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Fis strategic insights vol 8 june 2012
1.
WWW.FISSTRATEGICINSIGHTS.COM
VOLUME 8 • JUNE 2012 Innovation and Disruption: IN THIS ISSUE Two Sides of the Same Coin • Innovation and Disruption: Two Sides of the Same Coin By Fred Brothers • P2P Innovation for EXECUTIVE VICE PRESIDENT, STRATEGIC INNOVATION Your Bottom Line Many of you saw me speak about disruption and • Financial Profiles innovation at one of FIS’ three recent client conferences. of High-performing I was really pleased by the number of our clients that Community Banks stopped me after the presentations to either agree or • Prepaid Only vs. Prepaid disagree with my comments, and to applaud this year’s and Gift Consumers conferences as the best they’ve attended in some time. I agree that InfoShare 2012 in Orlando, FIS Client Conference 2012 in Milwaukee, and the FIS International Conference in Dubai were all better than ever. I also believe your candid feedback is critical for FIS™ to make ongoing improvements in our client conferences and the presentations of FIS executives who speak at the events. Please continue letting us know how we’re doing. Innovation and disruption represent “two sides of the same coin.” When technology evolves or a market changes, if you’re the incumbent (holding that account, processing that transaction, serving that customer need, etc.) you’re likely to view the change as a disruption, and potentially a threat to your business. Conversely, if you’re the outsider (to that account, transaction, customer, etc.), you’re much more likely to view the same change as innovation and a potential opportunity – to take market share, hurt your competitors, create more value, win customers, raise prices, etc. I don’t believe in “fighting big, macro market trends” (some call it “swimming against the current”). Either way, the result is usually the same – the trend wins; those fighting it don’t. Smart incumbents (and their partners) strive to understand the big, macro market trends, then figure out how to embrace trends and leverage market shifts to their (and their customers’) advantage. They see both sides of the coin, which allows them to assess both upsides and downsides and plot a course correction to leverage change and not squander resources on a losing market tactic or business model. FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 1
2.
FIS Strategic Innovation The
FIS Strategic Innovation Group’s role is to focus on both sides of the coin – disruption and innovation. I’ll explain this further but, first, let me be clear about what we don’t do. For the most part, we don’t focus on “sustaining innovations,” which are the logical evolution and improvement of our existing solutions. FIS has many very capable business unit leaders and product managers who already are doing a great job of improving our existing solutions based on their knowledge of the market and lots of input from their clients. Instead, what my team focuses on is “discontinuous” innovations – the transformational technologies and approaches that have the potential to disrupt existing solutions and/or create significant opportunities for those nimble enough to embrace the change and capitalize on the opportunity. These could be FIS solutions. They could be someone else’s solutions. At a high level, the Strategic Innovation Group: 1. Monitors innovations and disruptions, both inside and outside of banking and payments 2. Envisions where the banking and payment industry will be in the intermediate future (2 – 4 years) 3. Identifies the industry’s future threats, opportunities, growth engines and competitive necessities 4. Ensures that FIS offers market-leading solutions to mitigate those threats and capitalize on those opportunities, so our clients can remain successful and competitive in their markets for their customers. I’ll give you some examples of the first three stages; then I’ll bring those of you who didn’t catch the conference presentation up to speed on what FIS is doing to address the fourth stage. Monitor Innovations and Disruptions Let’s look at three examples of change in the financial industry, which can be viewed as either disruptions or innovations, depending on your perspective. Disruption of branches, rise of digital channels Few would argue that branch traffic has declined during the past decade while digital channels have become very important. What’s news is that we hit an inflection point in consumer adoption around 2010. According to an ABA tracking (annually recurring) survey, the Internet as a preferred banking channel soared between 2010 and 2011 for all age groups. In 2009 only 11 percent of 55-and-older consumers said they prefer the Internet as their primary banking channel. By 2011, that percentage rocketed to 58.1 FIS’ February 2012 consumer survey found that online banking Figure 1: Online banking has reached high levels of penetration among all generations penetration remains higher Online and Mobile Banking Transactions in Past 30 Days among younger generations. 90% 6.0 90% 6.0 More than half (55 percent) Average mobile transactions Mobile banking penetration Average online transactions Online banking penetration 80% 80% of respondents 65-and-older 70% 5.0 70% 5.0 participate in online banking and, 60% 4.0 60% 4.0 on average, they make 4.1 online 50% 50% banking transactions a month – 3.0 3.0 40% 40% not much less than the younger 30% 2.0 30% 2.0 Baby Boomer cohorts (Figure 1). 20% 20% 1.0 1.0 10% 10% 0% 0.0 0% 0.0 Gen Y Gen X Young Old Matures Gen Y Gen X Young Old Matures Boomers Boomers Boomers Boomers Source: FIS survey, February 2012; n = 3,205 FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 2
3.
