, please contact: Europe Americas Asia-Pacific Walter Sinn Ranu Dayal David Pitman Vice president and director Vice president and director Vice president and director BCG Frankfurt BCG New York BCG Sydney +49 69 9150 20 +1 212 446 2800 +61 2 9323 5600 [email protected] [email protected] [email protected] Related BCG Studies Winners in the Age of the Titans: Creating Value in Banking 2004, May 2004 Creating Value in Banking, June 2003 The Next Frontier, Value Creators Report, December 2004 Back to Fundamentals, Value Creators Report, December 2003 Investment Banking & Capital Markets (quarterly report), March 2005

Investment Banking & Capital Markets (quarterly report), November 2004 A Restless Recovery: Global Asset Management 2004, December 2004 The Path to Value Creation: Global Corporate Banking 2003, November 2003 Disclaimer The Boston Consulting Group is a general management consulting firm that is a global leader in business strategy. Founded in 1963, the firm now operates 60 offices in 37 countries. Although BCG has a substantial financial-services consulting business, this report, which we now publish annually, is not intended to provide investment advice to any party. Any investment decision should be made only after independent review and analysis. For further information, please visit our Web site at www.bcg.com. If you have questions or comments about Succeeding with Growth: Creating Value in Banking 2005, please contact us at [email protected].

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EXECUTIVE SUMMARY The banking sector continued its strong stock-market performance in 2004. Banks created tre-mendous shareholder value in 2004, creating $900 billion in market value and increasing total market capitalization to an all-time high of $5.4 trillion. For five consecutive years, the banking sector out-performed overall markets and delivered an average total shareholder return (TSR) of 7.4 percent, even as markets worldwide suffered negative returns. Moreover, banks paid out high dividend yields of almost 3 percent a year, helping to compensate for market declines in 2001 and 2002. Profitability improvements drove stock-market gains in 2004. BCG’s analyses of the main drivers of shareholder return clearly show that profitability improvement was the main reason for 2004’s strong performance. Banks around the world focused on improving their effectiveness, thereby in-creasing their average return on equity (ROE) by 1.1 percent over 2003, generating an overall ROE of 15.5 percent. Banks reached high levels of profitability and now have to think about strategies to build on their good performance. The challenge today is succeeding with growth. Stock-market top performers know how to activate the four levers of sustainable value creation: improve performance, grow organically, make success-ful acquisitions, and improve capital allocation. Pushing profitability above the cost of equity is the key to value creation. Our study underlines, however, that pure efficiency gains have limits, as large universal banks have seldom managed to maintain cost-to-income ratios (CIR) below 45 percent. Banks have to be aware of these limits and consider their growth options. Top performers pushed the growth lever. In contrast to their less-successful competitors, top per-formers had already managed to increase their value primarily through growth in 2004. Having a suc-cessful growth strategy becomes decisive when the strategy facilitates tapping into very competitive global revenue pools. In terms of market potential, BCG forecasts that mature markets will have the largest revenue pools in absolute terms for a long time, despite significantly higher growth rates in emerging markets. Banks therefore have to tackle the challenging task of growing organically in competitive mature markets. To do this, top performers employed such successful strategies as de-veloping sophisticated customer relationship management (CRM) approaches, achieving higher cus-tomer penetration, employing smart channel mixes, exploiting niche opportunities, and leveraging superior products and processes to aggressively attack target markets. Acquisitions create new strategic options. Acquisitions can create considerable value, and half our top performers’ growth derived from acquisitions. Successful players primarily used in-market acqui-sitions to grow in size and build complementary capabilities. In Europe, cross-border mergers have been picking up recently, and in prosperous emerging markets, especially in Asia and Eastern Europe, many banks have started to establish growth platforms by acquiring small players and then injecting their own know-how. Top performers manage their business portfolio systematically to pur-sue credible growth opportunities.

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I. THE STATE OF THE BANKING INDUSTRY Outstanding Profitability Drove Value Creation Banks continued to create considerable shareholder value. The banking industry increased market capitalization in 2004 by 19 percent to $5.4 trillion. Follow-ing an all-time high in 2003, bank stocks outperformed the overall market once again, pro-ducing a strong 6.6 percent av-erage growth rate over the five-year period from 2000 to 2004. Total shareholder return (in-cluding capital gains and divi-dends) rose to more than 21 percent, higher than the all-industry average of 17.9 per-cent. (See Exhibit 1.)

Exhibit 1. The Industry Continued to Create Outstanding Shareholder Value

Total market capitalization ($trillions) Total shareholder return (%)(1)

+0.3% -9.1% -11.3% +42.2% +19.8%

3.94 3.95 3.59

3.18

4.53

2000 2001 2002 2003 2004

BanksAll industries

1999 2000 2001 2002 2003 2004

3.2

-11.7-15.3 -16.2

-10.6-16.8

44.937.8

EOY

+6.6% -0.8%7.4%

Sources: T.F. Datastream; BCG analysis.(1) Includes capital gains and dividends.

21.217.9

5.42

Over the past five years, banks delivered positive returns while the overall market declined. For the past five years, the broad stock market delivered nega-tive TSR, whereas banks earned their shareholders more than 7.4 percent in capital gains and dividends. Neverthe-less, “old economy” businesses improved their performance as well, thus leaving banking in fifth place over the past five years but still in the top third of the overall industry ranking. (See Exhibit 2.)

Exhibit 2. Banking Stocks Performed Well Compared with the World Average

Total shareholder return, 2000–2004(1)

0.3%

1.6%

2.7%

3.1%

6.2%

6.7%

7.4%

7.6%

8.9%

9.7%

11.9%

-7.2%

-12.7%

-17.8%

-0.8%

Total shareholder return, 2004(1)

Retail

Transportation

Banking

Automotive

Chemicals

Information technology

Media and entertainment

Pharmaceuticals

Telecommunications

Utilities

World

Oil and gas

Electricity

Sources: T.F. Datastream; BCG analysis.Note: All data were calculated after conversion to the U.S. dollar.(1) Includes capital gains and dividends.

Engineering and machinery

Insurance

18.5%

4.6%

13.6%

12.4%

22.2%

20.6%

21.2%

24.0%

34.5%

28.7%

30.1%

-1.5%

19.4%

9.2%

17.9%

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In 2004, a change in profitability proved the largest driver of TSRs. Banks showed a very con-stant dividend flow of 2.7 per-cent on a five-year average, which accounted for one-third of TSR performance. In 2004, dividend yield accounted for only 14 percent of the strong increase in shareholder return. Taking a closer look at capital gains, recovering fundamentals pushed value creation more than a change in expectations. Looking at fundamental per-formance drivers, a further in-crease in profitability mainly drove fundamental values in 2004, whereas on a five-year basis the main driver was a change in equity growth. (See Exhibit 3.)

Exhibit 3. Powerful Forces Drove Banks’ Total Shareholder Return

+2.5

+9.9+12.4

+6.0+18.4+2.821.2

TSR 2004 Dividendyield

Capital gain Expectationpremium

Funda-mental value

Change inprofitability

Change ingrowth

Drivers of capital gain

Drivers of fundamentals

Sources: T.F. Datastream; Bloomberg; BCG analysis.Note: If historic data for 2004 were not available, calculation was based on IBES consensus forecasts; drivers of fundamentals are represented by DAVE; change in profitability is calculated by a change in spread valued by actual equity; change in growth is calculated by a change in equity value by the previous year’s spread

Drivers of TSR

Five-yearperspective (%)

Five-yearperspective (%)

7.4 +2.7

+4.7 +0.6 +4.1

-3.0 +7.1

TSR 00-04 Dividendyield

Capital gain Expectationpremium

Funda-mental value

Change inprofitability

Change ingrowth

2004perspective (%)

2004perspective (%)

Excellent fundamental performance drove banks’ stock values to new heights. Market capitali-zation consists of two ele-ments: fundamental value and expectation premium. Funda-mental value reflects an esti-mate of a company’s value based on performance meas-ures such as return on equity, growth in equity, and free cash flow. The expectation premium is the difference between over-all market capitalization and fundamental value. Between 2003 and 2004, market capi-talization in the banking indus-try increased by $900 billion, with most of the increase at-tributable to improved fundamentals and little change of the expectation premium. During this pe-riod, expectation premiums decreased to 37 percent, whereas fundamental values rose by more than 24 percent to a new all-time high of $3.4 trillion. (See Exhibit 4.)

Exhibit 4. Excellent Fundamental Performance Drove the Increase in Market Capitalization

Legend

x%

Market capitalization

Absolute expectation premium = market cap minus

fundamental value

Fundamental value based on analysis of company fundamentals

Expectation premium as a percentage of market cap

Fundamental value vs. expectation premium

2000 2001 2002 2003 2004

$trillions

2.0

1.61.5

1.1

1.8

3.4

2.4 2.1 2.12.7

5.4

4.03.6

3.2

4.5

Sources: T.F. Datastream; Bloomberg; BCG analysis.Note: If historic data for 2004 were not available, calculation was based on IBES consensus forecasts.

