Stepping Into the Breach: How to Build Profitable Middle Market Share

Transcription

46
The Future of Retail Banking
Stepping Into the Breach:
How to Build Profitable Middle
Market Share
The $50-billion U.S. middle market banking segment, comprised of companies with between $10 million and $500 million in annual revenues, is undergoing a dramatic competitive shift. The distressed condition of many
specialty finance and monoline lenders is clearing wide swathes of opportunity and tipping the balance of power toward commercial banks. Regional
banks have stumbled as well, creating opportunities in the broader commercial sector, while some megabanks have retrenched in certain geographies
and sectors. It is a great moment for gaining share in the market. Best-inclass lenders reap ROEs of 20 percent or higher. However, getting to best-inclass is not as simple as picking up where specialty lenders left off.
To step successfully into these profitable gaps in the middle market landscape, banks need to reinvent the business model and redefine best-in-class
execution. We see nine imperatives for banks seeking an edge in this market.
Build relationships
Banks pursuing profitable middle market share must follow a path we see as
critical across the entire banking spectrum. What we are calling relationship
banking has a basic premise: in order to attain sustainable, profitable growth,
expand relationships with your best customers.
To step successfully into profitable
This approach, while not new, is in stark contrast
to the expand-at-all-costs approach of the past
gaps in the middle market
several years. It is also particularly relevant for
landscape, banks need to reinvent
commercial banks with large national clients.
the business model and redefine
These larger clients – and even some more local
businesses – have needs that go beyond the
best-in-class execution.
lending products that are usually a bank’s entrée
into serving them. And while lending is critical to securing relationships in the
first place, it is not nearly as instrumental in driving profits as other products,
such as cash management services (Exhibit 1).
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To begin, banks need to make clear distinctions between how they serve
local middle market clients and large national corporate clients. A one-sizefits-all approach to relationship banking is not sustainable. Banks suffered
steep losses in the smaller middle market segment during the crisis, often
driven by an overreaching attempt to lend in geographies and industries
where they did not have sufficient experience or knowledge. For smaller
clients, best-in-class banks will return their focus to their home turf, looking
to build scale on a local level with in-footprint clients. Competitive advantage
in the smaller middle market segment will derive not from over-extension and
volume, but from targeted lending in areas banks know best.
For larger, national-scale clients, banks need to leverage lending interactions
into deeper and more lasting relationships based on products and services that
are both stickier and more profitable. (Although they are demanded more by
large corporate customers, some middle market businesses may also need
specialized finance products such as FX and interest rate derivatives.)
Redesign client coverage and account planning
Regardless of client size, an important foundation of relationship banking is
seamless coverage and rigorous account planning.
Exhibit 1
While credit is important to securing middle market relationships,
cash management drives economics
68 percent of middle market
relationships involve credit
Upper middle market
bank relationships1
Percent of total
Cash
management
only
But cash management
still drives profitability
Average revenue per mid-market client indexed
(100 = lending only)
3,000
32
800
1,000
100
Credit only
25
Credit & cash
management
43
2008
1
Lending
only
Percent
of lending
clients
30
Lending +
cash
manage
ment
(or other
corporate
banking
product)
50
Lending +
investment
banking
10
Lending +
cash
manage
ment
(or other CB
products) +
Investment
banking
10
Survey of 1,608 U.S. corporations with annual sales over $100 MM; of these, corporations with sales from $100 MM to $500 MM
considered upper middle market
Source: Phoenix-Hecht, 2008; McKinsey analysis
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There is great opportunity in targeting profitable industry sectors or verticals that are aligned with a bank’s existing capabilities and geographic
footprint. Banks should also consider which products are most profitable
and build capability to serve sectors that rely heavily on those products.
For example, cash management, that profitable standby, is in high demand
with professional services, retail, insurance, government and non-profit
clients (Exhibit 2). Cash-centric clients spend two times more than their
credit-intensive peers and also use more products (8 for cash-centric versus. 6.2 for other segments).
Understanding customer needs is also crucial for banks in designing relationship manager (RM) coverage. Our research has shown that larger and smaller
clients value different RM attributes. As an example, smaller clients place a
higher value on product knowledge, whereas larger clients tend to value industry and local market knowledge (Exhibit 3).