In contrast, mobile
banking is still largely a tool of Gen Disruption of free checking, rise of prepaid and Y with a 34 percent penetration and averaging 1.5 alternative financial services mobile banking transactions a month. We expect this to Directly related to the disruption of the banking revenue change rapidly as smartphones become ubiquitous and model is the disruption of free checking and the rise of more financial institutions provide easy-to-use mobile prepaid cards and alternative (and differently regulated) banking and payment solutions. According to the most financial services. According to Bankrate.com’s 2011 recent figures from ComScore MobiLens, 12.7 million Checking Account Survey (of the five largest banks consumers used a mobile banking app in June 2011, up and five largest thrifts in the top 25 U.S. markets), only an astounding 45 percent from six months prior to that.2 45 percent of noninterest accounts are now free – an Mobile is growing so fast that we measure changes in incredible 31 percentage point decline from the peak of consumer adoption in months instead of years. 76 percent free checking in 2009.3 Disruption of the banking fee model, rise of alternative At the same time, prepaid card use rose significantly. In income sources 2011 prepaid card use rose 18 percent year-over-year to The effect of Durbin, NSF fee reform, and a fed funds reach 13 percent penetration of the U.S. adult population. rate at 0 percent has been to fundamentally disrupt the And, the percentage of adults that has checking accounts, banking fee model and how our industry funds the cost savings accounts, credit cards or debit cards has declined of maintaining checking accounts. Just as local retailers roughly 11 percentage points since 2010 according to are struggling in an Internet-shopping world to get Javelin.4 General purpose reloadable prepaid cards are consumers to pay full price, bankers are struggling in a functioning as checking accounts for an increasing number post-regulatory change market to get consumers to pay of consumers. The Javelin survey also points out that only for their checking accounts. The disruption of the banking 27 percent of prepaid users obtained the prepaid card fee model requires that we find new sources of income they use most often from a bank. More commonly, they’re for financial institutions. One opportunity that I believe getting them from retailers (37 percent). Other common will become an industry norm in the next few years is sources include employers (14 percent) and government to monetize the data in your systems in ways that your agencies (7 percent). If you’re a bank the majority of the customers will permit. prepaid action (and revenue) is occurring outside of your domain. On a recent flight I pulled down the tray table and there was advertising covering every square inch of the tray Identify Banking and Payment Industry’s table. To be honest, having advertising staring me in the Future Growth Engines face on a plane was initially a little off-putting to me. But then I thought about the struggles the airline industry In this era of regulatory mandates around fee structures, has faced in the past few years – intense competition, banked but underserved consumers are the segment of increasing regulation, downward pressure on income, our customers that are most accustomed to paying fees increasing costs and major technology shifts. That sounds for financial services. My nephew is a good example. He a lot like the banking industry, doesn’t it? In the end, the doesn’t have a checking account or credit card with a tray table ad didn’t matter much to me. The flight took off bank because he hasn’t had the chance to become credit on time, they brought me a cold Diet Coke and we landed worthy. But, he’ll pay $5.00 to cash his paycheck and safely and on time – these are the criteria I use to measure a fee to reload his prepaid card. My family’s assets are my satisfaction with an airline. The more I thought about somewhat larger than my nephew’s, but the only business it, the more the airline’s incremental revenue from that we maintain with our local bank is a checking account, and tray table ad looked like a pretty smart tactic – instead I refuse to pay any fees. We have a great credit score and of charging me for my Diet Coke (which would have more assets, yet our primary checking account provider really been off-putting to me). Their strategy of seeking probably loses money on our relationship because most of alternative sources looked very … well … strategic. our assets and loans are held at other institutions. Instead of trying to get more business from me, maybe my bank should be talking to my nephew. FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 3
4.