37.2%39.4%34.4%41.7%40.0%

+24%

Widening economic spread accelerated fundamental value creation. The banking industry real-ized a record increase in fundamental value resulting from a continued improvement in ROE. Backed by a positive macro-environment for banks in most markets (low loss provisions and interest rates), the average ROE rose a further 1.1 percent to 15.5 percent in 2004. Moreover, banks benefited from a drop in the cost of equity to less than 10 percent, in part because of falling interest rates. Conse-quently, the resulting economic spread almost doubled from 3.5 percent to 5.9 percent. Combined with overall equity growth of 9.4 percent, added value on equity (AVE) increased by 83 percent to $132 billion, surpassing its previous high in 2000. (See Exhibit 5.)

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Banks now face the challeng-ing task of sustaining their suc-cess in creating value. Continu-ing to increase profitability remains important but becomes more and more difficult as profitability has already reached a high level. Banks should therefore attempt to leverage their economic spread by putting additional equity to work. Profitable growth will be the challenge to banks for the years to come.

Exhibit 5. Increasing Economic Spreads Boosted Added Value on Equity

Added value on equity ($billions)

Profitability spread (%) Growth of equity (2) ($trillions)

15.5%14.4%13.0%14.0%17.5%

9.6%10.9%9.8%9.5%9.3%

2000 2001 2002 2003 2004 2000 2001 2002 2003 2004

ROE(1)

COE

727357

123 132

2000 2001 2002 2003 2004

-40.9% -22.3% 27.6%

Sources: T.F. Datastream; Bloomberg; BCG analysis.Note: If historic data for 2004 were not available, calculation was based on IBES consensus forecasts.(1) After tax.(2) Organic and external growth.

1.51 1.62 1.782.05

7.3% 9.9% 15.2%2.24

9.4%

83.3%

• The banking industry outperformed the worldwide stock market over the last five years. • Banks’ market capitalization reached an all-time high in 2004. • A further increase in profitability proved the main driver of value creation.

The Consolidation Process Continues Banking titans strengthened their positions in market-cap rankings. Between 2003 and 2004, the six largest banks—the titans—with market capitalizations above $100 billion, increased their value by almost 20 per-cent. Citigroup stood firmly at the top of this ranking with only marginal changes in mar-ket capitalization. Bank of America, with its integration of FleetBoston, took second place by size, surpassing HSBC Holdings in third place, which increased its market cap by 9 percent. JP Morgan Chase re-mained in fourth place. Royal Bank of Scotland increased its market cap through acquisitions of smaller banks while still keeping its low close to 40 percent cost-to-income ratio. The Royal Bank of Scotland’s 22 percent increase in market capitalization between 2003 and 2004 lifted it to fifth place. The last of the titans, Wells Fargo, mainly concentrated on growing in its home market. (See Exhibit 6.)

Exhibit 6. Bank of America and the Royal Bank of Scotland Improved Their Respective Titan Rankings

0

40

80

120

160

200

240

280

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30

Citigroup

Market capitalization,end of 2004($billions)

Ranking by market capitalization

Sources: T.F. Datastream; BCG analysis.

HSBC HoldingsBank of America

JPMorgan Chase

Wells Fargo

The Royal Bank of Scotland

UBSWachovia

American Express

Santander

Fannie Mae

Barclays

BNP Paribas

Mitsubishi Tokyo Financial Group

Morgan Stanley

U.S. Bancorp

BBVA

HBOS

Merrill Lynch

Goldman Sachs

Mizuho Fin. Grp.

Freddie Mac

Credit Suisse

CréditAgricole

Lloyds TSB

Deutsche BankSumitomo Mitsui Fin. Grp.

Société Générale

ABN AMRO

Washington Mutual

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The consolidation process continues at the cost of small banks. The largest 100 banks increased their share of market capitali-zation from 62 percent to al-most 70 percent. Within the top 100, shares for the six larg-est companies increased from 15.6 percent to 18.0 percent over the last five years. This phenomenon clearly illustrates the consolidation process driven by these large compa-nies. While smaller companies have grown their market value by only 2.1 percent, the aver-age market-cap increase of the top 100 players was 9.0 per-cent. Consolidation efforts from the titans slowed down after the megamergers of recent years as these banks were busy with their post-merger integration efforts. We expect, however, that the titans will once again drive nu-merous transactions—in-market as well as cross-border—in the near future. (See Exhibit 7.)

Exhibit 7. Continuing Consolidation Occurred Among the Top 100 Banks

(Sour1) Top 100 banks by market capitalization in that respective year.

ces: T.F. Datastream; BCG analysis.

Share of market capitalization of top 100 banks

62.1%

69.4%

Jan.2000

Dec.2004

5.42 T$

3.94 T$

1-6 26-50 51-75 76-1007-25

5.6%8.7%

14.8%

22.3%

18.0%30.6%

37.9%

2.1%

9.0%

5-yearCAGR

Banks ranked by market capBanks ranked by market cap

Top100(1)

Rest

9.8% 7.9% 9.5% 9.1%9.6% 5-yearCAGR

• Consolidation continues—the top 100 banks further increased their market share. • Six titans with market caps above $100 billion dominate the global banking market. • More M&A activity is expected in the near future—including cross-border transactions.

Mortgage Finance Has the Highest Segment Returns and the Lowest Risk Over five years, mortgage finance delivered twice as much as the average bank’s returns. Mort-gage finance provided an aver-age annual TSR of almost 15 percent. In addition, the seg-ment showed the lowest over-all risk with volatility (beta) of 0.8. Mortgage business models vary significantly across coun-tries. In the United States, the mortgage value chain of origi-nation, lending, and servicing has been highly deconstructed by specialized players; whereas in Europe, universal banks mainly act as full-service pro-viders, putting mortgages on their own books owing to a lack of liquid secondary markets. Mortgages clearly benefited from low interest rates, booming in the United States, Australia, and Europe. Japan is now following this trend.

Exhibit 8. Mortgage Finance Showed the Best Performance over the Five-Year Period

Total shareholder return,

2004 (%)

Total shareholder return,

2000–2004 (%) 7.48.414.82.5

11.814.37.4

Average market sensitivity,2000–2004

1.21.5

0.8

1.51.41.2

1.5

Investmentbanks

Universalbanks

Consumerfinance

Transactionbanks

Mortgagefinance

Assetmanagers

Averagebanks


21.222.116.2

34.5

2.612.0

24.4

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Looking only at 2004, consumer finance companies generated the highest shareholder return in fi-nancial services with 34.5 percent. High, increasing expectations for this segment indicate a strong belief in the market’s continuing expansion. (See Exhibit 8.) • The mortgage segment performed best over the last five years. • Consumer finance profited from a U.S. boom and delivered the highest returns in 2004.

Canada Is Best-Performing Region over the Long Term—Japan Is Recovering Canada showed top performance over the last five years. The Canadian market ranked first, with an average annual return to shareholders of 23.3 percent, followed by Australia and France, which also posted long-term double-digit returns. The Canadian market is highly consolidated with regulatory limits on the entry of foreign capital and a prohibition on mergers among the five largest banks. Canadian banks operate at high profitability levels, av-eraging 17.3 percent ROE over the past five years. Because they already reached such high profitability levels, successful growth—partly in international operations—proved the main value driver for Canadian banks in 2004, accounting for almost two-thirds of their fundamental value increase.

Exhibit 9. Canada Was the Top Performer over the Past Five Years and Japan Led in 2004

Total shareholder return, 2000–2004(1)

7.4%

-5.3%

-0.8%

5.8%

8.3%

9.1%

9.2%

9.5%

16.8%

18.3%

23.3%

Total shareholder return, 2004(1)

21.2%

30.4%

12.4%

24.3%

20.7%

22.0%

12.5%

19.6%

26.4%

24.1%

27.7%

United States

Australia

Italy

Switzerland

Japan

Spain

United Kingdom

Germany

World

Canada

France

Sources: T.F. Datastream; BCG analysis.Note: All data were calculated after conversion to the U.S. dollar.(1) Includes capital gains and dividends.

Japanese market recovered in 2004. Although ranked last for the five-year period of the study, the Japanese market did recover in 2004 to generate the highest regional TSR at 30.4 percent. A govern-ment initiative to reduce nonperforming loans (NPL) along with the general economic recovery in Japan mainly drove this upturn. Japanese banks successfully restructured their credit portfolios—five of the six “megabanks” in Japan even reached government-set targets ahead of schedule. Further-more, strong top-line growth in retail banking, especially consumer finance and asset management, improved Japanese banks’ fundamentals significantly. (See Exhibit 9.)