To capture the combined value of geographic footprint, product knowledge
and industry expertise, best-practice commercial banks support their re-
Exhibit 2
Industries with higher cash management use are more profitable
High
Cash
management
usage
Cash-centric
(20% of companies, 25% of profits)
Complex cash and credit needs
Retail
Attorneys
Consulting
Technology
Insurance
Some manufacturing
Healthcare
(provider/doctor
groups)
Hotels
Transportation
Wholesale trade
Publishing
International trade
Governmentt/public
sector (e.g., municipalities, school districts)
Financial intermediaries
Non-profit/membership
organizations
Restaurants
Healthcare
(hospitals)
Sophisticated opportunists
Large/public companies across industries
Large government/public sector entities
Agriculture
Mining
Transportation
Real estate
development
Low
Construction
Entertainment
(e.g., film finance)
Credit-centric
Low
Source: McKinsey analysis
Credit usage
High
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gional coverage with a meaningful degree of industry and product overlay.
They deploy front-line teams by geography and use industry sectors or
verticals to cover specialized sectors. Across regions, generalist RMs are
the primary customer contacts, working closely with product specialists
who provide targeted support. Industry verticals have dedicated expert
RMs and support teams.
Beyond coverage, it is very important to develop and institutionalize an
account planning process that prioritizes customers in each target group
and results in a holistic approach to customer-level profitability. A rigorous planning process starts with the selection of potential clients and
the scheduling of meetings. Next, a relationship manager should conduct a needs assessment for identified clients by each product and prepare action plans, finalized with a direct manager and product
specialists. With action plans complete, next steps should be defined
through activity plans that create a visible interface and a transparent
schedule for participants in the account plan. Finally, reporting mecha-
Exhibit 3
Large and small middle market customers value different areas
of expertise
Most important attributes of relationship manager
Percent of respondents by revenues
$2 – 5M
Knowledge of
credit needs
Other
8
35
8
4
29
22
9
$500M – 2B
25
16
23
7
5
17
22
17
$100 - 500M
35
17
24
Industry
knowledge
$25 - 100M
32
48
Product
specialist
Local
knowledge
$5 - 25M
29
33
5
Source: McKinsey Corporate Banking Survey, March 2009 (based on 400+ responses from McKinsey’s proprietary panel)
29
4
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nisms should be established to follow up on, track and review results of
action plans before closing.
Capitalize on disruption in the monoline space
Many players in sub-segments of the commercial space, such as monolines,
are experiencing severe disruption. Savvy financial institutions will step in
and take share by meeting pent-up credit demand. For example, at one
large regional bank, current cross-sell rates for lease products to middle
market and corporate banking customers were 3 to 7 percent, compared to
10 to 30 percent for a best-in-class institution. This leaves significant opportunity for deeper product penetration (Exhibit 4). In particular, the vendor
channel represents an attractive growth opportunity for well-capitalized
banks due to competitor dislocation and certain captive finance companies
scaling back their presence.
Enhance product offerings
To take full advantage of market opportunities, banks need to honestly assess
their product capabilities, identify gaps based on the needs of client segments, and develop competitive offerings.
For example, a bank could develop a standardized cash management product
for the low-end middle market or a suite of derivatives, FX and other specialized finance products for larger firms.
However, banks will need to go a step further and improve the functionality
and efficiency of delivery for the product suite, which could mean upgrading
systems, platform integration and reporting. The key drivers of customer satisfaction are access to systems, delivery of information, reliability of systems, effective issue-tracking and rapid resolution.
Revamp end-to-end underwriting and credit adjudication
Weaknesses in commercial lending and underwriting processes have contributed to both significant levels of customer dissatisfaction and unprecedented losses. This dissatisfaction can be addressed though the adoption of
two important principles:
• Functional excellence reduces excessive touch points, unclear accountability, over-stressed roles and sub-optimal spans of control by creating specialized roles for each component of the credit process (e.g., client service,
transaction management, credit and portfolio management).
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• Expert choreography improves process efficiency by eliminating wait
time, reducing unnecessary duplication of work due to lack of expert coordination; defining clear, differentiated “flight paths” based on deal
complexity (e.g., auto-decisioning for select customers); and creating
process champions.
Streamlining credit delivery can lead to a 30 to 50 percent increase in productivity. At one U.S. regional bank, an analysis revealed that almost 75 percent
of an 11-day approval process was spent on hold time. Reducing even a percentage of such delays, which are partially caused by approvers working on
higher-priority items, would speed delivery and leave clients more satisfied.
Reduce risk-weighted asset leakage
The current regulatory environment, in combination with limitations in balance
sheet capacity, make it more important than ever for banks to reduce capital
Exhibit 4
There is significant opportunity to grow lease cross-sell into existing
customer base
Representative bank cross-sell rates by division compared to competitor benchmarks
Representative bank
Division
Current cross-sell rates
of lease products into
banking customers
Factors impacting cross-sell
Percent
Small
business
15 30
Small businesses likely to have one
primary banking relationship
Highest propensity to lease (80%)
7
Middle
market
Relatively more difficult to penetrate
due to high volume of potential
customers
15 30
Smaller number of customers/RMs
make identifying customers for
cross sell easier
High propensity to lease (70 80%)
5
Best in class
Value potential
$15 million for each
additional percent
age point increase in
cross sell
$5 million for each
additional percent
cross sell
Relatively easy to cross sell if credit
relationship in place
Corporate
Most price sensitive
10 20
3
Source: McKinsey analysis
Large corporate customers have
multiple, diversified relationships, and
are most likely to lease with one of
their banks
$4 million for each
additional percent
cross sell
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wastage. Our experience shows that risk-weighted asset (RWA) optimization
can reduce leakage by 15 to 25 percent and increase revenues by 8 to 12
percent in the relevant books of business.