Robust services for
the banked but underserved represent a tremendous future growth engine. Such services include: Potential Growth Engines FIS Strategic Innovation • Payday lending is evaluating: • Prepaid cards • Money transfer services including both domestic and international P2P and • Alternative banking money transfer • Next-gen authentication • Prepaid mobile phone top up credits • Data analytics • Leveraged marketing Another future growth engine is innovation that facilitates Web transactions • Payday lending for consumers. BillMeLater allows consumers to finance online purchases • Small business electronic immediately vs. waiting on bank or merchant financing. Web transactions invoice presentment are rising rapidly driven by site improvements, free shipping promotions, and payment flash sales and daily deals, and growth in smartphones and tablets. Forrester • Social media management projects a 45 percent growth in online spending – mostly driven by people spending more online – between 2012 and 2016.5 Mobile banking and mobile wallet represent key growth engines. Top-of-wallet status becomes even more challenging to achieve in the virtual wallet than the traditional one. If you haven’t checked out the FIS mobile wallet, you should. http://fisglobal.com/products-mobilefinancialservices Although we’re evaluating many innovations so that our clients can reap the benefits of FIS’ huge annual investment in innovation, I’ll mention just one more for now: Data Analytics will help our clients dramatically improve the return on their marketing investment, by tailoring specific offers to specific households and individuals. Data Analytics deepens relationships with customers by identifying what products, services and ancillary offers such as merchant-funded rewards are most likely to resonate with specific customers. I am consistently amazed that in this mobile and Internet interconnected world − one in which Google knows what want before you finish typing it, and Facebook knows almost everything about everyone, and Amazon can tell you what you should want even if you don’t know you need it – that banks and credit unions are still spending marketing dollars on roadside billboards and statement stuffers. At most financial institutions, the Marketing Department is the last bastion of unoptimized, legacy spending. Most are still using the same marketing methods and delivery channels that were successful in the 1990s. Non-banks and non-credit unions have revolutionized marketing through the use of data, analytics, targeted offers and one-on-one marketing. If financial institutions don’t embrace the same, we risk being marginalized sooner than we think. Ensure FIS Offers Innovative and Competitive Solutions Several ways FIS and the Strategic Innovation Group are investing in innovative and competitive solutions include: Forming strategic partnerships − FIS partners selectively with early-stage growth companies that are pouring all of their efforts and talents into a single, fast-growth, innovative solution. These partnerships allow FIS and its clients to maintain the necessary agility to move with the market as innovations evolve, while offering you a fully-vetted solution and the strength of contracting with FIS instead of less-capitalized startup. Making strategic investments − FIS will occasionally take a minority interest in companies with which we’ve formed strategic partnerships. We will invest in companies with healthy outlooks but lacking adequate funds to fuel growth quickly enough to produce the innovation we want for our clients. Sometimes we also will take a board seat to help guide the evolution of the company and ensure that you get the level of quality, consistency and innovation you expect from FIS. FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 4
5.
Making selective acquisitions
− Although FIS announced earlier this year that we won’t be doing multi-billion dollar acquisitions in the next few years of FIS’ evolution, we will continue to make smaller acquisitions to obtain solutions, talent and capabilities we need to help our clients succeed. We will invest as much as several hundred million dollars annually if we believe that investment supports our clients’ ability to thrive. Reinvesting internally − The Strategic Innovation Group partners closely with our technology team and business units to ensure our internal reinvestment of capital is aligned with our strategic partnerships, strategic investments and selective acquisitions. In other words, we are investing in the innovation that will strengthen your firms against disruptive forces in the landscape and level the playing field. We do this because we know that the only way FIS will succeed is if we help our clients to succeed. Wow, this turned out to be a significantly longer article than I usually write, but this is a really important topic for our clients, our industry and our company. Thanks very for reading on to this point. In closing, I want to reiterate that we’re working hard to figure out where this industry is going and to ensure that you have the solutions you need to succeed − both now and in the future. We’re spending our investment dollars so you don’t have to. And as always, thank you for your business, for your partnership, and for your friendship with FIS. 1 ABA survey with Ipsos Public Affairs, September 2011 2 comScore press release, “Mobile Banking App Usage in the U.S. Increases 45 Percent from Q4 2010,” 26 October 2011 3 Bankrate.com, “2011 Checking Account Survey,” August 2011 4 Javelin Strategy & Research, “Prepaid Cards and Products in 2012: Enabling Financial Access for Underbanked and Gen Y Consumers,” April 2012 5 Forrester Research, “U.S. Online Retail Forecast, 2011 to 2016,” 27 February 2012 FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 5
6.