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Most countries operated with positive economic-spreads. In terms of value creation, countries can be divided into three catego-ries. The first comprises coun-tries such as Switzerland, Can-ada, and the United Kingdom, which generated economic spreads above the world aver-age, although these countries’ growth still lagged the world average. Only Australia and the United States experienced above average organic growth and profitability. The second category includes countries such as Spain and France, which show a small economic spread and growth below the world average but some value creation. The third group consists of countries such as Italy and Ger-many, which demonstrate no value creation because of negative economic spreads. It is important to note, however, that Italy is close to reaching profitability again, and Germany, despite its unsatisfac-tory profitability level, improved greatly in recent years and shows a positive delta in terms of value creation. Overall, we noted no negative profitability and found strong outperformers in every coun-try. (See Exhibit 10.)

-10%

-5%

0%

5%

10%

15%

-10% -5% 0% 5% 10% 15%

Exhibit 10. Growth Creates Value in Tandem with Positive Economic Spreads

Sources: T.F. Datastream; Bloomberg; BCG analysis.(1) If historic data for 2004 were not available, calculation was based on IBES consensus forecasts.(2) Difference between return on equity and cost of equity.

Country groups and value levers, 2004(1)

Organic growth, 2004

Economicspread, 2004(2)

World

World

Profitability stars by country, ROE 2004(1)

United Kingdom

United States

Switzerland

Canada

Spain

France

Sallie Mae

Lloyds TSB

Mitsubishi Tokyo

UBS

Country average Profitability star

Australia

Italy

Japan

Unicredito Italiano14.0

10.0

14.8

23.6

24.9

61.7

Germany Deutsche Bank

BNP Paribas

Bank of Nova Scotia

Westpac

Banco Popular20.3

20.6

15.2

17.3Germany

Japan

UnitedStates

Australia

UnitedKingdom

France

Italy

CanadaSwitzerland

SpainFocus: profitability

9.2

7.5

9.7

19.5

17.6

17.8

16.9

17.3

13.2

15.1

Focus: growth

• Canada exhibited the best long-term performance—with high profitability and successful growth. • Rigorous portfolio restructuring delivered top shareholder returns to Japanese banks in 2004. • Switzerland, the U.S., and the U.K. have the highest profitability levels.

Top-Performing Banks Fourteen banks outperformed their local markets in each of the past five years. The number of banks able to beat their na-tional market five years in a row increased to 14, convinc-ingly showing an increased shareholder-value orientation. Last year’s outperformers, Lehman Brothers, Standard Chartered, Bear Stearns, and Société Générale, are again in the top group, effectively out-performing their national mar-kets for six years running. They were joined by ten new institutions, including Bank of Nova Scotia, UBS, Erste Bank,

Exhibit 11. Fourteen Banks Outperformed Their Markets over the Five-Year Period

1 x 2 x 3 x 4 x 5 x

68

9

19

11

1517

86

Large-cap (1–50)

Mid-cap (51–100)

Large-cap (1–50)

Mid-cap (51–100)Mid-cap (51–100)

1 x 2 x 3 x 4 x 5 x

Number of years the bank outperformed the market

Outperforming the national stock market, 2000–2004:the largest 100 companies in banking

UBSWachoviaBNP ParibasU.S. Bancorp Société GénéraleBank of Nova ScotiaWestpacLehman Brothers

Standard CharteredFranklin TempletonDnB NORSEBErste BankBear Stearns


6

0

BCG


and Franklin Templeton, all of which performed well, even in 2000, and showed a clear value in-crease over the five-year period. (See Exhibit 11.) To identify global stock-market outperformers, we took an international investor’s perspective and developed the RRTSR measure. RRTSR adjusts companies’ TSR performance not only for the influ-ences of their local stock markets but also for risk, allowing a comparison between segments and across countries. (See the appendix for more details.) North American banks topped the country ranking after adjusting for risk and national stock-market performance. In the five-year RRTSR ranking for large-cap companies, the top six companies were North American. The Bank of Nova Scotia led the ranking with an outstanding five-year RRTSR. In addition to achieving higher levels of efficiency, cultivating a successful growth strategy in emerging markets in Latin America and the Caribbean drove the bank’s performance and gave it an edge over its Canadian competitors. The Royal Bank of Scotland ranked highest among European banks. Its share performance resulted from a careful acquisition growth strategy along with a highly competitive CIR. Sallie Mae, third in the five-year ranking, led the one-year race after continuing its success story in the consumer-loan business. (See Exhibit 12.)

Exhibit 12. North American Players Led Large-Cap Performers

The top ten large-cap performers by RRTSR

2000–2004

4. Royal Bank of Canada

9. Barclays

2. Bank of Montreal

10. ANZ

1. Bank of Nova Scotia

5. Bank of America

6. Lehman Brothers

7. Royal Bank of Scotl.

8. Washington Mutual

14.0%

12.9%

11.1%

10.4%

9.7%

9.3%

8.7%

8.2%

8.0%

12.1%3. Sallie Mae

2004

2. Freddie Mac

3. Nordea

4. Bank of America

8. Wachovia

5. Bank of Nova Scotia

6. Barclays

7. Toronto-Dominion

10. BB&T

1. Sallie Mae

9. American Express

17.2%

13.1%

12.5%

8.4%

5.8%

5.0%

4.8%

4.0%

12.2%

10.4%

Sources: T.F. Datastream; BCG analysis.Note: The sample consists of all banks ranked 51 to 100 by market cap in 2004.

Among mid-cap banks, Coun-trywide Financial produced exceptional TSRs that, in com-bination with segment-specific low volatility, translated into an RRTSR that ranked first for the five-year period. The for-mer mortgage monoline diver-sified its business and gener-ated strong organic growth. (See Exhibit 13.)

Exhibit 13. The Leading Mid-Cap Performers Generated Strong Returns

The top ten mid-cap performers by RRTSR

Sources: T.F. Datastream; BCG analysis.Note: The sample consists of all banks ranked 51 to 100 by market cap in 2004.

2. Danske Bank

3. Eurobank

4. Orix

8. Svenska Handelsb.

5. Countrywide Fin.

6. Capitalia

7. Bear Stearns

10. Capital One

1. Mediobanca

9. Franklin Templeton

15.4%

13.0%

12.9%

9.3%

9.1%

8.0%

7.8%

7.7%

7.3%

10.1%

10. SEB

7. Franklin Templeton

2. M&T Bank

9. Svenska Handelsb.

1. Countrywide Fin.

3. North Fork Bancorp.

4. Bear Stearns

5. Golden West Fin.

6. CIBC

15.3%

13.4%

11.8%

11.5%

11.2%

10.5%

10.4%

10.0%

8.6%

10.3%8. St. George Bank

2000–2004 2004

• North American banks again topped the rankings. • Bank of Nova Scotia led large caps with the highest efficiency and a global growth strategy. • Countrywide Financial led in the mid-cap category, winning through business diversification.

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II. TURNING PROFITABILITY INTO PROFITABLE GROWTH We assessed the four major levers for creating shareholder value. Top-performing companies successfully activate these four levers to create sustainable value: raise performance by pushing profitability above the cost of equity, organically grow the current business while maintaining profitability, acquire new businesses to im-prove the company’s position in existing and new markets, and optimize the bank’s capital allocation in line with share-holder expectations by redi-recting or returning capital.

Four Levers Create Sustainable Value

Source: BCG

Groworganically

Capital

Realizeacquisitions

Improveperformance

Return

Optimizecapital allocation

Shareholder

31 2 4

Profitability Improvement Is the Key but It Has Limits Banks further enhanced profitability in 2004. Many banks successfully did their homework over the past five years. Despite difficult market conditions and strong competition, a clear focus on effi-ciency and profitability—often underpinned by specific programs—drove the worldwide banking industry’s average profitability in 2004 to 15.5 percent ROE after tax. This represents another in-crease of 1.1 percent in absolute terms after a successful year in 2003 and significantly exceeded the 9.6 percent cost of capital in 2004. However, further profitability improvement has limits. Profitability is a prerequisite for value creation and the strongest driver of TSR when starting from a low profitability level. Nevertheless, profitability in-creases from high levels add only limited additional value. ROE appears to converge at 15 percent, especially for compa-nies above the $20 billion mar-ket-cap level. This indicates that the profitability lever can only partly explain market size and success. Banks need to leverage profitable growth to achieve top rankings in market capitalization. (See Exhibit 14.)

As size increases, ROE converges at approximately 15%

Exh

No

ibit 14. Growth, not Profitability, Drove Size Beyond $50 Billion

Sources: T.F. Datastream; BCG analysis.te: Full sample; if historic data for 2004 were not available, calculation was based on IBES consensus forecasts.

-30%

-15%

0%

15%

30%

45%

0 20.000 40.000 60.000 80.000 100.000 120.000 140.000

ROE(five-yearavg.)

