Financial services industry market value falls for first time in five years as the sub-prime crisis and credit crunch bite. Organic expansion into new markets is the top priority for financial services CEOs.
Oliver Wyman’s 11th annual “State of the Financial Services Industry” report Market value of the financial services industry fell by 2% to $10.5 trillion in 2007, the first decline since 2002. Stripping out currency effects, the drop was 7.2 %, with even sharper declines in mature markets while emerging markets thrived.
Firms that had underperformed their peers in the past suffered disproportionate losses in market value as a result of the sub-prime crisis and subsequent events, according to Oliver Wyman’s Shareholder Performance Index. Within the top 20 best performing large cap firms in 2007 globally, those from the Asia-Pacific region (8) outnumbered those from North America (7). Within sectors, European retail and commercial banks, North American life insurers and exchanges in general dominated the lists of leading OECD large caps in 2007.
Real estate markets (outside of the US), Asian equities and global commodities are bubbles on the watch list for 2008. However, the risk perception among surveyed CEOs is not uniform. While 48% cited deteriorating market conditions as a key threat in 2008, 69% still expect to outperform the financial services industry as a whole.
According to the report, performance skews widened across sectors and regions. While shareholder losses of firms in mature markets totaled more than a trillion dollars, 50 firms achieved Premier Performer status, down from 54 the year before. Over the past decade, these firms have consistently delivered shareholder returns above the rest of the market. Spanning all financial services sectors, they are scattered throughout Europe (23), Asia-Pacific (12), North America (11) and few other countries (4), and include both mid-caps and large-caps. Becoming part of the elite in turbulent times will require three key attributes: execution excellence, controlled growth and strategic evolution.
The report links findings with key results of Wyman’s annual CEO Growth Survey which identifies participants’ expectations for value growth along with key priorities and challenges for the coming year. Still fairly ambitious about the outlook for growth in 2008, most CEOs are setting major expansion targets, attempting to reach them through organic growth and product and service innovation. Compared to 2007, smaller M&A transactions sit high on the CEO agenda for 2008, particularly for European insurers (89% of surveyed CEOs) and North American firms (67%). Nearly half of the CEOs of emerging market firms, however, are seeking major cross-border acquisitions or mergers.
Oliver Wyman predicts a stormy 2008, and warns that earnings and valuations will come under multiple pressures, which the industry is ignoring in its own growth estimates. Current market valuations suggest 52% of firms are not trusted to create sufficient value in 2008, with investors putting an average discount of 6% on capital retained for firms’ growth plans. This differs significantly by geography and sector trading at “low trust” valuations are 73% of universal banks and 66% of insurers, along with US and Japanese firms. Trading at “high trust” valuations are 78% of specialty providers and 65% of investment banks, along with firms in the rest of the world.
Cautioning that further losses from the sub-prime crisis totaling up to $300 billion have yet to unfold, the report flags up four additional major risks: corrections in European real estate markets, with UK and Spain among the most exposed countries. A major drop in Asian stock markets, especially in China where many shares are trading at P/E ratios above 50, and India where shares have soared by 600% over the past five years
A further decline of the US dollar, sparking further devaluations of investors’ holdings and new interventions by central banks that may slow down global growth.
“Recent events have exposed failings in certain areas of risk and liquidity management, as well as other excesses that require correction,” says Scott McDonald, head of Oliver Wyman, Financial Services. “In order to thrive in the current challenging environment, CEOs will need a much tighter grasp of potential exposures and contingency plans for any worsening in the markets.”
“Despite this, we still believe unlike some commentators that the established trends of modern finance will remain intact: ‘originate and sell’ and risk transfer models will recover and grow in new conditions, and the industry should emerge stronger and more dynamic after necessary adjustments in market standards, governance models and improved use of existing risk management frameworks,” he adds.
In the above context, the report highlights a number of new growth opportunities arising from cross-sector models and propositions that transcend traditional boundaries between insurance, retail and investment banking and asset management. Examples include comprehensive offerings for the growing retirement market and innovative business-to-business partnerships.
A growing impact is to be expected from new forces in the industry, including giants in emerging markets that become increasingly acquisitive in the Western economies, sovereign wealth funds that represent a highly concentrated source of capital, private capital seeking new investment opportunities, and players from selected industries expanding into the financial sector. Not directly affected by the current crisis, many of these are best positioned to benefit and will be at the forefront of innovation and change in 2008.