P2P Innovation for
Your Bottom Line By Nancy Langer DIVISION EXECUTIVE, ePAYMENTS P2P Opportunity for Financial Institutions The opportunity for financial institutions to capture revenue in P2P payments is enormous – 11 billion transactions (roughly 97 per household annually) in 2011 according to Aite.1 Two-thirds of those transactions are currently paper-based – 51 percent cash and 17 percent paper checks. Migrating paper-based payments to electronic payments to capture “the last mile” of electronic connectivity is not without challenges. From the consumer’s perspective, convenience is a key factor in P2P payment preference. FIS research conducted with 3,205 consumers earlier this year shows greater preference for paper checks than cash for P2P payment. Although more than half of P2P transactions are cash, consumers would prefer to pay via paper checks (64 percent) vs. cash (56 percent) when the payment method is available to them (Figure 1). For some consumers it’s more convenient to write a check than run to the ATM for cash. There are some current barriers to P2P growth – namely the user experience not Figure 1: Convenience is a key factor in P2P payment preference being well integrated into the broader Payment Methods for Paying People such as Contractors, Household Help, payments and online offering and the lack of Delivery People, Babysitters interoperability and network structure. Despite 90% 90% Prefer (base = available) these barriers, we believe that electronic P2P 80% 80% will continue to grow rapidly. The expansion 70% 70% of mobile banking and integration of P2P with 60% 60% online and mobile banking financial services will deliver convenience to both payer and 50% 50% Available payee. We’ve seen how the convenience of 40% 40% mobile remote deposit capture (RDC) has 30% 30% dramatically reduced branch visits for RDC 20% 20% users. The hardware is in place for large numbers of consumers to make P2P electronic 10% 10% transactions either online or through their 0% 0% mobile phones. Smartphone penetration eked Paper checks Cash Credit Debit cards Online Gift cards cards payment Money order Prepaid cards into the majority (50.4 percent) of mobile service Source: FIS research, February 2012; n = 3,205 phone subscribers this spring according to Nielsen.2 Now, P2P networks need to become the convenient choice for consumers and small business payees. FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 6
7.
Current P2P Landscape With
an estimated more than 100 million active users, PayPal™ has dominated the P2P and person-to-business (P2B) landscape. No other player – PopMoney®, MasterCard® MoneySend™, Visa® Money Transfer – comes close to the number of users of PayPal. According to a recent article in American Banker, PayPal controls 90 percent of the current P2P market.3 That said, much of PayPal’s base is E-commerce rather than person-to-person. The landscape is changing and barriers are primed to be broken down. The large banks are more serious than ever about getting into the P2P business, which will dramatically boost consumer usage. Send and Receive Money from the clearXchange joint venture of Wells Fargo, Bank of America® and JPMorgan Chase allows customers of consortium banks to send and receive money to each other without exchanging account or other banking information after they’ve initially cleared a security process during registration. This will improve ease of use among consumers who bank with those financial institutions. Other players that will change the landscape include mobile players such as telecom consortium Isis, solutions that allow payees to accept card payments such as Square, social media and virtual currency companies such as Facebook and Zynga, and perhaps even niche apps such as Bump Pay, which enables two smartphones to transfer data including how much money someone wants to send to someone’s PayPal account by “bumping” mobile devices together. Evolution of the P2P Landscape: Integration and Interoperability To date, the user experience for P2P has been suboptimal because P2P offers are generally Figure 2: The effect of the network accelerates usage and stand-alone solutions and not significantly registry value integrated into other types of online payments. They also lack network leverage and interoperability among networks. My belief is Financial Institution A Financial Institution C that the only way P2P will migrate from paper to Sender Sender electronic payments among the mass market is through interoperable networks among the big Recipient Recipient P2P players. FIS has addressed the issue of integration of P2P P2P with other types of online payments by creating Consumer an FIS money movement portal. This portal will Registry Financial Institution B Financial Institution D include the option to pay people electronically. Sender Sender The P2P build-out is in progress for delivery later this year. Our bills and payments offer will include options to pay bills, make expedited payments, Recipient Recipient pay people, transfer money to another financial institution and move money internationally. And, it will be FI-branded. FIS also is building its own registry of senders and receivers among various financial institutions. The central point of P2P is what we call the registry that holds receiver and sender preferences in a secure environment (Figure 2). The sender at one financial institution is able to transfer money easily and securely to a recipient at another financial institution that is part of the network. As the registry grows the number of member financial institutions, it becomes more interoperable and the registry value increases. FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 7
8.