Market cap, Dec 2004 ($billions)

15%

30 70 110 150 190 230 270

15%

BCG


Limits to pure efficiency improvement become even more obvious when looking at empirical CIRs. For two-third of univer-sal banks, CIR ranged between 75 and 45 percent; up to the $20 billion market-cap level, only 14 percent sustained a ra-tio below 45 percent over the five-year period. While 45 per-cent is achievable for small universal banks with efficient business models, it appears, however, to be an insurmount-able limit in the long run for large banks above the $20 bil-lion market-cap level where complexity and variety place constraints on efficiency. (See Exhibit 15.)

Exhibit 15. Universal Banks Face Clear Efficiency Limits Beyond a Certain Size

Sources: Bankscope; BCG analysis.Note: Sample of more than 270 universal banks for which at least five-year data history was available, five year period base on actuals 1999-2003

Long-term cost-to-income ratios exceeded 45 percent above $20 billion in market cap

0%

20%

40%

60%

80%

100%

0 5 10 15 20

Cost-to-incomeratio (five-year average)

Market cap,Dec 2004 ($billions)

0%

20%

40%

60%

80%

100%

20 60 100 140

Only 14 percent of smaller banks had cost-to-income ratios below 45 percent

There is a clear border for banks above $20 billion

Cost-to-incomeratio (five-year average)

Market cap,Dec 2004 ($billions)

200

14%

45% 45%

75%

Consider growth options early on. It is important to deliver on expectations. Top-performing banks, having reached high return levels, are subject to increasing pressure to translate their success into sustainable growth. Examples of former profitability stars and stock-market “darlings” such as Lloyds TSB demonstrate how crucial a convincing growth story is for continuing stock-market rec-ognition. Not getting caught in this profitability trap—and being able to deliver on sustainable growth instead—is certainly a key management challenge for the future. • Impressive 15 percent ROE level seen in 2004—further improvements not likely to be achieved. • Efficiency programs have reached their limit—CIRs below 45 percent are difficult to sustain. • Banks must be aware of the profitability trap—creating growth options is the key challenge.

Top Performers Go for Growth Top performers from 2004 have a clear focus on growth. Growth represents an even greater management challenge than increasing profitability because growth exposes a company to greater risk and an increased need for innovative ideas. Top performers’ accom-plishments in 2004 point to growth’s importance for achieving superior value crea-tion. The 20 top-performing banks realized 99 percent of

Exhibit 16. Top Performers Focused on Growth, not (Further) Profitability Improvement

Sources: T.F. Datastream; BCG analysisNote: Top performers are top twenty by RRTSR five year performers of hundred largest banks; Profitability impact is described by a change in spread valued by actual equity;growth impact is calculated by a change in equity value by the previous year’s spread

Impact ofgrowth

Impact ofprofitability

Impact ofgrowth

Impact ofgrowth

Impact ofprofitabilityImpact of

profitability

2004

19%

81%

All banks

2004

19%

81%

All banksTop performers

2004

99%

1%

Impact of profitability and growth on fundamental value creation

BCG


their value creation (measured by AVE) through growth, while merely 1 percent was attributable to increased profitability. In 2004, however, the majority of banks were still working to improve profit-ability: when considering the average for all banks, the impact from growth was only 19 percent. (See Exhibit 16.) Mature markets will hold the largest revenue pools for many years. Turning to worldwide bank-ing revenue pools for 2004, 34 percent came from the United States, followed by Europe’s largest economies—those in France, Germany, Italy, Spain, and the United Kingdom—which together contributed 23 percent. These mature markets will reach only moderate an-nual growth rates of 2 to 3 per-cent, close to the countries’ gross domestic product (GDP) growth. In contrast, emerging markets will experience sig-nificant growth; given the large difference in the relative start-ing points for mature and emerging markets, however, the biggest absolute revenue increases come from the United States and Europe’s top five. These mature markets will also account for the largest revenue pools for a long time to come. By segment, retail banking accounts for more than 50 percent of total revenues and will have a 40 percent share of absolute growth through 2012. This suggests that a strong position in a mature (home) market and a strong foothold in retail banking may be criti-cal factors for achieving market capitalization above $50 billion. Empirical evidence shows that the six banking titans—Bank of America, Citigroup, HSBC, JPMorgan Chase, Royal Bank of Scotland, and Wells Fargo—earn on average more than 60 percent of their revenues from retail businesses and usually earn most of their retail revenues from their respective home markets. (See Exhibit 17.)

Exhibit 17. Highest Growth Rates Are in Emerging Markets, but Not in Absolute Terms

Sources: BCG Global GOAL Model 2004; BCG analysis. (1) Europe top five consists of the Germany, France, Italy, Spain and the United Kingdom

Global revenues pools, 2004 Projected annual growth rate, 2004-2012

United States

555

Europe top five

379

Japan202

Rest of Americas

142Rest of EMEA

203

Rest of APAC

172

23%34%

9%

12%

10%12%

(1)

Revenues, 2004($billions)

Japan Europetop five

UnitedStates

Rest ofAmericas

Rest ofEMEA

Rest ofAPAC

2.6%2.2%

1.7%

3.5%

5.4%

3.9%

(1)

CAGR, 2004-2012(%)

Absoluteannualgrowth2005 ($billions)

3.4 14.48.4 4.8 7.8 9.0

Define a winning growth strategy for the institution’s home market. Achieving organic growth is a challenging task—especially in mature markets, however, the answer on how to do so is actually straight forward: serve your customers better than your competitors do. When looking at winning home-market growth strategies, four major levers come to the fore:

• Understand your customer: use a segment-specific approach and sophisticated CRM concepts.

• Penetrate your customer: cross-sell by expanding the product offering. • Improve convenience: optimize the channel mix and/or online offering. • Regionalize and focus: achieve superior service quality by offering tailor-made (re-

gional) offerings.

BCG


TSR (5-yr) 43.9%RRTSR (5-yr) 1st (mid-cap)MC 2004 $22 billion

5-yr org. growth rate 33% p.a.P/B 2004 2.0

Countrywide Financial

TSR (5-yr) 11.8%RRTSR (5-yr) 25th (large-cap)MC 2004 $105 billion

5-yr org. growth rate 12.1% p.a.P/B 2004 2.6

Wells FargoWells Fargo: focus on improving service to customers. The U.S. banking titan Wells Fargo focused on organic growth over the last seven years—avoiding distractions caused by acquisitions and inte-grations. The bank focused on shaping its business model into high-performance, segment-specific customer offerings. Wells Fargo significantly improved its customer service and client satis-faction by implementing an integrated state-of-the-art channel mix. This included introducing new branch concepts as well as the United States’ premier Internet banking site and one of the country’s best-managed call center operations. Their results: a 12 percent annual organic growth rate over the last five years. Countrywide: from a monoline to a diversified financial-services provider. Countrywide, the largest independent residen-tial-mortgage lender in the United States, topped the five-year mid-cap rankings, managing to grow its equity by 30 percent a year, while simultaneously doubling ROE. While Countrywide’s core residential-mortgage business grew strongly on the back of the U.S. refinancing boom in 2003, the company began to focus on growing its non-mortgage banking busi-ness as part of its long-term strategy to develop from a monoline into a diversified financial-services provider. Countrywide acquired a small retail bank in 2001 and developed it into a fast-growing op-eration by cross-selling products. Countrywide also leveraged the retail-mortgage branch network by introducing financial centers providing banking services and operating at substantially lower costs than traditional bank branches. Non-mortgage banking now contributes 15 percent of Countrywide’s total pretax earnings, up from 1 percent in 2001. Systematically building up a new business line rather than acquiring an established player allowed Countryside to realize synergies in its core mort-gage business and ensure continuous organic growth. Think as an attacker when entering foreign markets. Most banking markets are heavily contested and market entrants face strong competition. By simply copying the incumbents, a competitor is bound to fail: winning customers requires doing something better than the established competitors. As it is unlikely that one bank can do everything better, a focused entry strategy is the key. There are examples of successful market entries where international players have leveraged superior product or process competencies from their home markets, typically combined with a clear segment-specific ap-proach: GE Capital: target niche markets by tailoring existing products. GE Capital exhibits strong product-based growth and is expanding quickly in its major markets by initially acquiring consumer-finance portfolios and then broadening its product offering. It is attacking established players by tai-loring products to specific markets and customer segments—for example, the French home-equity and the Japanese personal-loan markets. GE is exceptional at creating growth potential by identifying unfilled niches and serving them. GE Capital’s innovation and customer-focus approach have re-sulted in revenue growth rates above 15 percent per annum over a sustained period of time. . ING Direct: establish a low-cost base in retail and aggressively exploit it. ING is one of the most successful direct banks, using a low-cost online business model to serve the retail market. It aggres-sively leverages efficient processes and platforms by offering highly competitive savings and credit rates. This process innovation allowed ING to aggressively attack the large revenue pools of the retail markets in the United States, Europe, Canada, and Australia. ING’s success with this approach is im-

BCG


pressive: 500,000 new ING customers in the United Kingdom within 12 months after its market entry and 4.4 million total customers in Germany in 2004. These numbers underline ING’s success and show why they are a leader in the retail market. Bottom-line results rewarded ING’s continuous ex-pansion, proving their approach’s success: profits for ING Direct nearly doubled in 2004. • Top performers successfully activated the growth lever in 2004. • Successful growth requires balancing tactical and strategic growth initiatives. • Leveraging competencies is crucial in developing a focused approach to attack foreign markets.