There are four major sources of capital wastage. The first are internal models that calculate capital requirements based on regulatory approaches that
do not maximize capital efficiency. Second are poor credit processes –
lacking state-of-the-art monitoring and workouts – that lead to higher regulatory risk parameters and capital requirements. The third source is problems in collateral management: lack of updated collateral values and errors
in timeliness and booking of credit lines and collateral. Finally, data quality
issues directly translate into higher capital requirements; for instance, regulators may impose additional capital requirements for low data quality.
These problems can be addressed with a capital-optimized business model
built around six actions:
Stemming the tsunami of commercial loan losses
Default trends in commercial loan portfolios typically lag consumer loans by 12 to 18 months and are emerging as the
next major casualty of the global credit crisis. Banks that are already reeling from a liquidity and capital crunch will
likely face high default volumes and major losses in their commercial portfolios through 2010. The signs pointing to
this tsunami of losses are clear. Delinquency and charge-off levels in commercial real estate (CRE) and commercial
and industrial loans (C&I) are four to eight times higher than historical averages; at some banks they are even worse.
The Federal Reserve’s stress tests in March and April 2009 projected losses over the next two years, under adverse
economic scenarios, at 10.6 percent of CRE outstanding and 5.8 percent of C&I. This translates to $600 billion for the
19 banks tested. Over the next four years, we expect combined losses in these two areas to be in the range of $500
billion to $1.2 trillion, depending on the severity of economic scenario.
Many institutions are unprepared to deal with this level of losses, having allowed their loss mitigation capabilities to atrophy. The situation calls for immediate action. Banks must redesign commercial loss mitigation structures and supporting mechanisms and use proven and effective best practices. Banks need to catch problems early instead of waiting for
them to trickle down. They need to assign their best people to workouts rather than reserving them for business growth
initiatives, and sharpen the accountability and transparency of loss mitigation efforts. Additionally, compensation philosophy should be based on well-defined targets, rather than vague or broad top-down targets. Finally, banks need effective reporting on both activities and outcomes so early interventions can succeed.
Best-in-class banks can reduce commercial loan losses by 10 to 15 percent by following through on three imperatives:
• Strengthen early-warning mechanisms. The key to successful loss mitigation is identifying and working on at-risk
loans early. Failure to do so ensures that many loans will be dead on arrival at the loss mitigation group. Early de-
• Establish clear rules regulating client acquisition to avoid exposure to
clients likely to be unprofitable, given operating and capital costs.
• Provide commercial guidelines and tools that direct the front line toward
highest RWA-return products and maximizing collateral without jeopardizing RWA return.
• Instill risk-adjusted pricing, e.g., through a regulatory capital-compliant
risk-adjusted pricing tool per client and transaction, and introduce a segment-specific pricing process.
• Offer clients solutions for improving their financial profile and thereby their
credit rating.
• Set up market placement enablers through product, system and organizational features to selectively leverage possible market placement opportunities (e.g., syndication, securitization).
tection triggers allow banks to quickly identify and prioritize high-risk loans, based on the external economic outlook
and metrics specific to the debtor. Banks should also identify high-risk portfolio areas and sectors and develop specific action plans for them.
• Install world-class workout and restructuring processes. To effectively manage large volumes, institutions must ensure
that their processes and procedures are scalable, structured and consistent. This requires clear decision rules to
quickly move high-priority loans from the business to the loss mitigation group. Workout groups need checklists for
file preparation and execution. Leaders must also ensure that different groups adopt the same practices and monitor
each group’s activities to identify outliers with low recovery rates or high average resolution times. And once these
groups are spotted, the root causes of these problems must be addressed; for example, leaders must understand
each group’s criteria for selecting workout strategies.