A key part
of FIS’ strategy is to achieve Figure 3: Interoperability among networks creates a P2P Super Network interoperability with the other networks including clearXchange and others that could evolve, thereby creating a P2P super network (Figure 3). FIS’ commitment is to maintain an open network that will allow for maximizing connectivity with other networks. This will allow Wells Chase the majority of banked customers to easily and National ClearXchange securely send and receive money to each other FIS Banks Network Network B of A through their own financial institutions. Credit Regional Unions P2P Super Déjà vu Banks Network (prospec ve Network par cipants The non-FIs have invaded the P2P space in a Credit National Banks Unions illustrated) similar way we observed during the 1990s with the entry of Microsoft® and Yahoo® into online Other Networks Regional banking. But financial institutions prevailed Banks long term. Fast forward to the current crowded field of P2P players. PayPal is a threat because the company understands transactions and fraud and has the infrastructure in place to serve the mass market – and it’s clearly in the process of significantly expanding its payments services beyond the core P2P payment offering that was launched in 1998. PayPal is good at identifying gaps between old models and current consumer needs and filling those gaps. Right now the majority of its funds flow through checking accounts (ACH) and credit cards and PayPal could be considered “co-opetition” as opposed to competition. Although my belief is that financial institutions will again succeed against the plethora of E-commerce competitors, we need to pay attention to all of them. We need to learn from them and figure out how to leverage our assets aggressively to fill gaps in the customer experience. We need to reassess models that may not be optimizing opportunities in today’s “new normal.” In closing, I’ll leave you with these thoughts as your institution launches (or continues) its P2P payments journey. Leverage your institution’s strengths and credibility for safety and soundness. This is one instance when being a regulated institution is a good thing because of the clear and visible consumer protections that result. Consumers get it and most of them prefer to initiate and receive payments through their banking provider. Make sure your institution controls the offer’s branding and that the P2P network you join is fully interoperable. In addition, your P2P offering must be tightly integrated with your online and mobile banking offerings and you’ll need to provide customers multiple send and receive options (e.g., ACH, card, check, PayPal account). And finally, be willing to innovate and experiment; get practical experience. The next 12 – 24 months promise to be a breakthrough period for P2P payment pilots and rollouts by financial institutions. Consumer awareness and interest is going to spike dramatically and institutions that get involved now will be the ones that realize the greatest customer adoption and utilization. 1 Aite Group Survey of 1,036 U.S. Consumers, August 2011 2 Nielsen, “America’s New Mobile Majority: a Look at Smartphone Owners in the U.S.” March 2012 3 American Banker, “Wells, B of A and JPM Look to Shake Up P-to-P Payments.” 25 May 2012 FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 8
9.
Financial Profiles of
High-performing Community Banks By Paul McAdam SENIOR VICE PRESIDENT, RESEARCH AND THOUGHT LEADERSHIP In my recent articles I’ve explored various facets of community bank performance, mainly based on the characteristics of their customer bases. This month’s article profiles high- performing community banking organizations and specifically examines the financial metrics that differentiate the elite performers from the rest of the pack. Industry Profitability Rebounding, but Not as Much for Smaller Banks After a couple of very tough years, banking industry profitability rebounded nicely in 2010 and 2011 (see Figure 1). The positive upward trend continued in 2012 as the FDIC recently announced that first quarter commercial bank profits topped $35 billion. If this momentum holds, the industry will generate full-year 2012 profits of approximately $140 billion – nearly on par with record industry profits attained in 2006. But a thorough examination of this industry Figure 1: Industry profitability is rebounding, but still under pressure data reveals that a swelling portion of post- recession profits have been generated by the largest U.S. banks. Pre-recession, the U.S. Commercial Bank Profitability top 10 banks generated an increasing share (share of industry profit from top-10 and all other banks) $160 of industry profits, peaking at 53 percent in $140 2007. What you don’t see in this chart is that in 2008 and 2009 the top 10 banks remained $120 50% profitable as a group – albeit barely – while $100 55% 37% All banks the banks below the top 10 collectively 56% $ Billions $80 47% 2008 – 2009 lost money. As the economy improved, the 30% Non top-10 $60 banks share of industry profits generated by the Top-10 banks top 10 accelerated to 70 percent in 2010 $40 50% 63% 44% 45% 53% 70% and moderated to 63 percent in 2011. $20 Conversely, from 2004 − 2007, banks with $- assets of less than $1 billion generated 11 $(20) percent of industry profits on average. In 2004 2005 2006 2007 2008 2009 2010 2011 2011 they generated only 6 percent. Source: FIS analysis of data from FDIC Statistics on Depository Institutions (SDI) FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 9
10.