Break through Growth Barriers with Acquisitions Growth through acquisitions is essential for all top performers. BCG analysis shows that only less than half of all banks with strong growth through acquisitions delivered above-average returns for the last five years. The rest did not satisfy their shareholders and often showed strong negative returns. Examining the top performers, however, also indicates that banks can successfully create value through acquisitions. In this context, BCG identified fundamental transformations that we ex-pect will change the M&A landscape in upcoming years. First, new models for cross-border transac-tions are emerging with the potential of having cost synergies beyond the traditional 10 percent. Suc-cessful acquirers in cross-border transactions build on the ability to manage integration and transfer superior product platforms. Recent announcements from Banco Santander Central Hispano on reduc-ing Abbey National’s cost base by as much as 20 percent underline this trend. Second, today’s strate-gies move away from solely focusing on cost synergies towards looking for more creative approaches and growth options. Of course, there is no one silver-bullet solution for an M&A strategy, and banks have successfully employed very different strategies:

• In-market mergers leveraging complementary businesses • Cross-border mergers to drive consolidation—for example, in Europe • International string-of-pearls strategies with smaller acquisitions or bridgeheads for

future organic growth • Entry strategies into emerging markets to create strategic options for long-term

growth—focus on BRIC-markets (Brasil, Russia, India, China)

Bank of America: proving the value potential of in-market deals. BCG’s analysis revealed that “traditional” in-market mergers typically realized cost synergies between 10 and 15 percent of the smaller players’ doubled cost basis. The Bank of America–FleetBoston merger exemplifies, however, a second wave of in-market mergers that found more creative ways to realize synergies by leveraging players’ complementary proficiencies. Less than a year after the deal closed, Bank of America has already reaped the rewards of its merger with FleetBoston, emerging as the second-largest bank by market cap. Now, less than a year after the deal closed, it is the second-largest bank by market cap. ROE nearly doubled over a five-year period, while the CIR dropped to a premerger level of 52 percent. Bank of America continues to convert FleetBoston’s operations, and merger-related cost savings of $1.8 billion per year are expected, half of which may be realized in 2004. Cost cutting, including layoffs, reduced office space and IT costs, and important benefits are expected


Cost savings: $1.8 billion p.a.P/B 2004 3.7

Bank of America

BCG


from revenue synergies and improved selling efficiency. Corporate cultures experienced in mergers facilitated the quick integration. Nordea: realizing promising synergies from a European cross-border merger. Many consider cross-border mergers simply a strategy that bets on Europe liberalizing its regulatory frameworks in the near future. However, we see initial promising indications that cross-border synergies beyond this exist. The Scandinavian bank Nordea has clearly benefited from its late but successful post-merger integration with four other banks. The new bank initially disappointed expectations for quickly realizing synergies because its decentralized structure, cultural barriers, and changing man-agement slowed the integration process. A second wave of integration, however, concentrated on centralization and tight cost control and exceeded Nordea’s target of keeping costs flat after 2002. Centralizing IT and consolidating back-office and group functions drove down costs. Nordea restruc-tured or divested several operations and organized itself into one legal entity. The formerly loose banking network has turned into an integrated banking organization, successfully realizing the syner-gies of a real European cross-border merger.


Cost savings 5% p.a.P/B 2004 1.6

Nordea


5-year growth rate 43.3% p.a.P/B 2004 1.7

Royal Bank of ScotlandRoyal Bank of Scotland: employing an international string-of-pearls strategy. The Royal Bank of Scotland (RBS), a British universal bank, has built a strong track record of rapid expansion, best illustrated by its U.S. subsidiary, Citizens Financial Group, bought in 1988. Since acquiring Citizens, RBS has used it as a bridgehead, with Citizens adopting an aggressive external growth strategy and becoming one of the top-ten commercial banks in the United States. Supported by its experienced M&A team, Citizens extensively developed its acquisition and integration capabilities in 26 mostly smaller acquisitions. To do so, Citizens leveraged RBS’s strong product capabilities and strengthened the acquired companies so they could deliver high profitability and organic growth. RBS has reduced its CIR to a highly competitive 40 percent in 2004 despite ongoing integration ef-forts. This string of mergers proved highly successful, with RBS ranking seventh by RRTSR. Erste Bank: posting strong gains in central-eastern Europe. Central-eastern Europe has seen outstanding growth, accelerated by recent European Union accession and has attracted numerous for-eign investors. Foreign banks now account for about 70 percent of the market share in banking in the region, with Austrian banks holding more than one-quarter of all foreign interest. A particularly successful company has been Austria’s Erste Bank, second largest by market cap. After investing ap-proximately $3 billion in central-eastern Europe, it now has the largest branch network of interna-tional banks in the region, with a strong presence in the Czech Republic, Slovakia, and Croatia. Erste Bank earned a ROE of 38 percent in 2004 in the CEE region, while total ROE for the group was less than half that value. With a net-profit contribution of approximately 60 percent of total group earn-ings, growth in these new markets has proven highly beneficial to Erste Bank.

TSR (5-yr) 31.7%RRTSR (5-yr) 13th (mid-cap)MC 2004 $13 billion

CEE profit contribution 60%P/B 2004 3.0

Erste Bank

• Create growth options—new M&A strategies that avoid a pure cost focus will become decisive. • Consider all options—in-market, cross-border, string of pearls, and emerging markets.

BCG


Don’t Sit on Your Capital, Manage It Actively Top performers show that all three previously-mentioned value levers can be utilized for tremendous value creation, which then can lead to strong stock-market returns and outstanding cash generation. At this point, top performers also look at their investors to understand how investors expect them to use this money and then align their strategies accordingly. Sometimes no worthwhile investment pos-sibilities exist for a company, or a company might be preoccupied with integrating a recent acquisi-tion and, therefore, cannot focus on growth. Still, shareholders want significant returns from their in-vestments. In such a situation, paying shareholders back directly can have strong impact on the TSR—whether through share buy-backs or dividends. Knowing your shareholder and managing capi-tal as an external investor would are the golden rules for a successful financial strategy. UBS: grow, then return capital to shareholders. UBS, the largest Swiss bank, is a prime example of a bank with a sound financial strategy. In the absence of a need to fund major acquisitions, the cash-rich bank chose to return excess capital to shareholders. In-stead of engaging in unprofitable investments or stockpiling cash, UBS spent $3.1 billion in 2004 to buy back its own shares; in 2005, UBS will launch its seventh consecutive share buyback program, worth $4.4 billion. As a result, eq-uity actually decreased over the last four years at an average rate of 7.7 percent per annum, while re-turns to remaining shareholders and earnings per share increased. As overall market cap remained relatively constant, UBS achieved capital gains of 27.5 percent and 13 percent on the remaining shares in 2003 and 2004, respectively.


decrease in equity 7.7% p.a.P/B 2004 3.3

UBS

Focus on dividends in times of low capital gains. Especially in times of limited capital gains, divi-dends can make all the difference in terms of shareholder return. Despite general expectations, divi-dends comprised over a third of TSRs over the last five years (14 percent in 2004). By returning higher dividends to shareholders when growth is not achieved, banks can actively manage share-holder return. In 2001 and 2002, dividends were the sole positive driver of TSR, while capital gains dropped to negative levels. The contribution of dividends to TSR varies widely by geography, how-ever: in 2004, dividends represented nearly one-quarter of the TSRs of U.S. and French banks, whereas dividends made up for only 2.6 percent of the returns of Japanese banks. Strictly manage capital internally as an external investor would. Like every capital investor, banks have to balance risks and returns for their businesses and allocate economic capital accord-ingly. Capital allocation not only satisfies the risk requirements stipulated by Basel II but it also pro-vides a consistent measure of risk-adjusted return for internal evaluation. Economic-capital models enable management to compare “apples to apples”—the risk-adjusted profitability and relative value of businesses. Players such as Bank of America, Citigroup, and UBS use sophisticated capital-allocation models incorporating portfolio effects to successfully manage their business portfolio and carefully explore new strategic options. Know your investor. In the end, banks have to know their current investors in order to define the appropriate value levers and align financial and business strategy accordingly. Growth investors pri-marily look for strong capital gains and invest in profitably growing businesses. Expanding and ac-quiring will attract them the most. Value investors look for constant profit streams that can be paid out via dividends and therefore mostly look for high profitability and dividend yield. They are less attracted to banks that aggressively expand through acquisition. Restructuring investors target com-

BCG


panies with very low profitability and mainly look for performance improvements. More and more banks are beginning to recognize the importance of tailored investor strategies and communications programs and are implementing tools and measures accordingly. • Have a clear financial strategy based on investor segmentation. • Accept that there may be times when growth is not the best choice. • Be disciplined—return excess money to shareholders through share buybacks or dividends.

