The global financial services industry was worth $10.7 trillion in market value in 2006, and generated area of growth (26%) well above that of non-financial corporates (22%) in 2006. Growth of financial services was even faster in emerging markets (43%). Or so says the Mercer Oliver Wyman “State of the Financial Services Industry 2007” report, launched at Davos last week.
For the sector as a whole, says Mercer Oliver Wyman, revenues grew 18%, average ROE increased from 16% to 19%, and the average P/E ratio increased slightly. Emerging markets firms contributed $688 billion (29%) out of the $2.2 trillion in market value growth. Emerging markets have accounted for 29% of market value growth over the past five years, and now represent 21% of the market value of the world’s publicly-quoted financial institutions. European financial services ended a five year slump, with the region’s valuation increasing 32% in 2006, but leading UK banks lie in the lowest quartile of medium-term global shareholder performance.
Mercer Oliver Wyman says that, over the past decade, a group of 54 “premier performers” has delivered shareholder returns 2.2 times the returns of rest of the market. The members of this group demonstrate that sustained out performance is achievable independent of a firm’s region or sector, says the consultancy.
At the individual firm level, the premier performers delivered annual shareholder returns 8% above the rest of the financial services sector over 10 years. These firms represent 17% of the market value of the 400 firms included in the report’s SPI.
Though concentrated in Europe (26 firms) and North America (18), and in retail and commercial banking, the premier performers include both mid caps and large caps in strongly and weakly performing regions and sectors. They share several attributes: 94% have businesses covering both retail and corporate/institutional clients, enabling growth throughout the business cycle. 90% generated most of their growth organically, although more than half have also accelerated their growth through in-market consolidation. More than two-thirds have successfully managed the risks of expansion into new geographic markets.
Super-large cap firms (market capitalization greater than US $50 billion) appear to have suffered from a size penalty over the last five years, especially in Europe, as investors awarded greater market value increases to mid and large cap companies. The gap in market value growth ranged from 9% to 15% between equivalent-performing super-large caps and large caps. In 2006, this gap began to narrow as larger companies gain efficiencies and access new growth opportunities.
Anglo Irish Bank and Syd bank of Denmark are the best-performing large-cap and mid-cap financial institutions over the last five years; United Health, RBC, and Wachovia were the best performers in the super large cap group in the same time period.
Financial services CEOs project continued growth in 2007 and expect less M&A activity – they also see challenges emerging due to slowing growth and high consumer debt in mature markets. Mercer Oliver Wyman says there has been a step change in the involvement of private equity in the sector and firms will need to “think like capital” as they consider their own expansion initiatives.
“Value growth is increasingly skewed to nimble companies, independent of their size, sector or region,” says John Drzik, President of Mercer Oliver Wyman. “These firms ‘think like capital’, constantly improving their operational execution and migrating their strategic positioning by placing smart bets in high-growth and high-margin markets.”
The report also contains Mercer Oliver Wyman’s annual CEO Growth Index, which identifies participants’ expectations for value growth along with key priorities and challenges for the coming year. While CEOs are generally optimistic about 2007, and collectively project continued market value growth of approximately 10%, they also expressed concerns about a number of trends – including slowing growth in mature markets and increasing costs, partly as a result of fierce competition for talent.
Organic growth in existing markets, especially among the retail and corporate segments, remains the top priority (94% of respondents), while Asia (excluding Japan) and Europe represent the most attractive non-domestic market opportunities. CEOs expect lower M&A activity in 2007 with the exception of cross-border transactions. Only one in four CEOs intend to engage in a major merger or acquisition, (down from one in three last year), and only 34% of CEOs cited smaller acquisitions as a priority (down from 60% last year). 70% of CEOs cited credit products as a key driver for revenue growth in 2007.
The report predicts a challenging outlook for many recent growth drivers, such as mortgage and home equity lending, consumer credit and structured finance, and highlights areas where well-positioned firms are seeking new sources of earnings growth in 2007, including: Increasing consumer “pain points” around retirement, education and health-care will drive product and service innovation focused on “decumulation” products for consumers and yield and risk management for investors; With net interest margins of 3-3.5% US banks will attract further interest from Western European acquirers flush with a strong Euro eager to improve upon a non-US domestic spread of 1.75-2%. This is particularly true for firms with existing North American operations; Strong economic growth in emerging markets will continue to attract investment as deregulation accelerates. Based on current trends, emerging markets companies will comprise more than 40% of total market value growth over the next five years. The SPI 400 now features 74 companies from 23 emerging markets, including eight Premier Performers. The report also identifies a step change in the traditionally limited involvement of private equity in financial services. Private equity firms have invested an estimated $70 billion in financial services since 2000, and the past two years have seen four times the level of investment activity of the previous five years combined. So, the pace of private equity investment is now roughly ten times what it was early in the decade.
A group of 15-20 of the largest private equity firms now has the requisite appetite, industry expertise and access to funding to make financial services a growing strategic focus, says Mercer Oliver Wyman. Private equity investment to date in financial services has focused on specialty providers, subprime lending, credit insurance and re-insurance. Though private equity-backed firms represent only a small portion of the overall market, we expect these firms will have a disproportionate impact on their chosen sectors. More generally, following record fundraising in 2006 the presence of an additional $2 trillion of uninvested private equity capital, assuming typical leverage rates of between three and seven times, will press firms to “think like capital” as they consider their own development.
European financial services ended a five year slump, with the region’s overall valuation increasing 32%, led by retail and commercial banks (SPI score 152), investment banks (SPI 123) and universal banks (SPI 54). This reflects likely renewed interest in cross-border consolidation, not least as Basel II releases additional excess capital.
European insurers (SPI -78) while improving, dragged down the region’s overall performance, with many leading insurers in the lowest decile of the SPI 400 index.
European retail and commercial banks took 20 places out of the top quartile of the SPI 400. This group included many mid cap banks, and came from a variety of countries including five Italian and four Spanish banks. Most leading UK banks were concentrated in the lower quartile of the SPI index. Strongly performing (top quartile) large cap companies in Europe in the SPI ranking include: Anglo Irish Bank (2nd), Sberbank (6th), and Erste Bank (24th).
Exchanges led the performance of specialty providers again in 2006, driven by the limited number of investment opportunities and consolidation pressures.
German performance remained weak, with all leading banks and insurers in the lower quartile.