While the profitability
of community banks Figure 2: Community bank profitability rebound lags larger banks; the (assets of less than $1 billion) as a whole certainly efficiency ratio gap has widened improved post-recession, their average return on assets (ROA) has not rebounded as significantly Return on Assets Efficiency Ratio (by asset size) (by asset size) as that of larger banks with assets exceeding $1 80% billion (Figure 2). In contrast, the average ROA of 1.50% community banks fell just short of larger banks’ 1.25% 70% average ROA pre-recession and slightly exceeded 1.00% it during the downturn from 2007 – 2009. So, 60% industry profit dynamics have clearly shifted. The 0.75% question is whether the shift will be permanent. 0.50% 50% We see a similar pattern for efficiency ratios. The 0.25% gap between community and larger banks was 0.00% 40% fairly constant through 2007 at 7 − 9 percentage 2004 2005 2006 2007 2008 2009 2010 2011 2004 2005 2006 2007 2008 2009 2010 2011 - 0.25% points (Figure 2). The efficiency ratio gap widened Under $1B during the recession to 20 percentage points in Over $1B 2009 as the revenue-generating efficiency ratio Source: FIS analysis of data from FDIC Statistics on Depository Institutions (SDI) of community banks declined while that of the larger banks actually improved for a couple years. Post-recession, the efficiency ratio gap between Figure 3: Some community banks have performed exceptionally well; community and large banks remains wider than it yield on loans is a key driver was pre-recession. Return on Assets Yield on Loans (banks with assets less than $1 billion) (banks with assets less than $1 billion) High-performance Community Banks 2.5% 9% While the financial rebound of the community 2.0% bank market has lagged, it is absolutely possible for smaller banks to outperform the market as 1.5% 8% shown through extensive analysis of an FIS™ 1.0% database derived from eight years of bank Call 7% 0.5% Report data compiled by SNL Financial. The FIS database includes 4,380 banks with assets of less 0.0% 2004 2005 2006 2007 2008 2009 2010 2011 than $1 billion. We divided community banks into 6% -0.5% three tiers of performance – high, mid and low High Performing performing – based on ROA. The high performers -1.0% Mid Performing comprise the top 10 percent of community banks 5% -1.5% Low Performing 2004 2005 2006 2007 2008 2009 2010 2011 based on ROA, the mid performers represent Source: FIS analysis of bank Call Report data from SNL Financial. Banks with assets less than the middle 80 percent, and the low performers $1 billion. n = 4,380 represent the bottom 10 percent. On average, the high performers have consistently achieved an ROA above 2 percent. The mid performers’ average has been in the 1 percent range. The low performers were generating a sub-standard average ROA before the recession, which has been in negative territory since 2008 (Figure 3). FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 10
11.
Our analysis examined
statistical relationships between roughly two dozen bank financial metrics and ROA during the eight-year period to determine the metrics that are most strongly associated with ROA and did the best job of differentiating high from low performers. Of no surprise, metrics associated with credit quality were most predictive of bank performance. Credit quality can make or break a bank – particularly in the economic environment of the past few years. But beyond credit quality we uncovered several additional metrics that deserve special attention. Yield on loans is a key differentiator of performance among the three bank segments (Figure 3). On average, all community banks’ loan yields plummeted during the recession, but high performers did a better job of managing their loan portfolios. Analysis revealed several key actions taken by the high performers to preserve loan yield. • They consistently maintained higher loan pricing. • They had more-diversified loan portfolios. Higher performers tended to have fewer commercial real estate and construction and land development loans. However, they had consistently higher concentrations in traditional commercial and industrial loans, farm real estate and farm productions loans, and consumer loans. And the high performers were not over weighted in residential real estate. • High performers were more effective in shifting and rebalancing their loan portfolios as the recession hit – for example shifting out of commercial real estate and into agricultural. Because of higher loan yields, the high-performing community banks were able to maintain net interest margins 50 − 100 basis points higher than lower-performing community bank peers (Figure 4). How community banks managed their deposit portfolios was also a key differentiator between Figure 4: The higher performers have maintained strong margins while high performers and others. As the recession hit, effectively managing operating expenses high performers more quickly shifted their mix of Net Interest Margin Operating Expense Ratio deposits into core deposits and DDA balances. (banks with assets less than $1 billion) (banks with assets less than $1 billion) This effective management of deposit interest 5.0% 4.0% expense helped them maintain an impressive NIM in the face of declining loan yields. As you can see in the Operating Expense Ratio 4.5% 3.5% chart (operating expenses divided by average earning assets) on the right side of Figure 4, high performers did a much better job countering 3.0% 4.0% the downward trend in net interest margin and High Performing fee income by managing operating expenses. Mid Performing As the recession took hold in 2008, they did Low Performing an exemplary job of moving quickly to keep 3.5% 2.5% 2004 2005 2006 2007 2008 2009 2010 2011 2004 2005 2006 2007 2008 2009 2010 2011 expenses under control. In contrast, the operating Source: FIS analysis of bank Call Report data from SNL Financial. Banks with assets less than expense ratios of the low performers climbed as $1 billion. n = 4,380 the economy declined. FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 11
12.