BCG


III. RANKINGS OF TOP PERFORMERS Large-Cap Companies

TSR Risk Market Rank

1 5 Bank of Nova Scotia CAN UB 34.3 13.9% ++++ +++ + 24.9% 22 21 Bank of Montreal CAN UB 24.1 12.9% ++++ +++ + 22.3% 43 1 Sallie Mae USA CF 22.9 12.1% ++++ ++ + 32.3% 14 22 Royal Bank of Canada CAN UB 34.9 11.1% ++++ +++ + 18.7% 65 4 Bank of America USA UB 189.8 10.4% ++++ +++ -- 17.9% 86 18 Lehman Brothers USA IB 23.6 9.7% ++++ + ---- 16.3% 97 27 The Royal Bank of Scotland GBR UB 105.7 9.3% +++ ++ -- 14.4% 118 24 Washington Mutual USA MF 36.9 8.7% ++++ ++ - 23.8% 39 6 Barclays GBR UB 72.3 8.2% +++ +++ -- 10.0% 2010 20 ANZ AUS UB 29.5 8.0% ++++ +++ ++ 19.6% 511 14 UBS CHE UB 94.4 7.8% ++ +++ -- 8.6% 2612 41 Merrill Lynch USA IB 55.5 7.5% ++ ++ ---- 8.9% 2513 32 Société Générale FRA UB 45.0 7.3% +++ ++ -- 10.4% 1814 26 MBNA USA CF 36.0 7.2% +++ ++ --- 10.8% 1715 19 Westpac AUS UB 27.4 7.1% ++++ +++ ++ 18.2% 716 8 Wachovia USA UB 84.4 6.8% +++ ++ -- 14.0% 1217 42 Citigroup USA UB 250.0 6.6% ++ ++ ---- 6.4% 2918 11 National City USA UB 24.6 6.4% +++ +++ - 14.5% 1019 3 Nordea SWE UB 28.6 6.2% +++ ++ -- 10.3% 1920 31 BNP Paribas FRA UB 64.1 5.9% ++ ++ -- 6.7% 2821 12 HBOS GBR UB 63.8 5.8% ++ ++ -- 9.3% 2422 35 HSBC Holdings GBR UB 188.5 5.8% ++ +++ --- 5.0% 3023 23 U.S. Bancorp USA UB 58.5 5.3% +++ ++ -- 12.2% 1424 10 BB&T USA UB 23.2 5.3% +++ +++ - 12.5% 1325 13 Wells Fargo USA UB 105.1 5.1% +++ +++ - 11.8% 1526 15 ABN AMRO NLD UB 45.1 4.8% + ++ --- 0.1% 4027 36 Goldman Sachs USA IB 50.4 4.7% + + ---- 2.8% 3528 49 Nomura Holdings JPN IB 28.7 4.5% - + ---- -3.2% 4729 16 Hang Seng HKG UB 26.6 4.1% ++ +++ - 9.5% 2230 2 Freddie Mac USA MF 51.1 3.1% +++ +++ - 11.1% 1631 45 Morgan Stanley USA IB 60.8 3.0% - + ---- -3.3% 4832 28 JPMorgan Chase USA UB 139.0 2.7% - + ---- -1.9% 4433 37 Deutsche Bank DEU UB 48.3 2.5% - + -- -3.2% 4634 9 American Express USA CF 70.8 2.3% + ++ --- 1.2% 3635 7 Toronto-Dominion Bank CAN UB 27.3 2.2% ++ +++ + 8.3% 2736 38 Commonwealth Bank of Australia AUS UB 32.1 1.7% ++ +++ ++ 9.6% 2137 40 The Bank of New York USA TB 26.0 1.2% - ++ --- -1.5% 4338 47 UniCredito Italiano ITA UB 36.3 1.0% + +++ - 0.4% 3939 46 National Australia Bank AUS UB 35.0 0.8% ++ ++ ++ 9.4% 2340 25 Banca Intesa ITA UB 28.5 0.5% - + - -0.9% 4141 34 SunTrust USA UB 27.4 0.5% + ++ - 4.3% 3242 30 BBVA ESP UB 60.1 0.4% + ++ + 0.9% 3843 29 Lloyds TSB GBR UB 50.8 0.3% - ++ -- -2.9% 4544 17 KBC Bank BEL UB 23.9 0.0% + ++ + 3.8% 3345 43 Dexia BEL UB 26.1 -0.3% + ++ + 3.8% 3446 33 Credit Suisse CHE UB 50.3 -0.6% -- + - -6.8% 4947 48 Santander Central Hispano ESP UB 77.6 -0.8% - ++ + -1.4% 4248 39 Fannie Mae USA MF 68.9 -0.8% + ++ - 4.8% 3149 50 Fifth Third Bancorp USA UB 26.5 -1.5% + ++ - 1.1% 3750 44 Fortis BEL UB 35.9 -5.9% -- ++ + -7.9% 50

Seg-ment

M' cap '04 ($b)

TSR p.a.2004

Company Performance 2000–2004RR TSR rank

2000-2004

RR TSR p.a.Name Coun-

try

From('99-'03)

To('00-'04) Delta Company From

('99-'03)To

('00-'04) Delta Company

46 16 30 Wachovia 24 45 -21 Dexia39 18 21 National City 2 22 -20 HSBC Holdings50 30 20 Freddie Mac 28 47 -19 Santander Central Hispano43 24 19 BB&T 13 31 -18 Morgan Stanley26 8 18 Washington Mutual 31 49 -18 Fifth Third Bancorp

Biggest declineBiggest jump up

AM Asset manager MF Mortgage finance RR TSR: Risk-adjusted relative total shareholder returnCF Consumer Finance TB Transaction banks TSR: Total shareholder return ---(+++) strongly negative (positive)IB Investment banks UB Universal banks Risk: Volatility of returns ---(+++) very high (low)

Market: Stock specific impact of overall market ---(+++) strongly negative (positive)

Ranking is performed by taking all banks with an available 5 year RR TSR and dividing them into largest 1-50 companies (large cap) and 51-100 companies (mid cap)by market capitalization