• Enhance organizational capacity, structure, reporting and capabilities. The average caseload per loan workout officer
has increased by a factor of three to five. Banks must increase their capacity and ensure that they distribute the workload equitably. To manage the complexity and severity of the loan losses, they can create groups that deal with different
sizes of loans and staff them with loan officers with the necessary skill sets (including skills from different sectors, e.g.,
CRE, structured finance and retail). These employees also need the right tools, so they can select strategies that maximize value, set priorities and monitor recoveries and costs. To improve performance management, banks should develop key performance indicators and link compensation incentives (and future employment) to value creation. Finally,
given the heightened demand for transparency – from internal and external stakeholders – banks should develop structured, consistent and action-oriented reporting dashboards on portfolio trends, efficiency and effectiveness.
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• Optimize product mix and design by using more capital-efficient
product types for both short- and long-term financing that deliver
similar value to clients (e.g., overdraft instead of short-term structured solutions).
Broaden and intensify portfolio management
In the wake of the financial crisis, management of risk in the loan portfolio
has taken on heightened importance. Banks must develop more rigorous
portfolio management processes to track aggregate exposures by company, sector, region and industry. They must instill processes in their risk
paradigm and scenario analysis to test implications on various events and
develop contingency plans to respond to different scenarios.
Further, banks must identify and monitor high-risk client segments and
accounts, based, for example, on the likelihood of events that could
impact the industry and cause the client to fall into delinquency, such
as production disruptions, demand fall-offs and supplier or key customer bankruptcies.
Furthermore, loan portfolio management should inform and drive proactive
actions. As an example, banks should identify single-product relationships
and work to either deepen the relationship or end it, if there are no signs of
cross-sell efforts succeeding.
Strengthen loss mitigation
Loss mitigation capabilities atrophied over the course of the last boom
cycle and must be transformed. Delinquencies and charge-offs have increased six to eight times in commercial real estate and commercial and
industrial loans, across segments, creating a drag on capital and earnings.
There are three areas where banks need to focus: early warning; workout
and restructuring processes, and organization/capability incentives and
tools. (See “Stemming the tsunami of commercial loan losses,” page 52.)
Unleash talent
Performance management in commercial banks needs improvement.
Much ink has been spent describing how incentives have led to behavior adverse to the interests of banks and their shareholders. A good
example is relationship managers who are incented to sell loans by volume, without consideration or accountability for the long-term profitability or health of the loan. A less egregious, but still important
example is that relationship managers are not incented strongly enough
for cross-selling.
Banks need a complete redesign of incentive plans across the enterprise:
for the front line, product specialists, loss mitigation and support functions.
Both quantitative and qualitative aspects need to be considered. Pay packages must account for profit, health and volume of products sold and overall client profitability.
***
There is clear opportunity for banks seeking a stronger foothold in the profitable middle market. Distressed and dislocated players are leaving a wide
open field, but simply stepping into the breach would be a mistake. Winners
in the space will be those institutions that reinvent their business model not
only to grab share, but to build sustainable, profitable relationships.
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About McKinsey & Company
McKinsey & Company is a management consulting firm that helps many of the
world’s leading corporations and organizations address their strategic challenges, from reorganizing for long-term growth to improving business performance and maximizing profitability. For more than 80 years, the firm’s primary
objective has been to serve as an organization’s most trusted external advisor
on critical issues facing senior management. With consultants in more than 40
countries around the globe, McKinsey advises clients on strategic, operational,
organizational and technological issues.
McKinsey’s Consumer & Small Business Banking Practice serves leading
North American banks on issues of strategy and growth, operations and technology, marketing and sales, organizational effectiveness, risk management
and corporate finance. Our partners and consultants provide expert perspectives on a range of topics including corporate strategy, business model redesign, product and market strategy, distribution and channel management,
the impact of financial services regulation and performance improvement.
The following McKinsey consultants and experts contributed to
this compendium:
Whit Alexander
Daina Graybosch
James McKay
Greg Phalin
Philip Bruno
Tommy Jacobs
Howard Moseson
Leonardo Rinaldi
Robert Byrne
Piotr Kaminski
Sudip Mukherjee
Pablo Simone
Liam Caffrey
Rami Karjian
Fritz Nauck
Vik Sohoni
Prasenjit
Chakravarti
Akshay Kapoor
Sandra Nudelman
Dorian Stone
Catharine Kelly
Marukel Nunez
Sarah Strauss
Nick Malik
Pradip Patiath
Ameesh Vakharia
Robert Mau
John Patience
Tim Welsh
David Chubak
Marco De Freitas
Benjamin Ellis
Contact
For more information, contact:
Nick Malik
Christopher Leech
Marukel Nunez
Director
Director
Principal
(212) 446-8530
(412) 804-2718
(212) 446-7632
nick malik@mckinsey.com
chris leech@mckinsey.com
marukel nunez@mckinsey.com
Financial Services Practice
November 2010
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Copyright © McKinsey & Company
www.mckinsey.com/clientservice/financial_services

Stepping Into the Breach: How to Build Profitable Middle Market Share

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