Figure 5 profiles
the 2011 operating expense Figure 5: High-performing banks realized better operating expense ratios of the three bank segments. Again, we ratios across the board see that the high performers surpassed their peers across the board in managing expenses. 2011 Operating Expense Ratios (banks with assets less than $1 billion) While the differences in the salary and benefits and occupancy and fixed assets expenses of the 3.83% three segments seem modest at first glance, basis 3.22% points matter significantly in banking. The typical 2.91% 1.47% Other Operating Expenses community bank in our analysis had earning 1.08% 0.94% Occupancy and Fixed Assets assets of approximately $200 million. At this asset 0.48% Salary and Benefits 0.40% level the 16 basis point difference between the 0.34% high- and mid-performing banks in salary and benefits and occupancy and fixed assets amounts 1.63% 1.73% 1.85% to a $320,000 expense advantage for the high- performing banks. High Mid Low Performing Performing Performing The category of “Other Operating Expenses” is where high-performing banks gained their clearest Source: FIS analysis of bank Call Report data from SNL Financial. Banks with assets less than advantage. This category includes items such as $1 billion. n = 4,380 data processing, telecommunications, marketing and consulting and advisory expenses – and the high-performing banks excelled in managing all of them. But expenses associated with loan collections and real estate owned account for the biggest difference between the segments in this “Other” category. High-performing banks maintained significantly lower loan delinquencies and charge offs and gained additional operating expense advantages as a result. What’s becomes clear in examining a variety of metrics that separate high performers from their peers is that high- performing banks managed the bank for growth and did not simply try to save their way to prosperity. From 2004 − 2011, the high-performing banks experienced an average annual increase in operating expenses of 3.9 percent while operating expense of the mid-performing banks grew by an average of 3.1 percent. A Culture of Performance How did the high-performing community banks consistently accomplish these impressive results? Clearly these companies didn’t perform this well by accident because they performed well across all of the key financial metrics we analyzed. We can assume they have strong leadership and performance-based cultures. But the opportunity we’ve had to speak with executives from high-performing community banks within the FIS client base in recent months provides insights into key drivers of high performance. Such banks are very good at: • Focusing the entire organization on a highly visible and easy-to-understand strategy • Driving accountability throughout the organization • Simultaneously managing multiple challenges • Formulating timely reactions to changes in customers and competition • Introducing innovation in response to market demand • Managing operations that are flexible and able to respond to change quickly • Maintaining high levels of quality control with less variability in processes They leveraged these skill sets to overcome persistent challenges facing community banking organizations during the past several years. We can all learn from these institutions. We’ll continue to explore themes of differentiation and high-performance banking in future newsletter editions. If you have any thoughts or comments regarding bank performance that you’d like to share, you can feel free to contact me at paul.mcadam@fisglobal.com. FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 12
13.
PREPAID ONLY
VS. PREPAID AND GIFT CONSUMERS FIS research conducted in February 2012 with 3,205 consumers about their payment methods revealed two distinct segments based on payment method usage. The two segments − Prepaid Only and Prepaid and Gift users − are very different from each other demographically, attitudinally and behaviorally. Each segment will require specifically targeted appeals to gain ground against competitive payment methods. By Mandy Putnam DIRECTOR, RESEARCH AND THOUGHT LEADERSHIP FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 13
14.
PREPAID MARKET
The Prepaid market is divided into two segments − Prepaid Only users and Prepaid and Gift users: • Prepaid Only users did not use gift cards in the past 30 days while Prepaid and Gift users employed both payment types. Prepaid and Gift users outnumber Prepaid Only users by nearly 2-1 but Prepaid Only users utilize pre- paid cards nearly twice as much (5.0 transactions in past 30 days) as Prepaid and Gift users (2.9 trans- actions in past 30 days). As a result, the usage volume − transactions times number of users − is roughly equivalent for both segments. This calculation does not take into account transaction amounts, but does underscore the significance of both segments. Prepaid Card Usage (Past 30 days) Prepaid Only Both Gift and 4% Prepaid Card Usage Prepaid (Number of times) 8%* 5.0** Neither Gift Gift only nor Prepaid 25% 63% 2.9 Prepaid Prepaid and Gift * Read as: 8% of the sample used both gift and prepaid cards in the past 30 days; n = 3,205 ** Read as: on average Prepaid Only users used a prepaid card 5.0 times in the past 30 days FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 14
15.