BCG


Mid-Cap Companies

TSR Risk Market Rank

1 5 Countrywide Financial USA MF 21.5 15.3% ++++ ++ - 43.9% 12 27 M&T Bank USA UB 12.5 13.4% ++++ +++ -- 22.8% 73 34 North Fork Bancorp. USA UB 13.6 11.8% ++++ +++ - 23.9% 64 7 Bear Stearns USA IB 10.6 11.4% ++++ ++ --- 20.3% 95 21 Golden West Financial USA UB 18.8 11.2% ++++ ++ + 30.3% 46 28 CIBC CAN UB 21.1 10.5% ++++ +++ + 19.7% 117 9 Franklin Templeton Investments USA AM 17.5 10.4% ++++ ++ --- 17.6% 138 19 St. George Bank AUS UB 10.2 10.3% ++++ +++ ++ 22.4% 89 8 Svenska Handelsbanken (SHB) SWE UB 16.9 10.0% +++ +++ - 13.5% 1710 29 SEB SWE UB 13.0 8.6% +++ ++ -- 13.0% 1811 2 Danske Bank DNK UB 20.6 8.5% ++++ ++ + 20.2% 1012 43 Banco Popular Español ESP UB 15.0 7.5% +++ +++ + 11.5% 2213 30 Erste Bank AUT UB 12.9 6.8% ++++ ++ ++++ 31.7% 314 20 DnB NOR NOR UB 13.1 6.6% ++++ ++ ++ 19.4% 1215 10 Capital One Financial USA CF 20.4 6.5% +++ -- --- 12.0% 2016 32 Sumitomo Trust & Banking JPN UB 12.1 6.2% + -- ---- 2.3% 3517 18 AIFUL JPN CF 10.4 5.9% ++ + --- 7.0% 3118 13 Union Planters USA UB 16.5 5.9% +++ +++ -- 11.6% 2119 15 KeyCorp USA UB 13.8 5.6% +++ +++ - 14.1% 1420 48 State Street USA TB 16.4 5.1% ++ ++ --- 7.2% 3021 14 Marshall & Ilsley USA UB 9.9 4.8% ++ ++ -- 9.3% 2622 3 Eurobank GRC UB 10.7 4.8% - + --- -2.0% 4023 33 PNC Financial Services USA UB 16.2 4.7% ++ ++ -- 9.2% 2724 23 UnionBanCal USA UB 9.6 4.7% +++ + - 13.5% 1625 38 Standard Chartered GBR UB 21.9 4.5% + ++ -- 3.9% 3326 31 Banco Brasil BRA UB 10.0 4.5% ++++ -- + 38.4% 227 22 National Bank of Greece GRC UB 10.9 3.9% - + --- -4.9% 4228 17 Standard Bank Group ZAF UB 15.8 3.8% ++++ ++ +++ 24.4% 529 37 Bank of Ireland IRL UB 16.1 3.5% +++ ++ ++ 13.7% 1530 1 Mediobanca ITA IB 12.7 3.5% ++ ++ - 5.3% 3231 40 United Overseas Bank SGP UB 13.0 3.4% + ++ --- 2.6% 3432 26 Comerica USA UB 10.4 3.4% ++ ++ - 9.4% 2533 45 Kookmin Bank KOR UB 13.2 3.2% ++ -- -- 8.3% 2934 16 Almanij BEL UB 20.1 2.9% ++ ++ + 10.0% 2435 35 Allied Irish Banks IRL UB 18.1 2.9% +++ ++ ++ 10.9% 2336 24 Maybank MYS UB 11.3 2.7% ++ +++ - 8.8% 2837 36 OCBC Bank SGP UB 10.9 2.4% + ++ --- 1.2% 3638 12 Acom JPN CF 11.9 2.2% - + ---- -4.1% 4139 4 Orix JPN UB 11.5 1.9% -- + ---- -6.0% 4340 42 Northern Trust USA TB 10.6 1.4% - ++ --- -0.4% 3841 49 Mellon USA TB 13.2 1.0% + ++ --- 0.3% 3742 46 Nikko Cordial JPN IB 10.3 0.8% --- -- ---- -14.9% 4943 50 Sanpaolo IMI ITA UB 21.3 0.6% - + - -0.8% 3944 47 Charles Schwab USA AM 16.1 -0.8% --- + ---- -13.7% 4745 25 Firstrand ZAF UB 13.0 -0.9% +++ + +++ 12.5% 1946 41 Commerzbank DEU UB 12.3 -1.2% --- -- --- -14.7% 4847 39 DBS Group SGP UB 14.7 -1.3% -- ++ --- -7.8% 4548 6 Capitalia ITA UB 10.1 -1.8% -- -- - -7.1% 4449 44 HVB Group DEU UB 16.7 -2.1% ---- -- -- -20.1% 5050 11 Takefuji JPN CF 10.0 -2.7% --- + -- -10.3% 46

Coun-try

Seg-ment

TSR p.a.2004

Company Performance 2000–2004RR TSR rank

2000-2004

M' cap '04 ($b) RR TSR p.a.Name

From('99-'03)

To('00-'04) Delta Company From

('99-'03)To

('00-'04) Delta Company

40 19 21 KeyCorp 12 37 -25 OCBC Bank24 9 15 Svenska Handelsbanken (SHB) 7 31 -24 United Overseas Bank15 1 14 Countrywide Financial 26 47 -21 DBS Group43 30 13 Mediobanca 23 42 -19 Nikko Cordial29 18 11 Union Planters 16 33 -17 Kookmin Bank

Biggest jump up Biggest decline

AM Asset manager MF Mortgage finance RR TSR: Risk-adjusted relative total shareholder returnCF Consumer Finance TB Transaction banks TSR: Total shareholder return ---(+++) strongly negative (positive)IB Investment banks UB Universal banks Risk: Volatility of returns ---(+++) very high (low)

Market: Stock specific impact of overall market ---(+++) strongly negative (positive)

Ranking is performed by taking all banks with an available 5 year RR TSR and dividing them into largest 1-50 companies (large cap) and 51-100 companies (mid cap)by market capitalization

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Segment Ranking

Company

RR TSR rank RR TSR Name Country M' cap '04 ($b) rank TSR

1 14.6% Legg Mason USA 7.4 1 26%2 10.4% Franklin Templeton Investments USA 17.5 2 18%3 9.4% T. Rowe Price USA 8.0 4 13%4 6.7% Investors Group CAN 8.1 3 16%5 -0.8% Charles Schwab USA 16.1 5 -14%

1 12.1% Sallie Mae USA 22.9 1 32%2 7.2% MBNA USA 36.0 3 11%3 6.5% Capital One Financial USA 20.4 2 12%4 2.3% American Express USA 70.8 4 1%5 2.2% Acom JPN 11.9 5 -4%

1 9.7% Lehman Brothers USA 23.6 1 16%2 7.5% Merrill Lynch USA 55.5 2 9%3 4.7% Goldman Sachs USA 50.4 3 3%4 4.5% Nomura Holdings JPN 28.7 4 -3%5 3.0% Morgan Stanley USA 60.8 5 -3%

1 15.3% Countrywide Financial USA 21.5 2 44%2 14.2% Housing Development Finance Corporation IND 4.3 1 44%3 8.7% Washington Mutual USA 36.9 3 24%4 3.1% Freddie Mac USA 51.1 4 11%5 -0.8% Fannie Mae USA 68.9 5 5%

1 11.6% Investors Financial Services USA 3.3 1 34%2 5.1% State Street USA 16.4 2 7%3 1.4% Northern Trust USA 10.6 4 0%4 1.2% The Bank of New York USA 26.0 5 -1%5 1.0% Mellon USA 13.2 3 0%

1 13.9% Bank of Nova Scotia CAN 34.3 1 25%2 11.1% Royal Bank of Canada CAN 34.9 2 19%3 10.4% Bank of America USA 189.8 3 18%4 9.3% The Royal Bank of Scotland GBR 105.7 4 14%5 8.2% Barclays GBR 72.3 9 10%6 7.8% UBS CHE 94.4 12 9%7 7.3% Société Générale FRA 45.0 8 10%8 6.8% Wachovia USA 84.4 5 14%9 6.6% Citigroup USA 250.0 19 0%10 5.9% BNP Paribas FRA 64.1 13 7%11 5.8% HBOS GBR 63.8 11 9%12 5.8% HSBC Holdings GBR 188.5 14 5%13 5.3% U.S. Bancorp USA 58.5 6 12%14 5.1% Wells Fargo USA 105.1 7 12%15 4.8% ABN AMRO NLD 45.1 18 0%16 2.7% JPMorgan Chase USA 139.0 22 -2%17 2.5% Deutsche Bank DEU 48.3 24 -3%18 1.0% UniCredito Italiano ITA 36.3 16 0%19 0.8% National Australia Bank AUS 35.0 10 9%20 0.4% BBVA ESP 60.1 15 1%21 0.3% Lloyds TSB GBR 50.8 23 -3%22 0.0% Mitsubishi Tokyo Financial Group JPN 66.4 19 0%23 -0.6% Credit Suisse CHE 50.3 25 -7%24 -0.8% Santander Central Hispano ESP 77.6 21 -1%25 -5.9% Fortis BEL 35.9 16 0%

TSR '00-'04

Universal banks

Consumer finance

Mortgage finance

Transaction banks

Investment banks

SegmentPerformance '00-'04

Asset manager

We have listed the five biggest banks by market capi-talization for each segment. Although for the universal banks we have listed the 25 biggest institutions.

RRTSR: Risk-adjusted relative total shareholder return TSR: Total shareholder return

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Country Ranking

RR TSR rank RR TSR Name Segment M' cap '04 ($b) rank TSR

Australia 1 10.3% St. George Bank UB 10.2 1 22%2 8.0% ANZ Banking Group UB 29.5 2 20%3 7.1% Westpac UB 27.4 3 18%4 1.7% Commonwealth Bank of Australia UB 32.1 4 10%5 0.8% National Australia Bank UB 35.0 5 9%

Canada 1 13.9% Bank of Nova Scotia UB 34.3 1 25%2 12.9% Bank of Montreal UB 24.1 2 22%3 11.1% Royal Bank of Canada UB 34.9 4 19%4 10.5% CIBC UB 21.1 3 20%5 2.2% Toronto-Dominion Bank UB 27.3 5 8%

France 1 9.8% Natexis Banques Populaires IB 6.6 2 11%2 7.3% Société Générale UB 45.0 3 10%3 6.3% Union Financière de France IB 0.7 1 11%4 5.9% BNP Paribas UB 64.1 4 7%5 0.0% Crédit Agricole UB 44.5 5 0%

Germany 1 10.1% IKB Deutsche Industriebank UB 2.4 2 8%2 8.8% DePfa Bank plc IB 5.9 1 18%3 2.5% Deutsche Bank UB 48.3 3 -3%4 -1.2% Commerzbank UB 12.3 4 -15%5 -2.1% HVB Group UB 16.7 5 -20%

Italy 1 3.5% Mediobanca IB 12.7 1 5%2 1.0% UniCredito Italiano UB 36.3 2 0%3 0.6% Sanpaolo IMI UB 21.3 3 -1%4 0.5% Banca Intesa UB 28.5 4 -1%5 -1.8% Capitalia UB 10.1 5 -7%