CONSUMERS WHO USED
PREPAID CARDS BUT NOT GIFT CARDS WITHIN THE PAST 30 DAYS ARE DISTINCT FROM CONSUMERS WHO USED BOTH PREPAID AND GIFT CARDS: • Prepaid Only users are twice • The majority of Prepaid and Gift • In sharp contrast, Prepaid as likely to be unbanked and users are members of Gen Y Only users are poorer, less underbanked (no deposits or or Gen X, homeowners and educated and less likely to investment accounts other than employed fulltime. More than be employed fulltime. checking) than Prepaid and four in 10 have kids at home and Gift users. college degrees. Nearly four in 10 have annual household incomes exceeding $30,000. Prepaid Only Prepaid and Gift Unbanked 23% Unbanked 10% Underbanked 16% Underbanked 8% Gen Y 21% Gen Y 28% Gen X 23% Gen X 28% Younger Boomers 26% Younger Boomers 21% Older Boomers 20% Older Boomers 14% Matures 10% Matures 9% Income <$30k 47% Income <$30k 21% Homeowner 50% Homeowner 67% Children 33% Children 41% College grad 33% College grad 44% Employed fulltime 47% Employed fulltime 61% FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 15
16.
LACK OF ACCESS
VS. EXCESS CONSUMERS WHO USED PREPAID CARDS BUT NOT GIFT CARDS WITHIN THE PAST 30 DAYS HAVE LESS ACCESS TO NON-CASH PAYMENT METHODS THAN THOSE WHO USED PREPAID AND GIFT CARDS: • Prepaid Only users are one-third (34 percent) less • More likely to be unbanked, Prepaid Only users likely to use credit cards and 12 percent less likely are far less likely to use paper checks to pay. to use debit cards than Prepaid and Gift users for in-person purchases. Payment Methods Used for In-person Purchases (Past 30 days) Prepaid Only Prepaid and Gift Cash 91% Cash 95% Debit cards 65% Debit cards 73% Credit cards 45% Credit cards 67% Paper checks 37% Paper checks 64% Mobile payments 9% Mobile payments 18% Contactless payments 7% Contactless payments 15% FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 16
17.
USAGE OF ALTERNATIVE
FINANCIAL SERVICES DIFFERS SIGNIFICANTLY BETWEEN PREPAID ONLY AND PREPAID AND GIFT USERS IN ONLY ONE AREA: • Prepaid and Gift users show double the number of transactions as Prepaid Only users at BILL PAY walk-up bill paying services. $ Estimated Annual Usage of Alternative Financial Services (Average number of times past 30 days annualized) Prepaid Only Prepaid and Gift Walk-up bill Walk-up bill 4.3 8.8 paying service paying service Check cashing Check cashing 4.3 3.7 service service Wire transfer service 4.6 Wire transfer service 3.8 Walk-up short-term loan/ 1.7 Walk-up short-term loan/ 2.8 payday lending service payday lending service Internet short-term loan/ Internet short-term loan/ 1.2 2.0 payday lending service payday lending service FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 17
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SPENDING CONTROL
VS. SPENDING CONTROL + REWARDS BOTH PREPAID SEGMENTS PLACE A HIGH DEGREE OF IMPORTANCE ON PAYMENT METHODS THAT ALLOW FOR CONTROL OVER: • Timing of when funds are debited from their accounts • Their spending Prepaid and Gift users also express enthusiasm for payment methods, which provide loyalty points or rewards. Points or rewards tied to prepaid cards could migrate some gift card volume to prepaid cards. REW AR DS Very or Extremely Important (Top-2 box on 7-point scale) Prepaid Only Prepaid and Gift Allows control over Allows control over timing of when funds 62% timing of when funds 56% taken out of account taken out of account Helps me to not Helps me to not spend beyond my 60% spend beyond my 56% means means Provides loyalty Provides loyalty 35% 48% points/rewards points/rewards Allows me to pay for Allows me to pay for 37% 34% goods over time goods over time FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 18
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Strategic Insights is
a newsletter that provides research, thought leadership and strategic commentary on recent events in banking and payments. The newsletter is produced by the Global Marketing and Communications team at FIS. FIS is one of the world’s top-ranked technology providers to the banking industry. With more than 30,000 experts in 100 countries, FIS delivers the most comprehensive range of solutions for the broadest range of financial markets, all with a singular focus: helping you succeed. If you have questions or comments regarding Strategic Insights, please contact Paul McAdam, SVP, Research & Thought Leadership at 708.449.7743 or paul.mcadam@fisglobal.com. FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 19