Japan 1 6.2% Sumitomo Trust & Banking UB 12.1 1 2%2 5.9% Aiful CF 10.4 3 -3%3 4.5% Nomura Holdings IB 28.7 44 2.2% Acom CF 11.9 5 -6%5 1.9% Orix UB 11.5 2 0%

Spain 1 7.5% Banco Popular Español UB 15.0 1 12%2 0.4% BBVA UB 60.1 2 1%3 0.0% Bance de Sabadell UB 7.2 3 0%4 -0.8% Santander Central Hispano UB 77.6 4 -1%5 -1.4% Bankinter UB 4.1 5 -3%

Switzerland 1 17.1% Luzerner Kantonalbank UB 1.6 1 14%2 7.8% UBS UB 94.4 2 9%3 -0.5% Julius Baer UB 2.7 4 -5%4 -0.6% Credit Suisse UB 50.3 5 -7%5 -0.9% Liechtensteinische Landesbank UB 1.8 3 -3%

United Kin

-4%

gdom 1 9.3% The Royal Bank of Scotland UB 105.7 1 14%2 8.2% Barclays UB 72.3 2 10%3 5.8% HBOS UB 63.8 3 9%4 5.8% HSBC Holdings UB 188.5 4 5%5 0.3% Lloyds TSB UB 50.8 5 -3%

United States 1 10.4% Bank of America UB 189.8 1 18%2 7.5% Merrill Lynch IB 55.5 5 9%3 6.8% Wachovia UB 84.4 2 14%4 6.6% Citigroup UB 250.0 8 0%5 5.3% U.S. Bancorp UB 58.5 3 12%6 5.1% Wells Fargo UB 105.1 4 12%7 3.0% Morgan Stanley IB 60.8 10 -3%8 2.7% JPMorgan Chase UB 139.0 9 -2%9 2.3% American Express CF 70.8 7 1%

10 -0.8% Fannie Mae MF 68.9 6 5%

CountryPerformance '00-'04 Company TSR '00-'04

We have listed the five biggest banks by market capitalization for each country. For the United States, however, we have listed the ten biggest banks by market capitalization, given the size of that country’s economy.

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AM Asset manager MF Mortgage finance CF Consumer finance TB Transaction bank IB Investment bank UB Universal bank

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APPENDIX: SAMPLE AND METHODOLOGY Sample and Data The analyses presented in this report are based on a sample of more than 594 stock-market-listed universal and specialized companies in the banking industry. The companies include all major bank-ing players and more than 92 percent of the world’s total market capitalization as of January 2005. BCG selected the sample for the banking industry. Six segments are distinguished in the sample: universal and diversified banks with a broad busi-ness portfolio; asset managers (providers of retail broker ser-vices and money management, including investments, budget-ing, banking, and taxes); con-sumer-finance businesses (credit-card companies and providers of personal financial services); investment banks (providers of capital markets and corporate-finance ser-vices); mortgage finance com-panies (providers of mortgages and mortgage insurance); and transaction banks (providers of standardized and outsourced services in the financial sector). As a general rule, a company belongs to a segment if its dominant business focus is in that segment.

The Sample Included 594 Companies in Different Regions and Segments

117

Asset managers 23Consumer finance companies 30Investment banks 50

227192

177

34

Mortgage finance companies 10 Transaction banks 5Universal/diversified banks 476


Most of the historical capital-market and fundamental data for the sample come from Thomson Fi-nancial DataStream. IBES consensus forecasts, if available, replaced missing data for 2004. To ob-tain an undistorted picture of the past, we adjusted the sample for large mergers and acquisitions.

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Definitions and Methodology Total Shareholder Return (TSR): The change in a company’s stock prices and/or gains from rein-vesting dividends paid in a particular period. Technically speaking, TSR is the percentage change of the return index on a given stock. Risk-Adjusted Relative Total Shareholder Return (RRTSR): A performance metric developed by BCG for measuring the true capital-market performance of a company. Just like TSR, RRTSR meas-ures shareholder returns as capital gains and dividends, but it adds two additional elements to basic TSR.

RRTSR is Superior External Value Measure

RRTSR enhances the methodologies RTSR and Sharpe Ratio.

SharpeRatio

TSR

Risk adjusted?

Market adjusted?

Yes

Yes

No

No

RRTSR

RTSR

One, RRTSR adjusts for the overall national stock market’s im-pact on the particular company’s stock. This feature is especially important in an international performance evaluation. It facili-tates, for example, comparing stocks in a bull market with stocks in a bear market. RRTSR will be higher the smaller the impact of a positive overall market development is—either be-cause the overall market performance is small or because the stock’s correlation with the market is limited. Two, BCG has successfully used the performance measure relative total shareholder return (RTSR) in several studies to measure the impact of different national markets on analyses. The new measure RRTSR takes the concept of RTSR one step further by also adjusting for risk. To be more precise, RRTSR calibrates for different stock-price volatilities to ac-count for higher expected stock returns from stocks with greater risks; this allows, for example, comparing the re-turns from a company focusing on mortgage finance (which has lower average risk) with the returns from an investment bank (which typically has higher average risk). Therefore, for any specific stock’s TSR, the RRTSR of the stock will be higher the lower the stock’s risk is.

RRTSR Adjusts Total Shareholder Return for Risk and Market Influences

Source: BCG value management.

RRTSR

Excess risk-adjusted performance of stock

Excess risk-adjusted performance of market

Correlation between local market and stock

Stock risk

Market risk

Volatility of stock vs. local market

Risk of stock/market

Excess performance stock/market

Risk of world portfolio Standard deviation of TSR of world portfolio

TSR (stock/market) minus risk-free rate

Standard deviation of TSR of stock or local market

Beta of stock in local market

Standard deviation of TSR of local market

Standard deviation of TSR of stock

-

×

×

×

÷

÷Market adjustment

Risk adjustment

The formal definition of RRTSR for stock A in local market at risk level is as follows: M Nσ

);();();,( NMERAPNSERAPNMSRRTSR σρσσ ⋅−= with

)();();( SSRNfrNSRAPNSERAP ⋅=−= σσσ

where ERAP is the excess of the risk-adjusted performance (RAP) of the Modigliani-Modigliani model over the risk-free rate rf, ρ, which is the correlation between the returns of stock A and its am-

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bient domestic market M, and SR is the Sharpe Ratio of the stock or the market. The concept cali-brates different risk levels at the uniform risk levelσ N. Although this allows us to express RRTSR in meaningful units of returns, the ranking itself does not depend on the absolute level set forσ N. Fundamental Value and Expectation Premium. In some analyses, the total market capitalization of a stock is divided into two parts: fundamental value and expectation premium. To compute fun-damental values, standard cash-flow projections based on companies’ current profitability and his-torical growth rates are used. The profitability is assumed to “fade” to COE over time because of competitive pressures and other factors. In addition, it is assumed that growth also fades to the long-term economic growth rate. These industry forces push profitability and equity growth to long-term levels regardless of whether starting levels are above the long-term levels (indicating a superior per-formance is fading) or below (indicating a recovery). Fade rates are held constant over time and are empirically derived from an optimization procedure that fits the valuation model’s values to empiri-cally observed market capitalization. The absolute expectation premium is defined as the difference between market capitalization and fundamental value, whereas expectation premium is simply the share of absolute expectation premium within total market capitalization. Expectation premiums, therefore, might very well be negative. Total Business Return (TBR). TBR is calculated as change in fundamental value over two years plus free cash flow to shareholders. It measures value creation on a percentage basis in companies using fundamental data only. Added Value on Equity (AVE) and Delta Added Value on Equity (DAVE). AVE measures a bank’s economic income. AVE is calculated by multiplying the spread of ROE over COE with the amount of the bank’s eq-uity capital. AVE measures (in absolute units) what has been earned in excess of the oppor-tunity cost of equity capital. The difference between the AVEs of two successive years is DAVE. Since a change in profitability and a change in the amount of equity capital have an impact on DAVE, this performance metric integrates profitability and growth simul-taneously.

DAVE Integrates Profitability and Growth

+Increase in profitability Profitable growth

Return2

Return1

Cost ofcapital

Equity1,2

Return1,2

Cost ofcapital

Equity1

Return2

Return1

Cost ofcapital

Equity1Equity2 Equity2

1 2 1 2

Source: BCG value management.

Added value on equity1 (AVE1)

DAVE = AVE2 – AVE1

Added value on equity1 (AVE1)

DAVE = AVE2 – AVE1

Return on Equity (ROE). ROE is defined as after-tax profits divided by end-of-year equity capital. Cost of Equity (COE). Company-specific COE is computed for every year based on the capital asset pricing model (CAPM), with ambient total national markets as reference markets. Betas are calcu-lated over two years on a weekly basis.

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